Letters of Intent: A Tricky Legal Tangle

Posted on February 10, 2014 in Business Transactions

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You can’t be a ‘little bit pregnant’; can you have a legally non-binding agreement?

Full-blown written contracts can be such a chore, can’t they? Especially when you’re at the initial “exploration” stages of a business negotiation. You’re not ready to close a deal–you need more time to work things through and conduct your due diligence–but you want some form of commitment from the other side. So what do you do?

Entrepreneurs often resort to a letter of intent. Sometimes, they’re called a memorandum of understanding (although that’s more often in a government or international law context). You’ve had initial discussions; you’ve signed mutual confidentiality and nondisclosure agreements. You’re on your way. A letter of intent can show that:

  • You’re getting serious about moving forward.
  • You’re ready to make a public announcement of your collaboration (and make your competitors quake in their boots).
  • You’ve authorized any necessary spending for the transaction.
  • You’re committed to a time line for making this happen.
  • In short, you’re trying to find a more formal way to express interest without being legally obligated to go through with it.

Problem is, depending on how you word them, letters of intent can bind you just as much as any other kind of contract. Even if that wasn’t your intent. It’s like being a “little bit pregnant”–you either are, or you aren’t. Letters of intent say they’re not binding, but then they contain all sorts of terms (and enough of them) that a court could find that you actually do have a binding agreement. On the flip side, if you’re entering into an agreement that doesn’t bind you, why bother with it at all?

There’s a lot of room for misunderstanding in these memoranda of understanding. It’s like hedging your bet as to whether you’ll go to the prom with Charlie the Computer Geek. You don’t want to come out and say “no,” because you think you’d actually like to have a date to the prom. Charlie’s a nice guy and funny (in a quirky sort of way), but also you want to make sure that showing up with him won’t totally embarrass you. If you’re not careful about how you  accept the invitation, you may find that Charlie’s gone out and bought the corsage, rented the tuxedo and arranged for the limo. At which point, you’re either stuck going with Charlie, or could face being cybersmeared all over the computer lab.

Is Your Memorandum of Understanding Ripe for Misunderstanding?
If not worded properly, letters of intent can be construed very differently than you originally intended. In Newport Limited v. Sears, Roebuck Company, 6 F.3d 1058 (5th Cir. 1993), cert. Denied, 114 S.Ct. 2710 (1994), for example, Newport and Sears began negotiations for the development of a distribution center for Sears in the New Orleans area. They entered into a letter of intent, which included language that said: “Based upon our analysis and subject to the preparation of a mutually agreeable legal documentation, we are prepared to enter into the transaction on substantially the following terms and conditions . . . .” Ultimately, negotiations on the “more detailed document” broke down, and Sears decided not to pursue the project.

Newport claimed that there was a binding contract–after all, the parties had agreed to the transaction “on substantially the following terms.” Sears claimed that there wasn’t an enforceable agreement and pointed to the language that the deal was “subject to” a mutually acceptable agreement, which never materialized.

The Fifth Circuit court sided with Newport. It stated that “where the parties’ minds have met upon all essentials, a contract is created between them and binds them.” So despite the legal language that tried to hedge the bet, Sears found itself stuck because of the level of detail in all of the other provisions.

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, especially if you don’t have the right language in the agreement that lets you exit the deal easily and gracefully. So if you have to use one, make sure your letter of intent clearly states what you intended. And have an experienced legal eye look it over.

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