May 2007
Volume 3, Number 1
Table of Contents

The Structure and Use of Letters of Intent

By Gregory G. Gosfield

The primary utility of a letter of intent is setting the binding ground rules of a negotiation. A secondary use is to raise issues or allude to special circumstances in a vague, nonbinding fashion to provide some context to the interest of the parties. The fundamental source of contention over the intent of the letter is that it usually attempts to accomplish two purposes—and these purposes assume contradictory positions. The prime cause of problems is that the parties fail to accept the practical situation that some provisions must be static, concrete, and contractually binding and that other provisions must be fluid, perhaps vague, and nonbinding.

In distinguishing the two types of provisions, the touchstone is that only some provisions are agreed upon as enforceable obligations as a condition of negotiations. These binding provisions are the preconditions to contractual negotiation for a transaction and comprise a prenegotiation contract. These provisions should be valid, binding, legal, and enforceable.

The other provisions, the hypothetical terms of the possible business transaction, are optional contract terms that, if agreed upon, would create a purchase-and-sale contract. However, these hypothetical terms of the potential transaction should not be valid, binding, legal, or enforceable until intended to be as reflected by the fact that the circumstances match the conditions of enforceability. The distinction can be signified with more decisiveness: the drafter can prepare one writing, in the form of a binding letter agreement, to establish the conditions to negotiation, and prepare in a separate writing the nonbinding business terms.

Choosing the purpose. Absent a manifested resolution of the purpose, the court will step in to find the meaning that will bind the parties, whether by interpreting what is or construing what ought to be. The court characterizes the purpose of the letter, either as: (1) a mere gesture showing interest in the possibility of a transaction (agreement of interest); (2) a serious commitment to negotiate toward agreement upon a possible transaction (contract to negotiate); (3) an orderly collection of the necessary contractual terms ready to be binding, but missing the key ingredient—the intent to be bound (agreement subject to written contract); and (4) a patently enforceable contract, albeit in an abbreviated or informal format (contract for settlement).

Is there a contract, a duty, or a liability? The most ironic part of the ambiguity surrounding letters of intent is that even though this type of writing is generally captioned "Letter of Intent," the most contentious element is, first, whether intent exists, and second, if it does, whether it is the intent to form or not form a contract. There are usually four indicia of lessening significance to find what intent exists in the letter of intent: (1) does it contain an express statement by the parties, (2) did one party perform based either on the terms of the letter or on the party's reliance that the letter would reflect the performance, (3) are the essential terms of a contract included or determinable, and (4) does it contain formalities and other displays of solemnity that are customary for contracts of that kind?

Along with intent and essential terms, consideration is a third requisite element of enforceability that distinguishes private agreements from enforceable agreements. Consideration is generally considered to exist when one party either diminishes its own position, enhances the other party's position, gives a promise in exchange for a promise, or when sufficient solemnity has been demonstrated. But, when one party has an exclusive right of discretion to proceed under an irrevocable offer (in the case of a buyer, when there is an unfettered inspection right, and in the case of a seller, when there is an unfettered approval right by the board of directors), there is a threat that the exclusive discretion prevents the existence of consideration. The legal formality of consideration may be circumvented under the doctrine of promissory estoppel to the extent a party is seeking only damages rather than specific performance. When the party claiming promissory estoppel expects the other party to rely on the letter of intent to commence performance, a court can use its discretionary power to find that the promisee relying on the letter is entitled to damages notwithstanding the promisor's reservation of discretion.

Assuming the three fundamental contractual elements are present, real estate agreements generally are expected to be written contracts and subject to the statute of frauds. If the aggrieved party cannot prove a contract complies with the statute, then specific performance is not available to the aggrieved party. Courts are traditionally reluctant to insert missing terms to rehabilitate the contract for it to comply with the statute. On the other hand, when a sequence of writings can be combined and all essential terms for a binding agreement can be found, the contract may be enforceable. A parallel doctrine of "part performance" was adopted to provide relief from the statute of frauds and to reinforce that partially performed contracts can be specifically enforced, even if they otherwise fail to comply with the statute of frauds. Therefore, courts can continue to find a different path to relief for the plaintiffs by using the part performance doctrine. With part performance, because no contract is found, the court may find damages equivalent to reliance damages, rather than expectation damages.

Generally, because specific performance requires a showing that money damages are an inadequate remedy, money damages are the more common remedy. But because of the unique nature and quality of real estate as an asset, specific performance is a meaningful and available remedy. Courts may fashion damage calculations commonly grouped under expectation damages, reliance damages, and restitution damages. Expectation damages are the monetary equivalent of specific damages because they pay the amount of value the buyer would have had if the contract had been specifically performed. Reliance damages are measured by the amount necessary to put the buyer in as good a position as it would have been if it had never entered into the contract. Restitution damages are the amounts needed to restore to the buyer any benefits obtained by the seller from third parties for not having completed the sale to the buyer.

Separating binding and nonbinding provisions. There are essentially 11 binding provisions: (1) intent; (2) good faith; (3) disclaimer of exclusivity; (4) disclaimer, release, indemnification, assumption, and waiver; (5) limitation of liability; (6) confidentiality; (7) approval and authority; (8) expenses; (9) access; (10) termination; and (11) miscellaneous provisions. Miscellaneous provisions include such things as compliance with applicable laws and requirements of governmental authority; choice of law and venue; merger provisions as to the binding provisions to avoid parol evidence and to retain enforceability to the extent the owner believes it retains significant rights with respect to the obligations it has taken on; and prohibitions on assignment to confirm the party negotiating will be responsible for contracting and settling.

Nonbinding provisions are ordinarily terms that continue to be negotiated to reach a final definitive purchase-and-sale contract. The terms include price: how much is to be paid, when it is to be paid, and adjustments if the payor pays expenses that the payee might otherwise be expected to pay, such as broker commissions, transfer taxes, and permit fees.

Gregory G. Gosfield is a partner at Dechert LLP in Philadelphia, Pennsylvania.

For More Information About The Real Property, Probate And Trust Law Section

- This article is an abridged and edited version of one that originally appeared on page 99 of Real Property, Probate and Trust Journal, Spring 2003 (38:1).

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