Letters of Intent—Enforceability Issues
By Alfred M. Meyerson and Thad H. Armstrong
Alfred M. Meyerson is a partner and Thad H. Armstrong an associate in the Houston office of Thompson & Knight LLP.
Letters of intent are efficient tools used on a daily basis to get the ball rolling in real estate leasing transactions. They focus the parties on the material terms of the deal, psychologically commit them to the deal, and provide the skeleton for what will ultimately become the contract.
This article examines three categories of letters of intent—the fully binding, the nonbinding, and the partially binding letter of intent—and suggests drafting techniques designed to best achieve a client's goals. First, however, it is important to review some basic principles of enforceability that thread through all types of letters of intent.
Principles of Enforceability in General
For a letter of intent to be a binding contract, it must contain a manifestation of the parties' intent to be bound as well as the parties' agreement to the essential or material terms of the contract.
The most fundamental ingredient in any contract is the intent of the parties to be bound. If the parties do not manifest this intent, a court generally will not enforce the purported contract. Therefore, depending on a client's goals, an unequivocal statement respecting the parties' intent or lack thereof must be included in any letter of intent.
One commentator noted the following language that has been held to indicate an intent to create a binding obligation:
o"Please indicate your acceptance on the enclosed copy of this letter and return to us."
o"The parties will execute a definitive lease in the usual standard form of business lease in this community."
o"Please acknowledge your intent to proceed with the leasing of the captioned store under the above terms, conditions, and understanding by signing the enclosed copy of this letter and returning it within 10 days from the date hereof."
o"The parties agree to usetheir best efforts to reach an agreement."
John S. Hollyfield, Letters of Intent, Commercial Real Estate Leases: Selected Issues in Drafting and Negotiating in Current Markets, ALI-ABA Continuing Legal Education (May 31, 2001), available at Westlaw, SF85 ALI-ABA 225.
The following language, however, has been held to indicate an intent not to create a binding obligation:
o"The outline of our futureagreement."
o"This is a general understanding of the agreement."
o"When we have a draft we will discuss it and hopefully shall have a completed contract."
o"The validity of said proposed agreement is subject and conditioned on the parties agreeing upon and reducing to writing all terms and conditions necessary and incidental to the validity of said proposed agreement."
Ambiguous language about the parties' intent can often lead to the creation of an enforceable contract, especially in the case of real estate transactions, when the letter of intent contains all the material terms of the transaction (as discussed below). The safest—and best—way to avoid the pitfalls of ambiguous language is simply to know the intent of the parties and clearly state it.
Generally, a court will not specifically enforce a letter of intent when the purported agreement does not set forth all the essential or material terms. In real estate leases, the essential terms will in all likelihood include an adequate description of the property, the amount of the rent, the term of the lease, the time and manner of payment, and other matters typical to real estate transactions, such as the date of closing, representations and warranties, and brokerage commissions. Jurisdictional variations, however, should be confirmed before relying on theforegoing.
Duty to Negotiate in Good Faith
The Restatement (Second) of Contracts § 205 provides that every contract imposes upon each party a duty of good faith and fair dealing. A letter of intent purposely drafted to be nonbinding does not create an enforceable contract, and thus it imposes no duty of good faith and fair dealing. But a court could enforce a party's obligation to negotiate in good faith if an otherwise nonbinding letter of intent provides for such an obligation. Therefore, when an otherwise nonbinding letter of intent provides for an obligation to negotiate in good faith, one party's breach of the obligation is actionable.
A letter of intent that provides for an obligation to negotiate in good faith should prevent a party from renouncing the deal altogether, abandoning negotiations, or insisting on terms that do not conform to the letter of intent. See Teachers Ins. & Annuity Ass'n of Am. v. Tribune Co., 670 F. Supp. 491, 498 (S.D.N.Y. 1987). For example, in Channel Home Centers v. Grossman, 795 F.2d 291 (3d Cir. 1986), a prospective tenant and a landlord signed a letter of intent whereby the landlord agreed to take the property off the market and to negotiate the lease to completion.Although the lease negotiations were ongoing, the landlord received an offer from another prospective tenant for more than double the amount offered by the first prospective tenant. The landlord subsequently abandoned negotiations with the first prospective tenant and was sued. The court found that the letter of intent between the landlord and the first prospective tenant imposed an obligation on the landlord to negotiate in good faith and held that the landlord breached this obligation by failing to show an adequate reason for abandoning negotiations.
