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Is Your Letter of Intent Legally Binding?

- Monday, December 08, 2014
Many complex business transactions, and 99% of M&A deals, will begin with the two parties entering into preliminary negotiations and drafting what is called a Letter of Intent (LOI).

Why draft an LOI? Letters of intent provide a basis of understanding between the two parties and allows them to come to an initial agreement of some of the major terms that will be incorporated into the final transaction documents. Among other things, LOI’s usually establish terms such as price, payment method, confidentiality, timeline, exclusive dealing, and certain representations and warranties of the two parties.

But the million-dollar question is: Is a letter of intent legally binding on the two parties?
The short answer is… it depends. (Don’t you hate when attorneys say that?)

Many courts take the position that LOI’s are generally not meant to be legally binding. The reason being is that while the document itself outlines the initial understanding of the two parties, the terms in the LOI are usually meant to be further negotiated and codified within the final transaction documents.

That being said, why would anyone want to use an LOI at all? Two reasons: 1) there are certain terms that courts will hold as legally binding; and 2) there are ways to make other terms legally binding by adding the right type of language.

1) Courts will hold certain terms as legally binding even if the document as a whole is not legally binding. This will usually include terms that control the tone and scope of negotiations. For instance, representations and warranties placed in an LOI will often been seen as legally binding. If one party makes certain representations about the financial documents it will produce or certain warranties about how it will operate during the period of negotiations (i.e. not sell off any of its assets), a court will uphold those terms.

Likewise, if the LOI stipulates that the two parties will negotiate exclusively with each other and not entertain or pursue other deals, the court will find that to be a binding term.

Another big one is confidentiality clauses. If a confidentiality agreement hasn’t already been signed, the parties will almost always include a statement of confidentiality in the LOI. This too will be seen as legally binding on both parties.

2) The truth of the matter is that contract law gives wide latitude to competent adults entering into any type of agreement as long as there is adequate consideration. This means that you can always add certain language to the LOI as a whole (not recommended) or to certain sections of the LOI to show that the two parties intended for that particular section to be legally binding.

For instance, you may not want the final purchase price to be legally binding but you may want a legally binding holdback provision stating that ‘x’ percent of the purchase price will be held in escrow for a period of time post-closing just in case something goes wrong.

If that is the case, just say so. Using language such as, “Both parties agree that this section is intended to be legally binding”, or something to that affect, will suffice in creating a basis for legal enforceability.

Letters of intent are instrumental in creating a general understanding of the major terms of a complex transaction. While it is not wise to make the entire letter legally binding, it is good strategy to pinpoint items that you know will not change, along with items that would protect you during the period of negotiations, and add language that will have a legally binding effect on both parties.

Jamal Jackson, JD/MBA is a corporate attorney licensed in the State of Illinois. He is the Managing Partner of Jackson Corporate Law Offices (www.JacksonCounsel.com), Co-Founder of Initiative Consulting Group, LLC (www.initiativecg.com) and a Public/Motivational Speaker engaging audiences in the topic areas of Business, Leadership, and Legacy (www.JamalEJackson.com).
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