Is Your Letter of Intent Permanent and Binding?

Violins are made from about 70 different pieces of woods, most of which are carefully carved and glued together. As a result, violins have a lot of glued seams. Since violins are made of wood, with humidity changes, the wood will swell and contract, causing the glue to crack and seams to open.

To prevent this and to prevent cracks in the wood, itself, string players use a variety of humidification products in their cases dry winter months. In addition to trying to keep their violins in air conditioned (and dehumidified) environments during humid summers, some string players also have dehumidification products in their cases.

I am careful to keep my violins in an environment in the optimal 40-60% humidity range. Yet, when I recently took my best violin to a luthier for adjustment, he still found an open seam in my instrument which needed to be re-glued.

This was not a huge surprise, because even today, despite the availability of synthetic glues, it is not used on the finer instruments. Fine instruments are glued together with water soluble glue made from animal skin and tendon.

Although “hide glue,” as it is known, is strong and serves the purpose of holding the violin together, it is not supposed to be permanent. It is preferable for the seam to open than for the wood to crack. Also, however, by using water soluble hide glue, a luthier can open an instrument without causing damage to the wood should it become necessary to repair something inside.

Letters of intent and term sheets (LOIs) are like hide glue. They are meant to provide a strong framework for a transaction and to serve as an aid in negotiating a final contract. However, they are not intended to be permanent and binding.

Most LOI’s include a disclaimer sentence saying that with possibly a few exceptions, the LOI is “non-binding.” However, even with that language, what appears to be a routine LOI can transform into a binding contract. 

What is a Letter of Intent?

An LOI is a short written document signed by the parties to a transaction. Typically, an LOI will describe the basic terms of a contract that the parties will negotiate and sign in the future.

Parties to a LOI usually do not want it to be a binding contract. However, sometimes, the parties will include terms, such as confidentiality clauses, which are intended to be binding even if the parties do not enter into a contract.

Why Parties Use Letters of Intent

LOI serve a valuable purpose in business transactions. They allow the parties to assure that they are in agreement on the major transaction terms before they invest thousands of dollars in time, attorney fees, and other expenses pursuing the transaction.

Some LOIs may incorporate confidentiality or access provisions. These LOI terms provide a seller with some protection so it can share information with a buyer to conduct additional due diligence while negotiating a purchase agreement. LOIs also may include exclusivity clauses in which provide the buyer with comfort that the seller will not continue to market property while the parties are negotiating their contract.

When Will a Letter of Intent be Binding?

The parties usually will want certain LOI terms, such as confidentiality clauses to be binding. But parties to an LOI usually do not want for the LOI to be a binding contract to purchase property. Although LOIs may contain the basic transaction terms, they do not include the level of detail necessary to assure that the parties have a meeting of the minds for a successful transaction.

Unfortunately, sometimes LOIs contain language which transforms them into binding contracts, despite the parties’ contrary intentions.

Most LOIs have a disclaimer that states they are not intended to be binding. A flawed disclaimer can create ambiguity and result in more of the LOI being binding than originally intended. Such a flawed disclaimer might read as follows:

“Except as otherwise provided, this LOI is not intended to be a binding contract.”

It is not clear whether “otherwise provided” applies only to the LOI language or whether it might also apply to prior or future oral or written agreements of the parties or even to party actions. A better disclaimer will state any exceptions specifically so there is no confusion:

“Except for Paragraph X relating to confidentiality, this LOI is not intended to be a binding contract, and no action or inaction of any party shall be interpreted to cause this LOI to become binding.”

An LOI also can be a binding contract if it includes words like “offer”, “acceptance,” or “agree” that implies that the parties have a contract or if it includes other language which sounds binding. Use of mandatory words like “must” or “shall”, rather than precatory ones like “may” or “would,” can make the LOI look like a contract. For instance, if an LOI requires that the parties negotiate in good faith to enter into a contract and one party fails to do so, the other party might be able to collect damages for the benefit of its bargain.

An LOI which contains conditional language can become binding if the condition is fulfilled. For instance, consider an LOI that says “After deposit into escrow, the buyer’s deposit shall be nonrefundable.” Unless the LOI very clearly states to the contrary, if the buyer happens to make the deposit, it might be nonrefundable–even if no purchase agreement is ever signed.

How Can the Parties Make Their Non-Binding Letter of Intent Binding?

The parties’ actions can cause even an otherwise non-binding LOI to become a binding contract. For instance, if one party to the LOI reasonably changes its position to its detriment in reliance on a requirement in the LOI, that may create an enforceable contract.

Parties also can create a binding contract by acting like they have a binding contract. For instance, if they issue a news release announcing an upcoming purchase or merger based upon the LOI without stating it is conditioned on future events, that act might be considered evidence of intent to be bound by the LOI. Communications between the parties referring to the LOI as a “final agreement” or similar language also might result in the LOI being treated as binding.

Additionally, Courts may enforce an LOI as a binding contract where the parties have partially performed the contract. Usually, this would accompany other actions consistent with a binding contract, but if the parties proceed to perform under the terms in the LOI, such as by handing over control of a business or property being sold, the terms of that transfer would be governed by the LOI.

How to Prevent a Letter of Intent From Being Binding

Through careful drafting of the LOI, itself and taking steps not to act as if they have a contract, parties can prevent their LOI from being a binding contract.

A strong disclaimer of any contract in the LOI, itself, with any exceptions specifically set forth is a starting point. The LOI also may state that no party’s reliance on the LOI nor any other action or inaction of a party is to be interpreted as creating a contractual obligation until the parties sign a formal contract.

Parties frequently do not hire attorneys until after signing an LOI. Yet, an attorney can help the parties by preparing a strong LOI tailored to their particular business needs.

The parties should not act as if they have a contract. Continuing to disclaim the existence of a contract until a formal contract is signed is a starting point. Both parties should take care so that neither party changes its position such that a Court might interpret a contract as existing.

With consistent use of hide glue, luthiers around the world are assured that they can maintain string instruments be able to take instruments apart when necessary. With consistent use of a strong LOI form, frequent disclaimers, and the help of an experienced business attorney, an LOI can provide a non-binding framework to hold together a business relationship until the parties sign a permanent contract.

© 2018 by Elizabeth A. Whitman

DISCLAIMER: The content of this blog is for informational purposes only and does not provide legal advice to any person. No one should take any action regarding the information contained in this blog without first seeking the advice of an attorney. Neither reading this blog nor communication with Whitman Legal Solutions, LLC or Elizabeth A. Whitman creates an attorney-client relationship. No attorney-client relationship will exist with Whitman Legal Solutions, LLC or any attorney affiliated with it unless and until a written contract is signed by all parties and any conditions in such contract are fully satisfied.