Letter of Intent
In a typical residential sales transaction, the first formal document usually exchanged is an offer, usually by the buyer to the seller. The seller then either accepts or submits a counter-offer, and back and forth it goes until one side either accepts the other's counter-offer or calls off the negotiations. Upon the acceptance being communicated the two sides have successfully entered into a legally binding contract. This is true, even though such offer or acceptance documents might specifically provide that the parties agree that at some future date, they will either execute a "formal contract," and/or execute written escrow instructions. If the offer and acceptance documents contain all the major "deal points," including the identity of the property and the price to be paid, the parties will be bound to their contract.
Letter of Intent in Commercial Transactions
Unlike residential transactions, in a typical commercial sales transaction, the first formal document usually exchanged between the parties is a "letter of intent." Is a "letter of intent" ("LOI") merely the commercial equivalent of the residential offer, and do the same legal principals stated above apply? If the LOI is properly drafted, then the answer is a resounding NO! On the other hand, if the LOI is carelessly drafted, then the answer may turn out to be an unintended YES.
Given the complexities of commercial transactions, most parties do not want to be bound until all of the terms of the contract, no matter how "insignificant" such terms may appear, have been mutually agreed to. The purpose of a properly drafted LOI is to define the important terms which the submitting party is tentatively willing to incorporate into a formal contract, with the understanding that they are not legally bound to enter into a contract, even one containing the terms of the LOI, and are not legally bound to buy or sell the property on any terms or conditions, unless and until a formal contract has been executed.
Clarity is Crucial for a LOI
It is crucial that the LOI makes it absolutely clear by the words used that it is intended to be a non-binding LOI, and not a binding offer. The first rule to follow to avoid inadvertently turning an LOI into a binding offer is to never use the words "offer" or "acceptance" in the LOI. The second rule is to affirmatively state in the LOI that: "This Letter of Intent is not a legally binding document, and it does not create any rights or obligations between the parties, and the parties are not in any manner bound to the transaction until such time as they both execute a formal purchase and sale agreement."
A common mistake is to include a date by which the LOI "will expire," "be withdrawn," or words to that effect. That creates ambiguity about whether the party intends to be bound to the LOI if it is "accepted" within the deadline period. It also creates an inference that the deadline giving party is agreeing to "not shop" the property until the deadline date has passed. Such "non shop" provisions have been held to be enforceable, even when contained within an otherwise non-binding LOI, if the court believes that the parties intended to agree to keep the property off of the market during a specified period of time.
Binding & Non-Binding LOI
If the parties do not intend for their LOI to be binding, there is also no reason for the LOI to be signed by the buyer or seller, as opposed to being signed by their brokers. Although a seller or buyer may request that the other party sign the LOI, it is best to not have the seller or buyer sign, which again reinforces the non-binding nature of the document.
It is also important for a party to a mutually executed LOI to not remain silent if the other party starts to act as if the LOI is a binding document. By affirmatively advising the acting party that they are proceeding at their own risk, that the LOI is not binding and that no contract exists, they will avoid the trap of an "equitable estoppel" argument wherein one party asserts that they detrimentally relied upon the LOI in taking their actions and that the LOI should thus be enforced as if it were a contract.
The lesson to take away from this is that so long as your "intent" is made clear, and your actions are consistent with such intent, a "letter of intent" will remain just that, and not more.
About the Author: David Allen, a partner at Jaburg Wilk, has been representing clients in both transactional and litigation real estate and business related matters for over thirty years. He is licensed as an attorney in both Arizona and California, and is also a licensed Arizona real estate broker.
Founded in 1984, Jaburg Wilk offers extensive experience, diversity in practice areas and the ability to think like a business owner. We are an Arizona mid-sized AV rated law firm, the highest rating that a law firm can receive. Our attorneys, paralegals, and other support staff meet our clients' diverse legal needs and provide exceptional service through our 21 Fundamentals which comprise The JW Way.