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Plugging the gap

15 July 2009

A letter of intent can be a useful device to plug the gap during commercial negotiations pending agreement of a final contract.

However, for those involved in the legal process, the letter of intent has the potential to create more problems than it solves. The danger is that once a project starts and a letter of intent is signed, the parties may focus on the work being carried out rather than the potentially difficult contractual issues that have yet to be resolved and agreed. Given the potential for problems, are letters of intent ever appropriate or should their use be restricted to certain circumstances?

Parties to commercial negotiations often wish to document their progress in writing. Letters of intent can come in a number of guises and are sometimes known as heads of terms or agreement or memoranda of understanding. Whatever they are called, their significance and whether they are legally binding (or certain provisions are binding), depends on each transaction and the drafting of the document. Even where they are not legally binding, they can create a strong moral commitment and so should be considered with caution.
Letters of intent can provide a useful structure against which to negotiate the main contract terms, enabling the parties to flush out in the heads what the significant issues are. However, they can also leave the contractual position unclear.

Unless specifically dealt with, it can be difficult to know if the provisions in the letter of intent are legally binding. The words ‘subject to contract’, while helpful, may be insufficient.

The conduct of the parties, and communications between them, will be key to any determination in court as to how long the terms operate. For instance, in a recent case, the letter of intent indicated that full contractual terms would be signed within four weeks.  The High Court ruled that this term expired at the end of the four-week period and no longer applied after that date.

A letter of intent can cause the parties to lose momentum in coming to a full and final agreement. This appears to be what happened in a recent case where the parties, despite having agreed the detailed terms to the full formal contract at a relatively early stage, never signed it. It meant that the relationship between them continued to be governed by the letter of intent with potentially severe consequences for the supplier.

Practical points to include in a letter of intent

Legally binding

  • Specify which terms are intended to be legally binding. It may be sufficient to limit these to the governing law and confidentiality terms. In corporate finance transactions, the exclusivity or lock-out provisions may be binding. In other cases (eg the provision of interim services), it may be more appropriate to specify that all terms are binding, including limits on liability, or to insert standard terms.

Good faith

  • Where an agreement is not subject to contract, the parties may include an obligation to negotiate ‘in good faith’. This means that each party must observe moral and ethical standards in negotiations and not break off without reasonable cause.

Duration

  • There may be a specific time period over which the letter of intent applies. Any extensions of the letter should be carefully documented and the parties should not continue to trade after expiry of the letter of intent.

Costs

  • In commercial situations, it is wise to include specific cost underwriting provisions in the form of an indemnity. If possible, clarify that even in a ‘breach’ scenario the party underwriting the costs still agrees to meet them.

Scope of the works

  • Consider the scope of any works covered by the letter of intent. If instructions are given for additional works, it is possible that these might not be governed by the terms of the letter.

Commercial terms/limits on liability

  • If the letter of intent is to cover interim services, then a supplier should consider including limits on its liability in respect of those services. It may be worth attaching standard terms and conditions to the letter where appropriate.
  • Lock-out provisions and confidentiality obligations  Any lock-out provisions should be for an appropriate duration and legally binding. Confidentiality obligations should be tailored to the specific circumstances.

Jurisdiction and governing law

  • The governing law provision should be appropriate but should also take account of the implications of local law if the activities or parties are in other jurisdictions.

Entire agreement

  • The interaction of the letter of intent with any subsequent contract should be looked at carefully. Should the current letter supersede all previous correspondence and negotiation? Should the subsequent main contract supersede the letter of intent?

 

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Chris Wills LLB (Hons)
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