Letters of Intent (LOIs) can be enforced in both real estate and business transactions. This is a surprising fact for most professionals since many of these types of documents have non-binding provisions. Despite that, signed LOIs can in fact be binding in certain situations and sellers especially should take caution before signing those contracts.
What is a Letter of Intent?
A letter of intent (LOI) declares one party’s intention to do business with the other. The purpose of an LOI is to:
- Communicate what each party wants from the other in a potential deal
- Give the parties a starting point for more negotiations
LOIs are used to gauge the seller‘s interest and save time. It would not make sense to draft a full purchase and sale agreement for each lead if you are a buyer hunting for deals. So instead, buyers draft a short LOI with the main deal points and present it to the Seller as an outline for a possible deal.
A typical LOI will include the main deal points such as:
- Sale price
- Escrow period
- Deal deadlines
Can a Party Enforce a Non-Binding LOI?
Yes. Despite what your agent (or the buyer’s agent) will tell you, LOIs can be enforceable (Source – Mann v. Mueller). This is true even if the letter of intent states that it is ‘non-binding’ on the parties.
You likely won’t be able to force a sale just with a letter of intent, but other elements can be enforced:
- “Good Faith Negotiations” – if a party to a signed LOI didn’t put in the time to negotiate a purchase contract in good faith, the LOI can be used to for them back to the table (for at least some period of time).
- Exclusivity – buyer can preclude the seller from selling the property, entering into a purchase and sale agreement, or opening escrow with another buyer.
- Agreed Terms – parties to a signed LOI can be precluded from negotiating certain terms in the purchase and sale agreement.
- Confidentiality – a properly worded LOI can prevent a seller from showing the letter to leverage a higher offer from another buyer.
- Disclosure of Due Diligence Materials – if the seller agrees to provide the buyer with certain documents per a signed LOI.
Signed LOI together with the intent of the parties can be enforced in some limited capacities as indicated above. In practical terms, this mostly affects the seller’s ability to negotiate with other parties. To be enforceable, the LOI must meet the requirements of a valid contract.
What are the Typical Terms in a LOI?
Letters of intent will usually include standard terms:
- Purchase Price – important how this term is defined in a sale of a business. Does the price include inventory and receivables? Important to state what is exactly included in the purchase price.
- Binding Effect – the LOI should clearly state what terms are binding and which are non-binding.
- Timeline – the term should be defined as to the length of the LOI and/or the length of escrow after a PSA is signed.
- Exclusivity – sellers ability to sell to another party during the term of the LOI can be limited.
- Confidentiality – parties may want to limit what can be shared with parties outside the agreement.
What are the Pros and Cons of Signing a LOI as a Seller?
- Efficient negotiations to close a sale
- Lower legal costs – LOIs are short and easy to draft
- If terms in the buyer’s LOI are not acceptable – terminate the negotiations quickly and without consequences
- Easier to execute a deal with main points already agreed with Buyer
- Exclusive negotiation period with buyer could result in missed opportunity to sell to someone else
- LOIs can be legally binding
- Limited ability to negotiate on certain terms with the buyer
- Non-binding terms can be vague and require additional negotiation
- Could subject the seller to liability
Should Sellers Ever Sign a Letter of Intent?
As a general rule, we advise sellers to never sign a letter of intent because the negatives are much more consequential than any advantages. None of the advantages listed above require a signature by the seller. A commitment secured by seller’s signature only benefits the buyer. If the buyer will not consider a deal without an LOI, this step might be required to complete the sale.
Aggressive buyers can force a seller into exclusive negotiation with the threat of litigation and performance with a signed LOI. Even if such litigation will be fruitless, sellers under duress could face a prospect of choosing between litigation or giving into the buyer’s demands and selling at undesirable terms.
It is unlikely that a seller could force a buyer to close with just an executed LOI, but a buyer could force a seller to exclusively negotiate. An exclusive negotiation period with a buyer is essentially an option to purchase. In that case, sellers should be compensated with adequate consideration.
Letters of Intent in Real Estate Transactions
LOIs are commonly used by buyers to gauge seller’s interest in off-market deals. Once a seller is open to selling, a buyer will present a letter of intent with the major deal points such as the price, term, contingencies, earnest money requirement, and agent’s commission.
A well crafted letter of intent in complex commercial transaction or lease can be very beneficial to all parties. Commercial leases are 40 pages or longer, and LOIs can be a quick test to see if there is a basis of agreement between the parties.
Letters of Intent in Business Sales
LOIs in business sales operate in very similar fashion to real estate LOIs. Some business sales can be more complicated than property sale due to the nature of the business and due diligence required. Buyers might also have to absorb employees, assume loans, and assume existing liabilities of the business. The LOI might or might not address those concerns.
Some points to note:
- Working Capital – should be clearly defined in the LOI, otherwise it might be included in the purchase price and thus reduce the net to the seller.
- Transition/Training – the period of time the seller will require the buyer to train the new staff of existing processes. Sellers should seek a clearly defined time period and compensation to set buyer’s expectations.
- Non-Compete – most buyers will not want to see the seller start a competing business right after the sale. Time and distance of any potential competing business by the seller should be clearly outlined in the LOI.
Using a Lawyer to Negotiate, Draft, and Enforce LOIs
Sellers, buyers, and agents can strategically use a lawyer to push forward a deal to a signed contract, or create leverage by attempting to enforcement of a letter of intent.
If a buyer presented you with a letter of intent, an attorney can help you avoid the potential dangers in signing a LOI that you might regret. With proper negotiation, a lawyer can take the bite of any enforceability provision in a letter of intent.
Enforcing a letter of intent on a seller is not common practice, and it does not happen often. However, the mere threat of such action against a non-cooperating party (or a seller not negotiating in good faith) can be an effective point of leverage.