The Tech Attorney Blog » Letters of Intent: Sticks, Stones and Words Will Hurt You

Letters of Intent: Sticks, Stones and Words Will Hurt You

Posted on February 8th, 2008 by Adamesq

Oversensitive Documents
Back in my pre-mp3 days, a cassette (plastic object containing analog audio recordings) with prank phone calls was circulating through college campuses. On one of the calls, a prankster dialed up a local lawyer and claimed that he had been hurt on the job. The lawyer naturally targeted his questions to find some kind of tangible injury (payday). When asked how he got hurt, the prankster told the attorney “he said mean, awful things to me…and I was very hurt about this!” It took the attorney a while longer to catch on. Oh yes, the oversensitive client might as well be wearing a big red flag when they walk in for an initial consultation with a personal injury attorney. PI lawyers can’t quite put a dollar value on “words” alone. Well, that’s why there are lawyers that write corporate documents (transactional attorneys) and lawyers that litigate them (commercial litigators). We love words.

As a lawyer who writes and reviews documents for businesses on a regular basis, I find that composing a corporate document is an art form. Every sentence has a reason for being there. Your corporation is oversensitive to the careful craftsmanship underlying every document used in transacting business. Having non-legal staff or officers handle what the corporation considers “business” paperwork can, and often does, cause serious damage. The language in that paperwork really can hurt you…or at least your bottom line…big time!

Enter the “Letter of Intent”
One of the first documents a company drafts following preliminary negotiations is a “Letter of Intent” (alias “Memoranda of Understanding”, “Memoranda of Agreement, etc.). While not “necessary,” they are often used in the business world as precursor to a formal contract. When properly used, a Letter of Intent pinpoints the key factors and mutual understandings behind entering an actual contract. You can think of it as an overview, or a roadmap, of the deal you’re getting ready to make. Businesses often use them to show a commitment to each other (possibly for others to see), to put a timeline in order, or as a green flag for investing resources and beginning due diligence. Many companies have their sales staff draft the “Letter” because they consider it a “non-legal” document. Don’t make that mistake! Although the sales team sees letters of intent as precursors to a new deal, making bonus, and corporate growth, most lawyers don’t like them because they are self-contradicting. Poorly written LOIs have been known to change their spots!

On one hand, Letters of Intent are supposed to be legally worthless. It is not intended to bind the parties. On the other, it often has essential elements of a contract and prompts parties to act “in anticipation of” a future agreement. In the lawyer’s world, they’re they can change from “non-binding” to “binding.” Translated to “normal-speak”: letters of intent can cost your business a ton of money if they’re not written properly.

If the deal goes south, either party may argue that the points in the letter constitute an enforceable agreement. (Why is “south” the direction for things that go bad?) Treading on LOI territory is dangerous. If not written very carefully, an LOI can turn into a massive breach of contract action. Despite the legal implications, the LOI is often that “first document” I mentioned above, that corporations allow sales managers to draft.

The Guidelines
Regardless of who drafts your letter of intent, there are two general rules to keep in mind: keep it clear and keep it concise. You’ll want to be sure to overtly express in the LOI that neither party intends to be bound by the letter. If not clearly stated, chances are that the courts would rule that your letter of intent is a binding, enforceable agreement.

Keeping the letter of intent concise means that you want to limit your legal wording and briefly disclose the most prevalent points in closing the deal. Often, representatives from two companies sit down at the negotiating table. One or both sides are eager to put the basic terms down into a LOI for their attorneys refine and draw up into a final agreement later. Either through pressure, an effort to show sincerity, or just excitement in putting the deal together, someone will look at the dry legal statement in the LOI expressing the desire not to be bound by the terms discussed as a big negative. From a business perspective, it’s easy to understand. “We don’t want it to look like we’re not serious with this ‘we don’t intend to be bound’ language.”

Unfortunately, the legal language in the deal just can’t always reflect the electricity in the air. One company found out the hard, expensive way. Their letter of intent stated in part “[T]his LOI is not intended to create, nor do you or we presently have any binding legal obligation. . .” The next paragraph tried throwing a positive spin on the downer with “. . .however, it is our intention, and we understand, your intention immediately to proceed in good faith in the negotiation of such binding definitive agreement. . .” Well, the court decided that second statement countered the dry, legal disclaimer and formed a contractual requirement to move forward and close the deal!

Probably the biggest cases involving an LOI-gone-bad involved Getty Oil and Pennzoil in 1984. It is a textbook case (really, it was in our contracts textbook back in law school). Getty Oil and Pennzoil put together an LOI (theirs was called a “Memorandum of Agreement”) for a very large transaction where Pennzoil would purchase stock from Getty Oil. The parties later issued press releases where they agreed “in principle” to the terms of the Memorandum. Getty Oil ended up accepting a better stock offer from Texaco. The court went into an analysis of not only the Memorandum, but the press releases and other materials before determining that Getty Oil breached the Memorandum of Agreement. Hence, a supposedly non-binding LOI became binding. Texaco ended up with a three billion dollar settlement against Texaco for interfering with the “contract.”

Last Letters on Letters of Intent
Even though certain elements are required to form a contract, it is very easy for the elements to “fall into place.” You don’t want to be in a situation where the court gets to decide if the pieces of your letter of intent are sufficient to establish that a contract exists. If the deal falls apart, your company’s pockets could end up patching the fallout.

Suffice it to say that commercial litigators keep quite busy hashing out disputes between parties who don’t understand their own contracts or, as in the cases above, don’t realize they’ve formed contracts. If a dispute arises later, a well-drafted LOI or agreement can be your legal fire extinguisher. It will cost your business a lot less in legal fees for prevention than it will for calling in the fireman.

Filed under: Tech Tips

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