Of course, if a letter of intent can impose an obligation to negotiate in good faith, it can similarly provide that the parties are not so obligated. If this is a client's intention, the letter of intent should provide that neither party is obligated to execute a final agreement and that either party may, in its sole discretion, refuse to execute a final agreement.
The doctrine of promissory estoppel provides another means of enforcing letters of intent. See RESTATEMENT (SECOND) OF CONTRACTS § 90 (a promise that the promisor should reasonably expect to induce action or forbearance on the part of the promisee and that does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise). Therefore, even if a letter of intent is otherwise unenforceable because of a lack of an essential term, a court may still award damages to a party that changed its position in reliance on a belief that the other party would proceed with the transaction.
For example, in Mooney v. Craddock, 530 P. 2d 1302 (Colo. Ct. App. 1974), a landlord promised a prospective tenant that he would construct a building to house the tenant's business, but the parties failed to agree on the amount of space to be rented and the time and method for rent payments, two essential elements of a lease under Colorado law.Even so, the court found that the prospective tenant had spent a great deal of money for the purchase of equipment, had invested considerable amounts of time and effort in promoting his business, and had acted to his detriment in several other respects. The court held that these facts justified invoking the doctrine of promissory estoppel and thus awarded damages under the otherwise unenforceable lease.
Conduct of the Parties
As noted above, ambiguous language of intent can lead to a binding agreement even though the parties may not have intended such a result. But language alone is not dispositive; the parties' conduct can be probative. The most famous examples illustrating this point are the cases of Texaco, Inc. v. Pennzoil Co., 729 S.W.2d 768 (Tex. App. 1987), and Seaman's Direct Buying Service, Inc. v. Standard Oil Co., 686 P.2d 1158 (Cal. 1984). In Texaco, the court found a "memorandum of agreement" to be a binding agreement because one party announced in a press release that it had reached an "agreement in principle" with the other. In Seaman's, the court held that a letter of intent was a binding contract because when the letter was signed, one party stated: "We finally have a contract" and "shouldn't we have souvenir pens here . . . ." Seaman's, 686 P.2d at 1161.
Because conduct can reflect a party's intent, the parties should be advised to act consistently with their intentions as set forth in the letter of intent. Otherwise, one party's inconsistent conduct could give the other an argument grounded in promissory estoppel or breach of the duty to negotiate in good faith.
The Nonbinding Letter of Intent
As set out above, an enforceable letter of intent must include two essential elements: a manifestation of the intent to be bound and all the essential terms of the deal. Therefore, to draft an unenforceable letter of intent, the intention of the parties not to create a binding agreement must first be unequivocally expressed. Second, as discussed below, it is advisable to omit at least one of the essential terms of the agreement. For the sake of clarity, this statement of intent should be contained in the introductory paragraph.
As a practical matter, the drafter wanting to avoid the creation of a binding agreement should not use contractual terms such as "agree," "this agreement," or "contract." Rather, it is advisable to use "propose," "we propose," and "proposal." Edward A. Peterson, The Letter of Intent: To Be Enforceable or Not to Be Enforceable, 12th Annual Real Estate Law Conference, South Texas College of Law (June 13, 1996). Furthermore, no press releases or similar announcements should be made relating to the transaction or the letter of intent, no nonrefundable fees should be paid or accepted, and the letter should contain a hard "drop dead date" after which neither party will be bound if the ultimate agreement has not been executed. Douglas W. Becker, "We Don't Have an Agreement, Just a Letter of Intent," 30th Annual Mortgage Lending Institute, University of Texas School of Law (Sept. 12, 1996).
Of course, the simplest way to avoid enforceability is to omit an essential term. In the case of real estate transactions, an easy way to accomplish this is to purposely draft the letter of intent with an inadequate description of the property.
