Letter of Intent

What Are Your Intentions

The sale of commercial real estate or a business is a complex transaction. In addition to the price, many other terms and conditions come into play. Before launching into a formal and detailed contract, therefore, most buyers and sellers sign a letter of intent (LOI) to set forth the basic framework of the transaction. Though they seem to be simple, non-controversial expressions of essential terms, LOIs can actually be quite complicated. Including an ill-considered term can lead to problems when the time comes for a more formal contract. Before signing an LOI, therefore, parties should make certain that their “intentions are good,” i.e., that they have thoughtfully selected a deal structure and terms appropriate to their objectives.

LOIs present several potential legal issues.

• Is an LOI binding? It depends. A written document signed by two parties generally constitutes an enforceable contract. Unless an LOI says otherwise, therefore, it would bind the parties. Thus, if a party leaves essential terms out of the LOI, they would not be part of the deal. For this reason, LOIs often specify that they are not binding or that only certain provisions are binding. For example, parties often agree to binding provisions that require the parties to keep the negotiations confidential and to deal exclusively with one another for a certain period of time. Exclusivity provisions often seem minor, because the parties do want to have a successful transaction, but they can make it hard for a disappointed seller to exit negotiations and move on to another prospect. Provisions dealing with financial terms, closing dates, and due diligence periods are typically not binding. 
• Does an LOI set the deal structure? It should! On many occasions we have seen LOIs fail to address the most basic structural terms. Often, parties are not aware of the different ways they can structure a transaction. For the sale of a business, LOIs often fail to mention whether the owner’s company is selling all its assets or whether the owner is selling the company outright. The difference can have major tax and liability ramifications.
• Does an LOI contain all terms of the deal? No. An LOI usually covers only the most important provisions. Of course, what is important to a seller may not be important to a buyer, and vice versa, so LOIs often reflect an accretion of terms as the parties negotiate according to their priorities. Because an LOI usually consists of only a few pages, many terms and conditions are left out, to be discussed in detail when the parties begin to negotiate a final contract.
• What should an LOI leave out? Good question! This is an important judgment call. One objective of an LOI is to avoid surprises. So, here is an example. Let’s assume an owner is selling her business to a company and will accept a promissory note from the company for a portion of the purchase price. Of course, the LOI should specify the amount, duration, and interest rate. But clauses in the note concerning grace periods, default, and litigation venue can probably await the formal contract. And, if she expects the principal of the company to personally guarantee his company’s obligation, she should probably say so in the LOI. After all, the principal presumably formed his company to minimize personal liability. If the seller wants him to become liable for his company’s debt to her, she should address that request at the outset.
• Should a seller provide financial information to a buyer upon signing an LOI? Not immediately. A buyer should always have a non-disclosure agreement in place before providing any confidential information. And, the seller should have an accountant review all financial statements, and a lawyer review all company documents, before a buyer sees them.
• Should a party just sign an LOI provided by the other side and wait for the contract stage to discuss terms in earnest? NO! It is important to have legal, financial, and tax advice before signing any LOI. This is because parties usually need help in determining what terms should be included in the LOI and whether each should be binding or not. And, even if some terms are not technically binding, a party cannot easily walk them back later. An LOI carries not only direct legal ramifications but also moral commitments that can foster---or undermine---trust at an early stage.

A letter of intent is a deceptively simple document that can be a dangerous trap for the unwary. We urge all clients involved in the sale of a business or commercial real estate to seek legal, tax, and financial advice before entering any letter of intent. For assistance, please call a member of our Transactions team at 203-744-1929. With our help, you can be confident that your intentions will be thoughtfully and carefully set forth!