Contracts: Letters of Intent

Contracts

Letters of Intent

BY JOSEPH VALOF

The letter of intent can provide the business person with a vital bridge between mere discussions and a binding contract. However, the huge damages award under the infamous Pennzoil v. Texaco case of the last decade demonstrated some of the pitfalls inherent in this commonly used business tool. The following should help your company to avoid those pitfalls.

Purpose

The main purpose of a letter of intent (sometimes also referred to as a “Letter of Understanding” or “Memorandum of Understanding”) is to facilitate the start of a business deal or project between the parties involved by identifying the key business and contractual understandings that will form the basis of the final contract.

Drafting Issues

Binding vs. Non-binding. A letter of intent is usually intended to be non-binding, but also may prove “binding” if the parties fail to so state, or if its language indicates a conflicting purpose. Where the letter of intent stays silent on whether it is non-binding then, generally, it is presumed to be binding and enforceable in the courts.

Confidentiality. A separate confidentiality agreement should be executed between the parties if confidential information is to be exchanged during the initial discussion stage. Such an agreement will impose binding obligations of confidentiality that survive the non-binding letter of intent, and may be attached to the letter of intent as an Exhibit.

Brevity. It is easy to say too much in a letter of intent out of a misguided zeal to cover all bases. For example, statements such as: “agree to bargain”; “make every reasonable effort to agree upon and have prepared as quickly as possible a contract providing for”; and “negotiate in good faith” each have caused a court to disregard a statement of non-binding intent, and rule a letter of intent to be binding on the parties. Thus, as a general rule, brevity is always recommended, and it is better to include just enough details to get the parties started.

In one recent case, the letter of intent clearly stated: “This letter of intent is not intended to create, nor do you or we presently have any binding legal obligation whatever ” But, in the very next paragraph the following statement was made: “[H]owever, it is our intention, and we understand, your intention immediately to proceed in good faith in the negotiation of such binding definitive agreement.” Schwanbeck v. Federal Mogul Corp., 412 Mass 703 (1992). The court held that the word “however” coupled with the intention to “proceed in good faith” created an obligation independent to the sweeping disclaimer that the letter of intent was non-binding.

Form Letter of Intent

The following might serve as a guide for your own letters of intent:

Mr. John Smith
[XYZ company address]

Dear Mr. Smith:

Purchaser intends to purchase, and XYZ intends to sell certain computer hardware. The purpose of this Letter of Intent is to summarize our discussions to date and to confirm our respective intentions with respect to the proposed transaction, as follows:

Purchaser intends to purchase the Model 100 Computer from XYZ for the lower of $10,000 or whatever better price XYZ is able to extend to Purchaser.

Purchaser has paid a $1,000 deposit to XYZ, which shall be promptly refunded in the event negotiations are terminated for any reason.

Purchaser and XYZ intend to conclude a binding agreement on or before January 30, 1996. In the event that a contract is not signed on or before such date for any reason or no reason, Purchaser or XYZ each shall have the right to terminate the negotiations without liability.

This is a letter of intent only. It is not intended to be, and shall not constitute in any way a binding or legal agreement, or impose any legal obligation or duty on either Purchaser or XYZ, Inc. If the foregoing reflects our mutual statement of intention, please sign and return the enclosed copy of this letter.

Sincerely,
Purchaser
Agreed:
By:
Title:
Date:

Comment: Avoid overstating your case in a letter of intent because, if you say too much, you may find yourself committed to more than you bargained for.
Mr. Valof will discuss another pre-contract tool in our next issue, that of the “teaming agreement,” whereby two or more contractors bind one another to bid jointly for a government contract.