This article originally published on the Corporate Law Insider blog of Bourque Law Firm, P.C. Reprinted with permission, all rights reserved.
Letters of intent can be a useful tool when entering into negotiations to buy or sell a business or property. However, many people who sign letters of intent have no idea that they may be creating a binding contract upon which they can be sued if things don’t work out.
This Corporate Law Insider edition provides businesses and individuals with guidance in handling letters of intent, memorandums of understanding, and similarly labeled documents.
If you do not want to be bound, it had better say that clearly in anything you sign
Many people believe that a document entitled “letter of intent” cannot be a binding contract. Such a belief is mistaken.
If a party does not wish to be bound, it should include clear and unmistakable language in whatever it signs stating that nothing is intended to create a contract or obligation between the parties. There is no such thing as overkill when including such language, which can and should be repeated for emphasis.
Conversely, if a letter of intent fails to contain clear non-binding language, but instead contains language where parties discuss an “agreement” or state that they shall be “obligated” to do something, they may very well have entered into a binding contract. Words such as “accept,” “offer,” “agree,” or “contract” similarly imply that a potential binding obligation (i.e. contract) exists.
ANY language implying or identifying an obligation or duty on behalf of a party can create a fact issue as to whether an agreement has in fact been reached. The scope of the contract will depend on the wording in the letter of intent and the surrounding circumstances. Thus, one should carefully read all letters of intent, memorandums of understanding, and other documents before signing them.
Language regarding “Negotiating in good faith”
When parties state that they “shall negotiate in good faith,” they may well have bound themselves contractually to do just that — even if there is other non-binding language in their document. As an Arizona court noted:
“[I]n certain circumstances an agreement to negotiate in good faith [can] be a valid contract where there is express language that conveys as much. In Rennick v. O.P. T.I.O.N. Care Inc., an agreement containing a non-binding clause was found to contain a contract to negotiate in good faith where the express language of the agreement obligated the parties. The agreement contained the language that the parties agreed to “continue good faith discussion directed toward the creation of formal written contract that, upon approval by the board of Director [sic] of each party, will be executed to establish the following arrangements.” Therefore, an otherwise non-binding agreement could create an obligation to negotiate in good faith where the parties included such language.”
Parties should also beware of language which allows the parties to “terminate” negotiations only after a period of time or after a particular event. Such language implies that there is no general right to terminate negotiations. Thus, I encourage clients who do not wish to be bound to negotiate to include the following language in their LOIs: “Any party to this letter of intent may terminate negotiations at any time for any reason.”
Where a contract to negotiate in good faith is proven, the measure of damages is typically those suffered in relying on the defendant to negotiate in good faith. This can include the plaintiff’s out-of-pocket costs in conducting the negotiations, which can be substantial if negotiations extend over a significant period of time and entail significant due diligence and other work.
I have litigated letter of intent disputes and they are not pretty. Battling in court over one’s business or property is painful and expensive. Risks and emotions run high when relationships go wrong.
So, the next time you see a letter of intent with any potentially binding language, do not sign it unless you wish to be bound. Instead, contact counsel to revise the document or, alternatively, scrap it and create an appropriate letter of intent that suits your needs given the particular potential transaction.
Art Borque, Esq., is an AV rated attorney with 24 years of experience. His Phoenix, Arizona, practice deals with Employment and Labor Law, Commercial and Tort Litigation, and Dispute Resolution.