Purchase and Sale: Letter of Intent

By David Tevlin

In a highly uncertain real estate market, buyers and sellers should consider the advantages of a preliminary written agreement known as a letter of intent (LOI). The LOI has two purposes: (1) to identify all relevant economic and business terms of the proposed transaction and (2) provide a basic outline of the anticipated transaction.

The most important issue to be addressed at the outset is whether the parties intend the LOI to be legally binding or legally nonbinding and/or binding in certain respects but not in others. It is not enough for the parties themselves to be clear about the nature of the LOI; the language in the LOI must also clearly indicate the intent of the parties since, in the event of litigation, a court will look to the language of the document to determine the parties' intention.

Purposes of an LOI

If the LOI is not intended to be binding in any way, why enter into one? Three reasons are as follows:

1. To determine if each party is seriously interested in consummating a transaction, thus minimizing legal and other expenses in fruitless negotiations.
2. If the transaction is to be financed by an issue of securities, the underwriting firm may require an LOI as a "comfort document" to justify the time and expense of a "due diligence" investigation.
3. In a negotiation that may take many months, an LOI may prevent misunderstandings by identifying the intentions of the parties at the inception of the negotiations.

In order to encourage serious negotiations, an LOI may emphasize the parties' obligation to negotiate in good faith, even when the LOI is not legally binding. A 1999 decision by a Delaware Court awarded $30 million in damages to a disappointed buyer after the seller sold to another buyer despite continuing negotiations pursuant to an LOI.

Scope of LOI

An LOI that is intended to be nonbinding often is prepared by a principal of one of the parties or by a real estate broker without consulting legal counsel. This may not be a good idea since, as already noted, a court interpreting the LOI will look to the language of the document rather than the oral testimony of the parties as to their true intent. An LOI should contain most or all of the contingencies and conditions intended to be in the final contract. Such contingencies include inspections of the property, review of leases and other relevant documents, environmental audits, feasibility studies and approval by the board of directors or governing body of a party.

Warranties and Representations

At the very least, an LOI should specify that each party's obligations in the final agreement will be conditioned upon receiving the usual and customary representations and warranties, such as no pending litigation and no notice of condemnation or other governmental action that would frustrate the purpose of the transaction.

Confidentiality

One or both parties may wish the LOI to remain confidential, even though a final agreement will not be. A seller may not wish to have it known that a property is available for sale, while the buyer may not wish to stimulate any competitive interest.

Exclusivity

A buyer may wish an LOI to state that the buyer has an exclusive right to negotiate for a specified period, during which time the seller will not negotiate with other parties. Such a provision is an express statement of an implied obligation to negotiate in good faith, as stated above.

Expiration Date

Whether an LOI is binding or not, a prudent practice is to set a deadline for an agreement to be reached. If the parties are still negotiating at that time, an extension can easily be agreed to, whereas each party may wish to be in a position to terminate the negotiations.

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