The Enforceability of Letters of Intent
With the overall improvement in the economy and the accelerated pace of real estate transactions, parties are increasingly relying upon letters of intent to hold deals in place while formal contract terms are agreed upon and drafted. Letters of intent have several advantages, allowing parties to quickly agree upon and document the key deal points without negotiating full agreements beforehand. And, with broad deal points agreed upon, it can then be easier to identify the remaining open items and address them in the formal agreements that are prepared following the execution of the letter of intent. Letters of intent frequently permit the parties to begin due diligence, and may contain exclusivity and non-circumvention clauses as well.
But what happens when, instead of finalizing the transaction, the deal falls through, perhaps where one of the parties uses the letter of intent to shop the deal around for better terms? Is the letter of intent an enforceable agreement that would give rise to liability in such a case? This article examines the issue.
In determining whether the breach of a letter of intent (LOI)can give rise to a cause of action, courts look to the intent of the parties as expressed in the LOI to determine whether the parties intended to be bound. Accordingly, "when the parties have clearly expressed an intention not to be bound until their preliminary negotiations have culminated in the execution of a formal contract, they cannot be held until that event has occurred."1 Where an LOI "leaves for future negotiation [material] provisions,….[a]bsent any indication in the letter of intent of an objective method, independent of each party's mere wish or desire, upon which to make these provisions definite, [courts will] decline to supply them by implication."2 This is because "an agreement to agree, which leaves material terms of a proposed contract for future negotiation, is unenforceable."3
On the other hand, where "[t]he plain language of the LOI manifests the parties' intent to be bound by its terms [and] it does not contain an express reservation by either party of the right not to be bound until a more formal agreement is signed," the LOI will be enforced.4
Accordingly, in determining whether an LOI is enforceable, courts are required to determine "whether the agreement contemplated the negotiation of later agreements and if the consummation of those agreements was a precondition to a party's performance."5
Applying these standards, courts have refused to enforce LOIs where there was no indication that the parties intended to be bound, but have regularly enforced LOIs where such an intent is expressed.
For example, in Amcan Holdings v. Canadian Imperial Bank of Commerce, the plaintiffs approached CIBC seeking financing for the acquisition of a company as well a refinancing of existing debt.6 The parties negotiated and executed a term sheet that, like most letters of intent, outlined the proposed terms of the financing. The term sheet provided that "[t]he Credit Facilities will only be established upon completion of definitive loan documentation, including a credit agreement…which will contain the terms and conditions set out in this Summary in addition to such other representations…and other terms and conditions…as CIBC may reasonably require."7 The term sheet contained detailed descriptions of the credit lines to be provided, the amount of funding under each, amortization and interest rates, fees, security, a proposed closing date and definitions of key terms.8
After execution of the term sheet, CIBC broke off negotiations and the contemplated financing was never closed.9 The plaintiffs thereafter commenced an action for breach of contract based on CIBC's failure to close the loan, breach of the covenant of good faith and fair dealing, and fraud. CIBC moved to dismiss, arguing primarily that the term sheet was not a binding agreement, but was merely an agreement to agree. In affirming the dismissal of the complaint, the First Department held that because the term sheet provided that the credit facilities would only be established upon the execution of loan agreements, the term sheet "was clearly dependent on a future definitive agreement, including a credit agreement. At no point did the parties explicitly state that they intended to be bound by the summary pending the final credit agreement."10
Moreover, the First Department rejected the plaintiffs' argument that the term sheet was enforceable because it contained all of the material terms of the agreement:
[t]he fact that the [term sheet] was extensive and contained specific information regarding many of the terms to be contained in the ultimate loan documents and credit agreements does not change the fact that defendants clearly expressed an intent not to be bound until those documents were actually executed.11
Similarly, in Aksman v. Xiongwei Ju, the parties entered into an LOI in contemplation of entering into a joint venture agreement for the development of certain software.12 The LOI set forth each parties' contemplated contributions to the joint venture and provided that the software was to be the joint property of both parties and could not be used outside of the joint venture.13 After the software was developed, the defendant allegedly used the software in violation of the provision of the LOI that precluded the parties from using the software "outside of this partnership without explicit consent of both parties."14
Following the plaintiff's commencement of an action seeking damages for breach of the LOI, the defendant moved to dismiss, arguing that it was an unenforceable agreement to agree. The First Department agreed, holding that the terms of the LOI demonstrated that it was "a preliminary, nonbinding proposal to agree, conclusively negat[ing] plaintiff's breach of contract claim."15 The First Department reached this conclusion based on the fact that the LOI "expresses the parties' intention to enter into a contract 'at a later date' and nowhere states that they intend to be legally bound until such future agreement is reached."16