Are letters of intent binding?

Even a document labeled “letter of intent” (LOI) may be enforced by a court of law as a binding, enforceable agreement if the court determines that the parties intended the document in question to be a binding agreement at the time it is signed.

Are You Kidding Me?

No. And when a business owner is threatened with the potential loss of a company as a result of an adverse court ruling, they do not view the matter as a joke.

First and foremost, business owners thinking about selling a business — and prospective buyers interested in purchasing a business — must understand that virtually any writing signed by a prospective seller and a prospective buyer can be characterized as a binding, enforceable contractual undertaking. And believe me, if someone thinks they have negotiated a good deal they do not want to lose, they can — and likely will — claim that any agreement that benefits them is a binding agreement.

What Do Courts Look At?

Under traditional principles of contract interpretation, a court of law is required to initially determine whether the language of a document is ambiguous as to parties’ intentions. If no ambiguity is found to exist in the subject document, the intentions of the parties will be derived solely from the language of the document itself. If, on the other hand, the terms of an alleged contract are deemed to be ambiguous or capable of more than one interpretation, evidence can be considered by the court before reaching a determination as to what the parties may have intended or understood at the time they executed the subject document.

As if that is not all confusing enough, certain states will allow a court to consider extrinsic evidence (i.e., evidence other than the language of the document in question) to determine whether or not an ambiguity exists. In the view of the Illinois Supreme Court, for instance, an extrinsic ambiguity exists when someone who is familiar with the context of events surrounding the execution of the document in question testifies that the document in question actually means something other than what it seems to mean.

How does this affect me?

Let me answer this common question with a personal story: In the Fall of 1999, I was engaged to represent a privately held printing company that had previously entered into a letter of intent with a prospective purchaser. In it, the client had understood that he was agreeing only to cooperate with the prospective purchaser in facilitating some initial financial due diligence. During the course of the ensuing due diligence process, it became clear to the client that the prospective buyer was not looking for financial information that would support the contemplated purchase price that had been set forth within the terms of the letter of intent. Rather, the prospective buyer was looking for financial information that could be used for their own benefit in attempting to renegotiate a lower purchase price.

Once the prospective seller understood the prospective purchaser’s apparent intentions, they terminated the due diligence process and refused to allow the prospective buyer any further access to either their physical work facility or financial information. The prospective buyer filed a lawsuit, claiming that the letter of intent was, in fact, a binding contract and requesting the court enter an order compelling the sale of the subject printing company, pursuant to the terms set forth in the signed letter of intent. Needless to say, the prospective seller was both surprised and upset by the lawsuit. Worse yet, the prospective seller was forced to incur hundreds of thousands of dollars in expert and related legal fees, defending the subject lawsuit — which it was ultimately able to do.

An expensive lesson, to say the least — and one that Morgan & Westfield’s clients and readers (as well as their transactional attorneys) would do well to heed.

So How Do I Protect Myself?

If you are an owner thinking about selling your business, or a prospective buyer thinking about buying an existing business, you should already know the answer to this question: Make certain you are working with knowledgeable third-party professionals before drafting and/or signing anything that pertains to the sale or purchase of a business — even something as seemingly unobtrusive as a letter of intent.

Buyer Makes an Offer or Issues Letter of Intent; Due Diligence Begins

The buyer makes an offer to the seller. If the seller accepts it, the buyer will make an initial deposit, which will be placed into escrow with an escrow company. When the seller countersigns the letter of intent or offer, the due diligence process begins. The buyer and seller will try to resolve the contingencies before the end of the due diligence period. If the period is set to expire and the parties need more time, the parties may agree to extend the timeframe.

These shorter documents do not contain the necessary language to affect a proper closing; however, they allow the parties to agree on the essential terms and move the deal forward. A more comprehensive offer to purchase, or definitive purchase agreement, should replace the shorter offer to purchase form, letter of intent, or term sheet. Replacing the shorter offer to purchase form, LOI, or term sheet with a more comprehensive offer to purchase is important. Here’s how the language we usually use looks:

“Seller and Buyer agree to replace this Offer to Purchase/Letter of Intent with a Definitive Purchase Agreement within five business days of acceptance.”

Purchasers of small businesses tend to use an offer to purchase, while buyers of mid-sized businesses tend to use a letter of intent. LOIs are commonly used for mid-market transactions with asking prices of $5 million to $50 million. Most LOIs are drafted by the buyer and reviewed by the seller’s attorney. In other words, these are all almost always custom drafted. For this reason, we do not need to address this.