Making Sure There’s No Deal Until There’s A Deal

2013 All Rights Reserved. Arizona Attorney

WHAT YOU NEED TO KNOW ABOUT DRAFTING AND LIVING WITH LETTERS OF INTENT

1. The Risk of an Unintended Binding Contract.

   Blue, Inc. and Green, LLC, two sophisticated commercial parties, agree to begin negotiations for the formation of a joint venture. Blue and Green are both enthusiastic about the proposed venture and believe it would be a profitable endeavor. Green drafts a letter of intent and both parties sign it. The letter of intent lists the basic elements of the proposed venture. It also provides - in its opening paragraph - that the parties are not entering into a binding agreement and do not intend to be bound unless and until several other agreements - the deal documents - are fully negotiated and signed.

   Blue and Green then begin to negotiate the specific terms of the proposed venture. During the following 18 months, they exchange numerous red-lined drafts of the deal agreements. Blue and Green also collaborate in planning and preparing for the venture: their executives work closely together on developing a business plan and often refer to one another as "partner" in email communications. Blue and Green form a jointly-owned LLC, which would eventually manage the proposed venture, although neither party contributes any capital to it. Blue, on behalf of this newly formed LLC, places a multi million order for several pieces of equipment that would be used in the venture's business, although it is ultimately canceled. Blue also hires an architect and an interior decorator to design a facility that it would eventually lease to the joint venture and involves Green in the design process. The parties also design the signage for the new facility and even set a date for a groundbreaking ceremony to mark the beginning of the facility's construction. After 18 months, Green and Blue have agreed on nearly all the terms of the venture agreements, although neither party has signed any of the agreements.

   At that time, however, regulatory changes lead Blue to the conclusion that the proposed venture would be a losing proposition. Blue announces that it will not proceed with the venture. Green, dismayed, sues for breach of contract. Because neither party signed any of the (nearly finalized) venture agreements, Green claims that the parties are bound by a conduct-based oral agreement. Green seeks to recover over $20 million in alleged lost profits.

   So, which prevails - the parties' initial express agreement not to be bound until certain conditions are met, or their subsequent conduct, which arguably evidences mutual intent to be bound?

   Unfortunately, this is not an unusual chain of events. The sheer number of cases across the country involving some version of this scenario reflects the inherent risks involved in drafting a letter of intent and, more significantly, living with one. A carelessly drafted letter of intent can be viewed by one party as a binding agreement while the other party believes it is merely a tentative framework for future negotiations. But, as the Green vs. Blue case demonstrates, even a well-drafted, expressly non-binding letter of intent may not be enough to save a party from the costs and uncertainty of litigation when the parties' subsequent communications or conduct could be interpreted as intent to be immediately bound or, worse, as actual performance of an oral agreement.

   In other words, it is not enough to draft the perfect letter of intent. In-house counsel and businesses should be aware of the possible consequences of subsequent communications (particularly written ones, including email) and other conduct that may later be construed as superseding or somehow waiving the earlier agreement not to be bound. In the real world of complex business transactions, where significant investment and collaboration are routinely required just to reach a deal, it is often impossible to avoid such communications or conduct. Bearing the risks in mind and following a few simple guidelines, however, will help to keep both parties' expectations aligned and may save either party from the unintended consequence of a binding agreement or, at the very least, from costly litigation.

2. How Do Courts Deal With Letters Of Intent?

   In Arizona, as in virtually every jurisdiction in this country, a contract (including a partnership) may be found based on parties' oral communications or conduct if it is clear the parties intended to bind themselves, even where they also plan to formalize their agreement in writing and even if certain terms are still missing. Blue and Green did much more than negotiate the terms of the proposed venture. They engaged in collaborative preparatory work: They drafted a business plan, formed a joint entity, worked together to design the venture's facility and even...