Letters of intent can be dangerous things in the wrong hands. Also called memoranda of understanding, term sheets, or discussion sheets, a letter of intent (LOI) is a document that outlines an agreement between two or more parties before the agreement is finalized. Kinda like a “pre-agreement agreement.” Paradoxically, entrepreneurs often use LOIs when they want a commitment from each other, but not a legally binding commitment. They will use them to
- clarify the key points of a complex transaction for the convenience of the parties
- declare officially that the parties are currently negotiating, as in a merger or joint venture proposal
- provide safeguards in case a deal collapses during negotiation
Here’s the problem with letters of intent:
Depending on the exact wording, LOIs can bind you just as much as any other kind of contract. Even if that wasn’t your intent. In fact, an agreement doesn’t have to be labeled an “agreement” or a “contract” in order to be legally binding. Whether or not a document constitutes a binding contract depends only on the presence of well-defined legal elements in the text of the document. And therein lies the rub: sometimes, entrepreneurs are so keen on getting something in writing (but without wanting to expend the legal fees), that they create LOIs themselves without making sure they have the right legal language in there. It’s like rushing to have an engagement party, only to find out that you’ve had a Vegas wedding instead. And walking away from a marriage is a lot messier than breaking off an engagement.
Is Your Memorandum of Understanding Ripe for Misunderstanding?
If not worded properly, letters of intent can be construed very differently that you originally intended. Here’s a cautionary tale:
Casey (from California) and Debra (from Delaware) were colleagues, eager to start a holistic health center in Sedona Arizona. They had excited discussed their visions for the center. They were still in the early planning stages and weren’t ready to sign a partnership agreement (so they thought) , but wanted to make a concrete commitment to the venture – and to each other.
So they created a letter of intent. The LOI indicated that they were committed to developing the idea and forming the business within 9 months, which they would own 50/50. That each would contribute $10,000 in start-up capital. That Casey would scout out real estate. That Debra would look into licenses, regulations, and other administrative details. That they would keep their discussions confidential and exclusive to each other.
Trouble was, Debra didn’t do any of the work she promised. Casey invested a lot of money in airfare, hotels, and brokers’ fees in trying to secure a location for the center and wanted Debra to reimburse her for half. Debra refused. Casey sued in California. Debra replied that Casey didn’t have a case – after all they had only signed a letter of intent. The court disagreed with both of them. It held that Casey needed to bring her lawsuit in Delaware, where Debra lived. But also, that there were enough material terms in the LOI to make the obligations legal and binding upon them as business partners, not just two people exploring an idea. So Debra would have to share in the expenses (not just the profits) of the venture.
Why might a court find that way? For example, nowhere did the letter of intent say that Casey and Debra’s relationship was subject to negotiating and signing a partnership agreement. Or that there were open-ended terms that the parties would need to agree upon before taking the next step. Such a result is v-e-r-y different from a “we can both just walk away if this doesn’t work out” attitude that many entrepreneurs have in mind when signing a letter of intent.
Letters of intent are supposed to make things easier by having the basic terms in writing. Ironically, you need an attorney even more with this type of agreement than you might with one that contains every jot and tittle . . . precisely because what’s left out can come as a nasty surprise. Especially if you don’t have the right language in the agreement that lets you exit the deal easily and gracefully. So make sure your letter of intent clearly state what you intended. Be sure to consult with an attorney before signing this type of an agreement.