Letters of Intent – Good or Bad? Jun 28, 2013

Before considering that question, it will be useful to examine just what a letter of intent is in a commercial context.

While there can be differences of opinion as to their use and format, many consider a letter of Intent to be a statement of the status of negotiations between parties at a point in time. It sets out the understandings of the parties to a proposed agreement, often (although not limited to) the purchase and sale of a business. The LOI helps to clarify what has been discussed and would form part of a definitive contract if negotiations proceed to conclusion.

In the view of many lawyers and commentators, a LOI should not be a binding agreement, since discussions are usually not sufficiently mature to warrant that status.

So, with that understanding in place, should they be considered good or bad, helpful or problematic?

In the view of the writer, a properly prepared LOI serves an important and useful purpose. It can help the parties focus on the issues on which they may be in accord, thereby also identifying those where further negotiation is required. The attempt to craft the LOI will clarify mutual understandings before extensive discussions, with the attendant time commitment, are undertaken, and before thorough due diligence has been committed.

Further, the LOI contributes to the negotiating process by creating a feeling of progress between the parties, enhancing the mutual commitment. And, on occasion, the LOI can be useful in discussions or dealings with arms’ length parties who may play a part in, or have some involvement in the deal, such as financers or agencies whose consent or permission may be required to complete the transaction.

And if all that is true, what can be the problems in using a LOI?

The effort to craft the LOI can take attention off the remaining discussions which would otherwise lead to the definitive agreement. However, in my view, this is a minor concern, and often plays no part at all. The true risk associated with the use of a LOI is in not drafting it properly. I subscribe to the theory that the LOI should be non-binding (except commitments to confidentiality and similar concerns), and so extreme care must be taken to ensure the risk of enforceability is avoided. If the LOI includes binding language, it can create legal obligations on either or both parties, and since the LOI is invariably much shorter than the ultimate agreement, it inevitably omits many issues that should be thoroughly addressed in the agreement, and is often sketchy on the issues it does address, the risk of confusion and lack of detail is unavoidable.

That risk is avoided by ensuring that terms creating legal obligations are avoided – words such as “agree” and “agreement”, “will” and “shall”. Instead the LOI should say a party “would” do certain things, and clearly state that it sets out “our mutual understanding of our discussions to date”, which “are subject to further negotiation and the settlement and execution of a definitive agreement”.

On balance, I believe a Letter of Intent can be an important component of a commercial transaction when used properly. But I always recommend the involvement of a legal professional accustomed to working in the commercial field to ensure it is used properly.