Letter of Intent of Contract? Tips to Avoid a Costly Mistake
By Brian Moore
Saalfeld Griggs PC
When parties to a transaction desire to confirm the terms of an agreement without actually drafting and executing a contract, they often resort to a Letter of Intent (“LOI”). Parties often verbally negotiate the most important terms, then they outline them in writing through an LOI. The execution of the LOI has traditionally been viewed by parties as a nonbinding indication of their intent to negotiate an agreement to become binding only upon the subsequent execution of a formal contract.
Recent case law, however, requires careful consideration when using an LOI. Simply calling a document a “Letter of Intent” will not avoid the imposition of binding obligations on the parties if the LOI demonstrates intent by the parties to be bound by the writing. Consider the recent case out of the Oregon Court of Appeals, Logan v. D.W. Sivers Co., in which the plaintiff was awarded $900,000 damages for defendant’s failure to perform under an LOI.
LOGAN V. D.W. SIVERS CO.
In Logan, plaintiff (Buyer) and defendant (Seller) had executed an LOI for Buyer’s purchase of Seller’s real property, a shopping mall. Buyer had already sold property in anticipation of deferring the gain under a 1031 exchange. Seller was aware of Buyer’s need to identify a replacement property for the exchange, and was familiar with the strict time limits associated with the identification and acquisition of a replacement property. The parties executed an LOI. In addition to outlining the basic terms such as purchase price and closing date, the parties conditioned the closing on a 60-day “nonshop” provision (Seller’s agreement to not solicit offers or contract to sell the property to anyone but Buyer). Within 21 days, Seller contracted to sell the property to a third party. Despite mitigating efforts, Buyer was not able to identify and close on a replacement property, and thus failed to qualify for the 1031 exchange. The consequential damage to Buyer was a tax liability of over $900,000. The Court of Appeals upheld a jury award to Buyer in the amount of Buyer’s tax liability.
The Court determined that an “agreement to negotiate,” as Buyer and Seller had, is an enforceable contract, even if some terms are left open, so long as the parties manifest an intent to be bound and the terms of agreement are sufficiently definite as to determine whether or not a breach has occurred. In Logan, the Court found that because the LOI indicated that “Seller agrees to be bound to . . . comply with the Non-Solicitation Provision,” the parties had manifested intent to be bound. The LOI further stated that Seller “will not seek nor enter into a letter of intent or purchase agreement for sale of the Property with any third party for a period of sixty (60) days from the date this letter of intent is signed by both parties and becomes effective.” Though the LOI left some terms open to be determined by further negotiation, not surprisingly, the Court found this nonshop provision to be sufficiently definite to determine if breach occurred. Accordingly, the Court upheld the award of over $900,000 to Buyer for its tax liability resulting from Seller’s breach of the nonshop provision.
WHEN ARE LOI’S APPROPRIATE?
Although the Logan case involved an LOI for real property, the case is applicable to LOI’s for any type of transaction. The case illustrates that it may be difficult to use an LOI without risking its enforcement as a binding document. Because of that risk, it is often advisable that you not sign any documents, including an LOI, until you expect to be bound by the terms of the document. If you intend for any provisions of an LOI to be binding, in most cases it is best to either negotiate and execute a binding contract instead of drafting an LOI, or place those terms in a separate, written contract.
Nevertheless, LOI’s can provide confirmation to parties that they have reached consensus on the essential terms of a transaction before spending time, effort, and money drafting an enforceable agreement. This is particularly true for more complex transactions involving multiple drafts and closing documents. The LOI can also prevent a party from later retracting a particular term as though it had not been previously discussed, keeping the parties somewhat ethically bound to the LOI provisions.
HOW TO KEEP AN LOI FROM BECOMING BINDING
If an LOI is necessary, avoid using any terms that could be interpreted to require a party to perform any obligation (e.g., “accept,” “offer,” “agree,” or “contract”). The LOI should appear primarily as an outline of essential terms. In addition, include a provision that unambiguously indicates that neither party intends to be bound by the LOI, and that no claims—contractual or otherwise—may arise from the LOI. If the parties do not wish to be bound by the obligation of good faith implied in Oregon contracts, they should clearly state such.
Lastly, if the parties intend to be bound by any terms of the LOI, but are not placing them in a separate agreement, the binding terms should be distinctly separate from the non-binding terms with a clear indication that the parties do not intend to be bound by any other terms of the LOI. To avoid damages, such as those awarded in the Logan case, a party may also wish to include a limitation on any consequential or expectation damages.
If you are considering a transaction involving an LOI, use caution in avoiding a binding agreement. If you have questions regarding the enforceability of an LOI, or the drafting of a subsequent agreement regarding real estate purchases, please contact a member of our real estate practice group for assistance.
Also, if you have questions or concerns regarding the drafting of an LOI or the drafting of a subsequent agreement regarding a business sale or acquisition, please contact a member of our corporate practice group for assistance.