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Beware of the “Harmless” Letter of Intent

Author: A. Howard Metro Date: 12/06/2013

Categories: Commercial Leasing, Corporate and Business Law, Real Estate Law

When you sign a “non-binding” Letter of Intent or Term Sheet before negotiating a lease, you might logically believe that you will not be bound by it. Unfortunately, based on recent trends and case law, that is not true.

Letters of Intent and Term Sheets (both referred to as “LOIs” here) serve the same purpose: they define the material provisions of the deal. They often state that they are non-binding. Once the parties sign an LOI it is commonly assumed that each party will negotiate to reach a final agreement, which includes the terms from the executed LOI. It all sounds harmless, but often the result is a one-sided document.

The Greatest Risk is the Unintended Result

Most landlords refuse to draft a lease unless a LOI has been executed. In order to provide the landlord with a timely signed LOI, tenants and real estate brokers often leave some issues unresolved and seek to protect themselves by using “non-binding” language. For example, although a LOI may include a personal guaranty it often does not include such details as who will provide the personal guaranty; the length of the guaranty; or how much of the rent the guaranty covers. Other relevant issues that can create real life business problems may simply be overlooked in the rush to finalize the LOI.

Recently, however, we have noted a disturbing trend as landlords refuse to deviate from the deal points of “non-binding” LOIs, even if new issues are presented in the proposed lease. It is the LOI or no deal. Be detailed and proactive when you negotiate a LOI with landlords and please do not sign without consulting your attorney.

Courts Are Finding LOIs Enforceable

Courts in Delaware and Maryland both found LOIs as binding. These cases provide insight into what facts and circumstances will change non-binding to binding and a Term Sheet into a contract.

In the Delaware case, a Term Sheet, which expressly stated it was “non-binding,” was found by a court to be enforceable because it also stated that the parties agreed to negotiate in good faith to reach an agreement. In the end, some aspects of the proposed agreement could not be fulfilled and one party completely ignored the duty to act in good faith. The Delaware Supreme Court awarded damages, finding that intent to negotiate in good faith was a binding duty irrespective of the “non-binding” language.

In Maryland, a similar case was decided in October of 2013. The lower court was presented with a LOI, the execution of which was a precondition to entering another agreement. Generally, such a LOI is not enforceable if the other agreement is not signed. Yet, the appeals court found it irrelevant that the second agreement was not signed because all necessary terms of the parties’ basic agreement were present and fulfilled in the LOI, which negated the need for the second agreement. Thus, absent any language expressly binding the parties, this court found that the LOI was enforceable because the parties clearly intended to be bound even though the second agreement was never prepared.

We as attorneys are staggered at how often we first see LOIs only after they have been signed. We encourage our clients to show LOIs to an attorney at an early stage, particularly with landlords and leases.

  1. Give as much care to the drafting of a LOI as to a binding contract.
  2. Do not wait to have your attorney review the LOI after it is signed. Consulting with your attorney at the earliest possible moment mitigates bad results.
  3. Think about your intent. Do you want the LOI to be non-binding or binding? Do not take this analysis lightly and make sure that the document accurately reflects your intent.
  4. Make sure you and your advisors take the time to prepare the LOI, and that it includes all important elements of the transaction(s). Leaving open issues for later requires a risk analysis. Too much ground may be lost which may not be recovered.
  5. Be careful when you use the words “good faith.” Courts tend to require a high standard of compliance.

If you have any questions regarding LOIs or have an LOI that you wish to have reviewed before executing, feel free to contact Howard Metro at (240) 778-2303 or hmetro@mcmillanmetro.com to discuss the matter.