A letter of intent (often abbreviated to LOI) is a document that records the intentions of all the parties who are considering entering into a legally enforceable agreement.
Letters of intent are more commonly used in business transactions than for personal legal issues. However, they can be used in any situation where two parties intend to work together and want to agree on the broad issues before resolving the finer points.
Most commonly, they are used where:
- discussions of terms take place over a period of time and an aide-memoire of what was agreed at each round is helpful for resuming at a later date
- different groups of people within a business are involved in discussing different matters, and there needs to be a record that pulls together all those different threads
- the two parties need to satisfy a third (such as a potential investor or a lender who will provide working capital) of their intentions
Examples of types of transactions would include business sales, asset purchases and joint venture arrangements.
An LOI is often in letter format, but it doesn’t have to be.
Heads of terms
If a letter of intent is drafted as a skeleton agreement, it is more often called heads of terms (abbreviated to HoT). A letter format might more appropriate where intentions or reasons are recorded. Heads of terms tend to be a summary of the terms, organised in the same order that the points might flow within a final agreement.
Both documents provide the basis for a full draft agreement. An agreement based on heads of terms is one that is usually just fully fleshed out with legal points.
Letters of intent and heads of terms can be used at any time. Negotiations do not have to have finished for the document to be drawn up. An LOI can be drafted early on for use by one side as a reminder about what to discuss.
What does a letter of intent cover?
Providing a letter of intent template is difficult because there is no required layout or structure. It can be as formal or informal as the parties like.
Typically, letters of intent and heads of terms will include:
- the names and addresses of the parties involved
- background to why the parties are negotiating (in other words, what are the parties seeking to happen)
- basic terms of the proposed agreement (such as a minimum purchase price)
- rationale or explanation of a particular stance on issues (for example, that one party takes a particular view on an issue because it is unable to do otherwise because of regulations or commitments to other parties)
- obligations of the parties (such as to negotiate in good faith)
- target date for completion and note of who will write the LOI or HoT into a full and formal agreement
- whether there is an exclusivity period and if so, an expiration date
Pre-conditions are things that must be done or produced before one party will sign the final agreement.
For example, it might be that regulatory approval is needed, or that some other deal or future agreement needs to be made with another party.
A common pre-condition is that the deal is approved by a majority of shareholders in the company, or partners in a partnership.
Another common pre-condition is that one side is given the opportunity to conduct due diligence (DD). This is a process of reviewing the documents and systems of one side by the other. The aim is to satisfy the one carrying out DD what risks there are in the proposed transaction. Those risks might then able to be reduced by further provisions in the final contract.
For example, a due diligence process might identify whether contracts exist, whether the financial statements are true and fair, and whether anything adverse has happened in the past that might affect future performance.
What is satisfactory completion is subjective, but usually means that one party has requested information from the other party and received sufficient detail for a decision to be made.
A pre-condition might be that a course of action is started, not necessarily finished.
Some people wrap terms about how discussions are to proceed into a document that they call heads of terms or a letter of intent.
Other matters might include:
- keep information discussed confidential in the same way that non disclosure agreements do
- not to solicit employees, suppliers or customers in the same way that a separate non-solicitation agreement would bind you
- not to negotiate a similar deal with anyone else for a reasonable period of time or until a certain date, in the same way that an exclusivity agreement would
The protection of confidential information is usually important to both parties, not just one, because while one might disclose more, often in the course of discussion sensitive information about both is unintentionally disclosed. Often two documents are used: a confidentiality agreement or non-disclosure agreement is signed in advance of a letter of intent to pre-empt what might be discussed.
Are letters of intent legally binding?
By itself, a letter is non binding, and is not a substitute for a full legal contract. Neither party is held to the contents.
One of the requirements for an agreement to be legally binding is that both sides intended to be bound. It would be very difficult to claim that points in an LOI that were a binding contract.
To make sure, a letter or HoT should start with the words 'Subject to contract and without prejudice'. 'Subject to contract' records that none of the content is contractually binding unless it is placed in another agreement. 'Without prejudice' is a statement that the contents are not necessarily the parties last words on the matters.
So it is important that you do not rely on an LOI and take action before you have a formal contract in place. If you do start acting under it, you may find that the other side does not, leaving you at a disadvantage and no rights to have the other side do what they were going to do.
Be aware that just because a document is called a letter of intent by the other side, it might not be just that.