There are various reasons why organizations enter into letters of intent, memoranda of understanding or engagement letters (collectively referred to in this post as “LOI”) instead of more fulsome definitive agreements. What organizations always need to keep in mind is that LOIs should be carefully considered and reviewed because they may have significant legal consequences. I asked my colleague Nick Pasquino to point out some areas to consider before signing a LOI.
Question: Why would an organization want to sign a LOI?
Nick: There are a number of reasons where I see LOIs being used. Many times parties are eager to start a project together quickly with a short LOI outlining fundamental business terms, on the understanding that a definitive agreement will be finalized at a later date (I always recommend against doing this without advice to reduce the likelihood of encountering issues later down the road). The other scenario I see LOIs is in negotiating significant transactions like amalgamations or asset sales, or commercial joint ventures, etc. LOIs can be used to set the key terms of the deal early on, to ensure everyone has the same basic understanding of what will be involved, and to establish a framework for negotiations. A LOI can be used to determine if it is possible to settle deal terms, without the added expense of a formal agreement.
Question: What are some of the areas that a LOI should cover?
Nick: A LOI can impose legally binding obligations between the parties unless it is expressly stated to be non-binding. Organizations need to be very careful here as the words matter! In many cases, some parts of LOIs are binding and others are non-binding. In the transaction context, for instance, it is common for fundamental concepts like confidentiality, negotiation exclusivity, allocation of costs and expenses, etc. to be binding, and for the “proposed deal terms”, which will usually be subject to negotiation and due diligence (like deal structure, pricing, adjustments, etc.), to be non-binding but listed in the LOI to establish a framework for further negotiation.
Question: Are LOIs enforceable?
Nick: It depends. If all the legal elements of a contract are present (offer, acceptance, consideration, intention to enter into contractual arrangements, certainty of terms, etc.), and the LOI does not expressly provide that the terms are non-binding, the LOI can create legally enforceable obligations – so they must not be entered into lightly!
Question: Any last words for organizations to consider before signing a LOI?
Nick: Very often LOIs are negotiated without the benefit of legal advice either because the organization viewed the LOI as an informal commitment, or elected not to involve counsel for financial or other reasons. If the LOI is not properly structured an organization can find itself in a difficult negotiating position or may be stuck with legally enforceable terms which it did not anticipate. The better approach is to speak to legal counsel before signing the LOI to ensure it will actually achieve its purpose for your organization.