Letters of intent

What are letters of intent?

A Letter of intent (LOI) is a letter from one party to another (eg from one business to another) that provides the basis for a proposed future agreement (ie contract). An LOI should be signed by both parties. A letter of intent could, alternatively, be drafted as an agreement between the 2 parties (ie as Heads of terms) - this will have the same effect.

An LOI can be used in many contexts to record negotiations and discussions where the outline and any details of the terms of a future agreement have been agreed upon. It’s not necessary for the negotiations to have been completed; they may be ongoing.

What happens after an LOI is signed?

Once an LOI is signed, the parties should do whatever they’ve agreed is necessary in order to be ready to enter into a final agreement. For example, by continuing negotiations and fulfilling any preconditions set out in the LOI. During this time, any legally binding parts of the LOI should be adhered to.

Once all requirements have been satisfied, the parties should draft and sign a final legally binding agreement (ie contract). Only once this final agreement has been signed should the parties definitively start acting on the obligations under it.

When are letters of intent used?

An LOI is generally used to show each party’s commitment to a long-term project or if the nature of a proposed agreement is such that it will take a long time to complete. 

This is generally because larger projects, such as construction contracts, tend to have lots of fine details that need smoothing out before the final agreement can be signed. 

Having an LOI in place can help a party to feel confident beginning to organise necessities for delivering their obligations under the proposed contract, even while the finer details are still being negotiated. For example, an LOI can be very useful for construction contracts, as it can enable one party to start the procurement of materials or preparation of sites before the final contract is signed. When undertaking such preparations, a party should be careful not to act too much to its detriment, as a final contract still may not be formed. 

Other examples of agreements for which it might be suitable to use an LOI include: 

• Business purchase agreements (eg an asset purchase agreement or a share purchase agreement)

• contracts for the purchase of property (ie real estate)

• Joint venture agreements

• Services agreements

• outsourcing agreements

What’s covered in a letter of intent?

An LOI will often cover the following issues:

• the key obligations of the parties under the proposed agreement

• the details of the proposed agreement (eg other terms that have been agreed to at the current stage of negotiations)

• the target date for signing the final agreement

• which party will produce the first draft of the agreement

• legally binding obligations of confidentiality, non-solicitation, and exclusivity, to protect the parties during the continued negotiations

The party that produces the first draft of the agreement will generally have more control over the final document. The other party may be happy to agree to this if they don’t have professional representation (eg their own solicitor) and may prefer to amend a document drawn up by the first party.

Preconditions 

An LOI will usually also cover preconditions to signing the agreement. Preconditions are requirements that the parties agree must be met before they will enter into the final agreement. 

Preconditions may require, for example, the production of certain key documents or approvals by external agencies (eg export control or safety certification bodies). 

If either of the parties is a company, check the company’s Articles of association and any Shareholders’ agreements to see if the shareholders’ approval is needed for the company to enter into the proposed agreement. In this case, obtaining such approval may be a suitable precondition to include in an LOI. If the parties are partnerships, the approval of the members may be needed before the partnership can enter into the proposed agreement. Check the partnership’s Partnership agreement for details on how such decisions must be made. 

One of the most common pre-conditions is the satisfactory completion by one or both sides of a due diligence exercise. This is an investigation into the other party (eg into its finances and business operations) to find out any key risks to the other business posed by the proposed transaction. These can then be dealt with in the agreement.

Are letters of intent legally binding?

A letter of intent (or Heads of terms) as a whole will not be legally binding. Usually, LOIs contain some terms that do not legally bind the parties and others that are legally binding and enforceable. 

The advantage of this is that the parties are not bound by the negotiations themselves. If one party decides to pull out, there is little that can be done to make them continue the negotiations. It is essential that an LOI document is drafted so as to make this clear. For example, it should contain the words 'subject to contract'. 

The parties may agree within an LOI that certain terms of the LOI are to be legally binding. These will be legally binding when the LOI is signed, regardless of what happens with the final agreement. Such terms are generally included to protect the parties against any risks inherent in their negotiations. For example:

• confidentiality provisions - if the parties have not already signed a separate Confidentiality agreement, a confidentiality provision in an LOI will create legally enforceable obligations of confidentiality between the parties (eg to protect any trade secrets or other information disclosed to facilitate negotiations)

• non-solicitation provisions - these prevent the parties from poaching each other’s employees or customers (eg those that they’re introduced to during negotiations). Such a provision must be reasonable both in scope and time

• exclusivity provisions - these prevent the parties from negotiating with anyone else for a period of time. The use of a time limit is a good way of putting pressure on the parties to progress with negotiations. The time limit should be reasonable, given the nature of the transaction in question