Is your Letter of Intent Binding?

If your business commonly uses a letter of intent (LOI) to memorialize its agreement regarding the main terms of a transaction, you may wonder if the LOI is binding. Typically the LOI addresses the price, due diligence terms, closing deadline and other crucial deal points. Thus, when the LOI has been signed by both parties, it is a sign that the key issues have been negotiated, agreed upon, and closing the deal is likely.

The LOI is often used between the buyer and seller in a transaction. Once the LOI is finalized, it usually provides the supplier sufficient comfort to begin purchasing material in order to provide its customer with the product by the deadline. In other words, the LOI serves as a “green light” to go ahead and spend the money to make the deal happen. Whether the LOI is binding is important because the supplier is going to want to recover its expenses on a project that received the “green light” but fell apart before a formal contract was signed.

While the LOI covers the key deal points, there are many minor matters and the boilerplate provisions that are not addressed or covered in the LOI. This means that the parties must still negotiate the final terms and the drafting of the agreement. While the LOI is not intended to be a binding document, there are certain clauses that are binding on the parties such as the confidentiality provisions and exclusivity clauses. It can create confusion when there are binding and non-binding terms in the LOI.

Your LOI should include a broad disclaimer that the parties are not legally bound by all of its terms until a separate and binding contract has been signed by the parties. It should be noted that several courts have ruled that the LOI is proof of the parties’ “meeting of the minds” necessary to create a valid contract that is sufficient to award damages if a breach occurs. The courts have applied an objective test to determine whether a binding contract exists, so whether the parties subjectively had the intent to be bound by the LOI is not relevant. The court looks at what a reasonable person in the same position as the parties to the LOI would have thought the LOI meant.

What if you want to ensure that the LOI is not binding? You should clearly state in the LOI that it is not legally binding on the parties. It should provide that it is for consideration only and that additional terms will be negotiated as part of the final contract. If there are certain clauses that both parties intend to be bound by (confidentiality provisions), it should be clearly noted and complied with. Finally, you should never refer to the LOI as being binding or as the finalized agreement in your communications with the other party.

Contact a knowledgeable business attorney at Nielsen Law Group for advice regarding your letter of intent or other business matters. You can schedule your initial consultation by calling (480) 888-7111 or submitting a web request here.