WHAT IS A LETTER OF INTENT?
A letter of intent (also known as an “LOI”) is a writing (often a simple letter) designed to initiate a business or real estate transaction by summarizing or outlining the parties’ intended major deal pointst. LOIs reflect a preliminary commitment by the parties to transact business with one another, and are generally intended to be a non-binding writing that precedes a more formal binding contract.
In our Texas real estate law practice, we primarily encounter and draft Letters of Intent in connection with Commercial Real Estate Contracts (Purchase and Sale Agreements) and Commercial Leases.
LOIs are common in commercial real estate transactions because final agreements that contain all details of the transaction can be somewhat complex and take an extended time to negotiate and finalize. By entering into an LOI, parties to commercial real estate transactions generally indicate their desire to work toward final agreements.
But beware, certain LOIs can be treated as enforceable;e contracts, and enforced by Texas Courts.
TEXAS LAW REFLECTS THE IMPORTANCE OF LOIs IN REAL ESTATE TRANSACTIONS
In John Wood Group USA, Inc. v. ICO, Inc., 26 S.W.3d 12, 19 (Tex. App.—Houston [1st Dist.] 2000, pet. denied) the First Court of Appeals stated that “the basic concept of a letter of intent is to provide the parties with a way to structure their agreement without entering a binding contract” and noted that “[l]etters of intent play a valuable role in conducting complex business transactions.”
The El Paso Court of Appeals echoed this sentiment: “We are mindful of the importance LOIs play in complex, highly-structured business transactions,..” Karns v. Jalapeno Tree Holdings, L.L.C., 459 S.W.3d 683, 691-92 (Tex. App – El Paso 2015).
IN THE REAL ESTATE BUSINESS, LOIs ARE GENERALLY NOT INTENDED TO BE BINDING CONTRACTS
Most often, LOIs are not intended by the parties to be binding. Rather (and as stated above), they are intended to serve as general statements of intent to engage in negotiations with the hope of reaching mutually agreeable terms for the transaction.
Frequently, LOIs facially state that they are not binding and that a future binding contract will be executed if and when final agreements are reached. But this isn’t always the case. Further, the language of the LOI (or the absence of certain language) and the actions of the parties could result in the LOI being treated as an enforceable and binding contract.
Texas Courts have cautioned that “the use of a letter of intent is not without risk. Absent careful drafting, the parties may find themselves bound by a letter agreement that does not contain all of the protections for which they would normally negotiate or for which due diligence is incomplete.”John Wood Group , 26 S.W.3d at 19
WHEN ARE LOIs BINDING AND ENFORCEABLE?
Under Texas law, “a letter of intent may be binding even though it refers to the drafting of a future, more formal agreement.” John Wood Group, 26 S.W.3d at 19. It is important to understand that Courts treat and analyze LOIs the same as other contracts. The standard rules of contract formation govern letters of intent. Thus, enforceability of an LOI turns on the same factors as other writings that purport to be contracts.
In Texas, “Parties form a binding contract when the following elements are present:
- an offer;
- an acceptance in strict compliance with the terms of the offer;
- a meeting of the minds;
- each party’s consent to the terms; and
- execution and delivery of the contract with the intent that it be mutual and binding.
LOIs that meet all of these elements can be enforced, even if one of the parties denies that it intended ti be bound.
In McCalla v. Baker’s Campground, Inc., 416 S.W.3d 416, 418 (Tex. 2013), the Texas Supreme Court reaffirmed a long-established rule that “[a]greements to enter into future contracts are enforceable if they contain all material terms.” The Court explained the rationale underlying this rule, noting that
while “agreements to enter into future contracts are often unenforceable . . . [because] courts have no way to determine what terms would have been agreed to after negotiation[,] . . . [t]his concern is not present when the agreement to enter into a future contract already contains all the material terms of the future contract.”
Most disputes about whether an LOI can be enforced turn on whether or not the document contains all material terms of the contemplated deal/transaction and whether all conditions or the LOI have been met. See generally Chalker Energy Partners III, LLC v. Le Norman Operating LLC, 595 S.W.3d 668, 673 (Tex. 2020) (” A party seeking to recover under a contract bears the burden of proving that all conditions precedent have been satisfied.”)
Simply stated, the inquiry is whether or not the letter of intent is merely an indefinite indication of interest in negotiating toward a contract in the future or a writing that contains all essential terms as contemplated by the parties with the only remaining issue being formalization of the agreement or negotiation of ancillary terms.
See Foreca, S.A. v. GRD Dev. Co., Inc., 758 S.W.2d 744, 744-45 (Tex.1988)
HOW TO PRVENT AN LOI FROM BECOMING A BINDING CONTRACT
A party who does not wish to be prematurely bound by a letter agreement should include “a provision clearly stating that the letter is nonbinding, as such negations of liability have been held to be effective.” John Wood Group, 26 S.W.3d at 19. “the use of a letter of intent is not without risk. Absent careful drafting, the parties may find themselves bound by a letter agreement that does not contain all of the protections for which they would normally negotiate or for which due diligence is incomplete.” Id.
Absent careful drafting, the parties may find themselves bound by a letter agreement that does not contain all of the protections for which they would normally negotiate or for which due diligence is incomplete. Under some circumstances, a binding contract may be formed if the parties agree on the material terms, even though they leave open other provisions for later negotiation. See Scott v. Ingle Bros. Pac., Inc., 489 S.W.2d 554, 555 (Tex. 1972). Similarly, a letter of intent may be binding even though it refers to the drafting of a future, more formal agreement. See Foreca, 758 S.W.2d at 746.
Therefore, a party who does not wish to be prematurely bound by a letter agreement should include “a provision clearly stating that the letter is nonbinding, as such negations of liability have been held to be effective.” E. Allan Farnsworth, Farnsworth on Contracts § 3.8b, at 193 (1990); see also 1 A. Corbin, Corbin on Contracts §§ 29 and 30 at 97 (1963); Andrew R. Klein, Comment, Devil’s Advocate: Salvaging the Letter of Intent, 37 Emory L.J. 139, 143 (1988) (“A well-drafted letter of intent should explicitly state that the parties do not intend to be bound.”).
By way of example, the First Court of Appeals evaluated a party’s effort to enforce an LOI containing the following language, and determined that the LOI was not an enforceable contract because the language clearly reflected that the parties did not yet have a deal:
“[t]his offer is a summary of a transaction to be more fully described in an Earnest Money Contract the specifics of which will be negotiated in good faith. This letter serves only as an offer… and is not binding as an agreement unless and until a fully executed Earnest Money contract is signed.”
