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Be Careful with Letters of Intent

Originally published: 07.01.06 by Mike Coyne

If you become involved in buying or selling a business, or if you are negotiating participation in a large project, you might be presented with, or may want to prepare, a letter of intent. Simply put, a "letter of intent" is a document that describes business terms that parties intend to include in a formal written agreement.

In an article published several years ago, an attorney described the letter of intent as a gentleman's agreement. In warning of the dangers of such agreements, he quoted a British Justice who wrote, "A gentleman's agreement is an agreement which is not an agreement, made between two persons neither of whom is a gentleman, where by each expects the other to be strictly bound without himself being bound at all."

Letters of intent are serious matters, and in some circumstances, a party may be bound by such a nonbinding agreement.

Why Letters of Intent May Be Binding

Many letters of intent are similar to a preliminary agreement. They describe the general terms which parties have agreed to, and frequently describe those issues which remain open. Quite frequently, letters of intent will state bluntly that the letter of intent is nonbinding. You might think that use of

the term"nonbinding" would be the end of the story.

Generally, judges will rule that the word "nonbinding" means just what it says--the parties merely entered into an unenforceable agreement to agree. In one case, a judge ruled that a letter of intent was unenforceable because the letter referred to the possibility that negotiations might fail, and that the parties hoped to sign a future binding agreement. However, there are ways that you can get stuck by a nonbinding letter of intent.

First, if you sign a letter of intent, you have an obligation to bargain in good faith. This means that you may not be able to walk away from the deal, abandon negotiations, or insist on conditions that do not conform to the letter of intent.

Courts have also bound parties to a nonbinding letter of intent under the doctrine of promissory estoppel. Under the doctrine of promissory estoppel, a party can beheld liable for damages if the letter of intent causes the other party to lose out on other opportunities. Under this theory, some parties have recovered various costs incurred in reliance of the letter of intent, such as the cost of architectural drawings, preliminary construction costs, and the like.

Some Practical Advice

Given the legal risks associated with letters of intent, our first advice is always to approach such a letter as if it may become a binding agreement. If you do not intend to be bound, say so – say that the agreement is "nonbinding." If you know there are things which might cause negotiations to fail, talk about them in the letter. If you don't want the party to rely on the letter, say so. Or, if you only intend the letter to be binding in a limited way, describe how it is to be binding. List in the letter all of the things that you still have to agree upon. Require that the letter be confidential so that third parties cannnot rely on it. Reserve the right to discontinue negotiations for whatever reason, so that you won't be required to negotiate in good faith. However, if you do break off negotiations, attempt to document that you did so in good faith.

In summary, treat the nonbinding letter of intent as a serious matter. Give it as much attention and care as you would a binding agreement.

Michael P. Coyne is a founding partner of the law firm, Waldheger Coyne, located in Cleveland, Ohio. Mike's practice focuses on business and tax planning for closely-held businesses and professional practices, as well providing legal counsel on qualified retirement planning, mergers and restructuring. For more informationon the firm, visit www.healthlaw.com,or call 440-835-0600.

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