by William B. Sing and Tamarah Feigl | Fulbright & Jaworski LLP
No one wants to waste time and money on a deal that the parties will never complete. A well-drafted, nonbinding letter of intent can be a valuable first step in determining whether there is a deal to be made before too much expense has been incurred.
What Is an LOI?
Term sheets, memoranda of understanding, and letters of intent are all documents that are preliminary to a final or definitive agreement. Unfortunately, these terms are often, and confusingly, used
interchangeably and there is no universal agreement on their definition or function. For purposes of this article, these terms will be defined as follows.
A term sheet is a list or short summary of a proposed agreement’s key terms that briefly outlines the general framework for the future negotiation of a definitive agreement. To avoid any ambiguity, term sheets should state that they are nonbinding, may be further negotiated, and may or may not result in a future agreement.
A letter of intent is a letter from one party to the other, countersigned by addressee. Unless it clearly states otherwise, it may constitute a binding agreement despite its informal appearance.
A memorandum of understanding is an agreement that is longer and more formal than an LOI or term sheet. An MOU may set forth all key terms of an agreement between parties and may constitute a binding agreement as to the terms contained in it. In such a case, the MOU may be the final and definitive agreement. In other cases, the MOU may specify certain nonbinding or binding provisions and state that it is intended to be the framework for further negotiation of a definitive agreement.
Both MOUs and LOIs may be viewed as detailed term sheets, and all three formats serve the same purpose: to outline the key terms of an existing or proposed agreement. Use of an MOU implies that the parties have reached an understanding and that the document is intended to be binding. Use of an LOI implies that, while the parties may intend to reach agreement in the future, they have not done so yet.
Despite any implication of the document’s title, every MOU and LOI should expressly provide whether and to what extent the parties intend it to be binding. If your document doesn’t do that, then you are asking for trouble.
Why an LOI?
LOIs can save both time and money in connection with complex transactions where the documentation will be extensive. Reaching agreement on all key terms to the proposed transaction before generating massive amounts of paperwork is a wise and worthwhile step. The LOI can bring to the surface major issues that must be dealt with, and if there is an insurmountable obstacle, it is better to discover it sooner than later.
Provided with a good standardized form of LOI, non-lawyer negotiators may prudently reach agreement on the business and economic aspects even when the transaction has legal ramifications. So long as the LOI is clearly nonbinding, legal review may wait until preparation of the final documents.
There are exceptions, of course. In transactions involving significant tax or regulatory matters, or in any case where litigation is pending or threatened, the key negotiators may want to have their lawyers present from the inception. On the other hand, the LOI is a waste of time if the transaction is routine and simple, especially if one party can dictate the terms.
Each LOI varies with the particular transaction, but the following terms are common to most of them.
• Correctly identify the parties and provide their contact information.
• Set out key terms already agreed to and any provisions still to be negotiated.
• Specify a time frame. If the parties are unable to achieve a definitive agreement by the LOI’s expiration date, one party should confirm by written notice to the other that negotiations have ceased and that the LOI has expired.
• Expressly state that the LOI is nonbinding and that neither party has any obligation to enter into any agreement not completely satisfactory to it. If there are exceptions to the nonbinding nature of the LOI, it should carefully identify those provisions, such as confidentiality clauses, exclusivity provisions, and parties bear their own expenses. In addition, the LOI should provide that any binding provisions will survive termination.
• Include that it will be superseded by the signed definitive agreement.
The proper use of carefully considered LOIs in appropriate transactions will reduce your risk of failure, increase your likelihood of success, and save time and money.
William B. Sing and Tamarah Feigl are real estate transactional lawyers in the Houston office of Fulbright & Jaworski LLP. Contact them at email@example.com and firstname.lastname@example.org.