When is an LOI used
Entrepreneurs use an LOI after completing discussions about a transaction; primarily for the sale or purchase of a healthcare facility, a merger, joint venture, and sometimes it’s used in an employment agreement.
- The LOI determines major issues and can make clear to both parties why the transaction might be a good and/ or bad idea.
- As a general business matter, whether you’re the buyer or the seller in the sale, both parties’ benefit from drafting an LOI early.
- DO NOT use a LOI if it becomes so detailed and overly negotiated where it is as expensive and time-consuming as the definitive agreement (full agreement) but lacks the same level of enforcement; simple transactions do not need an LOI.
Legal pitfalls
- Although the LOI sets the “stage” for the transaction, there can be concern amongst the parties about the enforceability of the document; LOIs are non-binding;
- Watch out, when reviewing and drafting an LOI, there are terms in the document which make the document binding. Pay attention to how announcements or other actions are written; its important that such documents should not make it appear that an agreement was executed.
- LOI’s favor the Buyer.
- Many states have different standards regarding the intent of the parties in an LOI. In Texas, the legal standard is if a “reasonable person” believed that there was an agreement. This standard has reached unpredictable outcomes in Texas and caused costly litigation. For instance, in Texaco, Inc. v. Pennzoil Co., Pennzoil won a $10.5 billion judgment against Texaco for tortious interference with Pennzoil’s “handshake” agreement to gain a controlling interest in Getty Oil for $5.3 billion. Texaco filed for bankruptcy. Here, the parties never signed a definitive merger agreement for the transaction. However, the court found that an agreement had been reached based on a 5-page Memorandum of Agreement and a press release that stated they had executed an agreement.
- Exclusive dealings or no-shop provisions in LOI’s are binding even if the rest of the deal is non-binding.
- Make sure to include a statement that the letter of intent that does not include all the essential terms of the deal.
Remember, even when you have an executed agreement, an LOI can still be enforceable
In Kelly v. Rio Grande Computerland Group, parties entered a “Letter of Intent” providing favorable employment terms for the largest shareholder to serve as President after merging of two companies. However, the purchase agreement omitted these and several other provisions. When the largest shareholder was not kept as the President or even as an employee, he sued the purchaser for breaching the “agreement” contained in the LOI and won thousands in damages from lost wages.
Therefore, although an LOI can appear to be a simple document, it makes sense to hire an attorney to review the document to avoid unnecessary legal traps.
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