Nevertheless, as suggested above, a court could find that a letter of intent is at least partially enforceable based on an obligation to negotiate in good faith. If a letter of intent is intended to be completely nonbinding or if the parties desire to negate the obligation to negotiate in good faith, a provision must be clearly drafted stating that any party may terminate the negotiations at any time and for any reason.
The Fully Binding Letter of Intent
To create a fully binding letter of intent, attorneys must keep in mind the basic principles of contract law, as recognized in a recent Texas case: "To form an enforceable contract, there must be an offer, an acceptance, and a meeting of the minds, and the terms must be expressed with sufficient certainty so that there will be no doubt as to what the parties intended." Harris v.
Balderas, 27 S.W.3d 71, 77 (Tex. App. 2000). Creating a binding letter of intent is thus achieved by applying the following rule: the letter must unequivocally express the parties' intent to be bound and include all the essential terms of the deal.
Furthermore, terms unique to real estate transactions should be included in a binding letter of intent because, although they are not essential to the formation of a contract, a court will not imply these terms if they are not set forth in a binding letter of intent. Therefore, terms respecting the date of closing, the condition of title, rental rates, lease term, tenant improvements, conditions to closing, representations and warranties, and any special provisions must be expressly set forth in a binding letter of intent.
The Partially Binding Letter of Intent
Most often, the parties will be wary of creating a fully binding letter of intent, but at the same time they will want the letter to set forth some preliminary obligations that will be binding and enforceable. In this case, a partially binding letter of intent can achieve the parties' goals.
As with the other two types of letters of intent, clearly defining the parties' intentions is crucial. To that end, it is advisable to draft the letter in two distinct parts, the nonbinding part and the binding part, and to preface each part with an express manifestation of intent.
Nonbinding provisions may include the rental rate, representations and warranties, lease term, tenant improvements, surveys, and conditions to closing, but they should always be tailored to meet the specific goals of the parties.
Provisions that the parties may want to be binding, irrespective of whether an ultimate contract is executed, typically include the following:
oThe landlord's granting the prospective tenant a right of inspection, which may include environmental testing.
oThe landlord's granting the prospective tenant access to the landlord's business information and records for purpose of due diligence.
oAn indemnification provision protecting the landlord from any damages or injuries resulting from the prospective tenant's investigations.
oThe tenant's agreeing to keep the results of its inspections and due diligence confidential and not to use the information to the detriment or in competition with the landlord.
oA "lock up" or "no shop" provision whereby the landlord agrees not to initiate or entertain third-party offers or to take the property off the market for a certain period of time.
oIdentification of brokers and amounts of commissions.
oAn agreement whereby neither party may make a press release about or otherwise announce the possible transaction.
oA cost-allocation provision setting forth who pays particular costs and expenses.
oA "drop dead" date after which neither party will be bound if the ultimate agreement has not been executed.
oThe governing law.
If the letter of intent is not in itself an enforceable agreement, any provisions that the parties intend to be binding should—and in some jurisdictions must—be supported by independent consideration. For example, in OfficeMax Inc. v. Sapp, 132 F. Supp. 2d 1079 (M.D. Ga. 2001), a landlord, Sapp, and a prospective tenant, OfficeMax, signed a letter of intent that included a "non shop" provision whereby Sapp promised not to negotiate a lease of the same premises with third parties. Sapp, however, engaged in negotiations with a competitor of OfficeMax that resulted in a lease agreement with the competitor. OfficeMax subsequently sued for breach of contract. The court found that the letter of intent was not a binding lease agreement between Sapp and OfficeMax because it lacked all the essential terms and the "non shop" provision was unenforceable as a separate covenant because it was not supported by independent consideration.
Letters of intent are valuable tools: they can save time and money and help facilitate an ultimate contract. To be most effective, however, the lawyer must know the client's goals and make sure the letter of intent accurately and unequivocally reflects those goals.
This article has pointed out the differences in the three types of letters of intent and suggested drafting techniques to help the drafter achieve the parties' desired goals. Because its legal consequences can be great, a letter of intent deserves the same attention to detail as any other legal document, and lawyers must understand the potential consequences of careless drafting. Otherwise, as one commentator put it (see Peterson, supra), a party to a letter of intent may not know what it has really signed until a jury has spoken.