Can a Letter of Intent be binding? Surprisingly to many, yes, it can. But what if it has the word “nonbinding” in it, even in its title? Again, surprisingly to many, yes, it can still be binding. But how can that be?
First, let’s define what a Letter of Intent, or “LOI,” is (and, to an extent, what it isn’t). Many, if not most, people intend their LOIs to be a non-binding indication of interest to explore the possibility of a transaction. Notice the words used in that immediately preceding sentence: They’re mushy, noncommittal, and lack any kind of obligation. If you want your LOI to be nonbinding, then those types of words are good to use in your document. For example, “The parties may continue to negotiate,” “The parties could enter into a definitive agreement” or “We might want to do some preliminary due diligence.”
But when you start using affirmative words like “shall,” and “will,” you start treading into the area of mandatory language, and what can mandatory words create? They can create obligations and a binding commitment. So, language like “The parties shall continue to negotiate,” “The parties shall enter into a definitive agreement,” or “We will proceed to due diligence” could be bad if your intent is to retain the legal ability to walk away from the deal if it turns out not to be what you expected.
See the differences between the sentences? The first three are carefully drafted to avoid making them sound like promises. The second three could be construed as being sloppily drafted, which could result in the person sending the LOI finding themselves bound to a transaction they might not end up wanting. Further complicating the situation of inadvertently binding yourself is that you haven’t even agreed to the detailed terms yet; all you’ve got is an agreement to agree (remember “The parties shall enter into a definitive agreement”?), and that gets messy fast because the other side knows they’ve got you over a barrel so they’re going to try to drive the hardest bargain they can.
But what if you’ve even gone so far as to use the word “nonbinding letter of intent” or “non-binding LOI” in in your document, maybe even in its title? California law says that might not even matter. If you’ve used mandatory words in the salient portions of your LOI, then those words can create a promise to follow through with the transaction, even if you’ve used the word “nonbinding” elsewhere in the document. So if you’ve sent an LOI containing such language, but after some preliminary due diligence you’ve discovered that the target is no longer interesting, then the counterparty could, if they wanted, argue that they’ve got you on a leash and they want to force you to go through with the proposed transaction.
Now, none of the above is to say that you shouldn’t consider making at least some portions of an LOI binding. Savvy parties might include language that says (paraphrased), “Upon signing this LOI, the seller shall cease marketing efforts and deal with the potential buyer exclusively, and this section is binding upon the parties,” etc. There are other terms that might be made binding, but they should probably just be the terms that create a bit of a framework around how the negotiations are to proceed in the event an LOI is signed.
If you’re considering a transaction, be it real estate, a business purchase and sale, or anything else, be very careful when initiating contact with the other side. What you write and/or say can come back to bite you if you’re not careful. A lawyer with experience in transactions and drafting and responding to LOIs can be very helpful because of one of my favorite truisms: “An ounce of prevention is worth more than a pound of cure.” Getting it right at the inception is critical, and can make or break a transaction so it’s definitely not worth saving a bit of money by avoiding a lawyer and doing it yourself. At the very least, pay a lawyer for 30 minutes or an hour to review your proposed LOI, or, even better, to draft it for you. You might be able to handle a great many other aspects of your deal, but this is a spot that can be a deep trap for the unwary.
Greg Borman is an attorney in San Diego, California, and he has advised and represented businesses and their owners on all manner of transactions, including the drafting and negotiation of LOIs. He can be reached at firstname.lastname@example.org and/or at (858) 232-7100.