As a business "deal" is coming together, the parties often wrestle over whether to start the documentation with a "letter of intent" (LOI) or simply proceed to the actual contracts. While different situations demand different answers to that question, here are some important considerations with respect to what may work best for you.
Using a LOI has the advantage of usually being much less costly, quicker and simpler to draft. While it usually only sets forth the basic terms of an agreement, it is usually not a binding contract, except for certain provisions, such as confidentiality provisions that are intended to protect both parties and take them back to their respective starting points without damage, should the deal fall through.
On the other hand, sometimes the nature of the persons involved, the complexity of the transaction or other factors may make negotiating a LOI a very difficult and time consuming event by itself. In these situations, it may be best to spend the time and effort negotiating the actual contract, thus just going through the difficult negotiation process in these instances once, rather than twice.
One of the most unusual, but extremely common, things I find in transactional work is that the contracts are being negotiated right up to closing. Both parties are proceeding on the deal as if things are going to close. Both are putting in lots of time, money and effort. Both seem "committed" to the deal. In these instances, I find it is often hard for each party to think of all the things they would really want negotiated and put into the contract until they are actually putting things together for closing. As they do so, the contract is literally being formed and drafted. The only thing that keeps this from going on forever is the fact that the parties or the facts have established a "magical closing date" that basically tells both of them: "We are going to close at this place and time. All contract changes must be negotiated so we can sign the contract and close then and there." As you can see, in these cases, having a LOI in place provides a basic outline from which to negotiate and act and without it, getting to a contract and closing may be all but impossible.
David Willis, a Texas attorney, recently wrote an article about using LOI’s in Texas, although it is pretty much applicable in most jurisdictions. He points out that most LOI’s are non-binding agreements which contain 4 items:
- Basic Terms and Method of the Transaction
- An Exclusivity Clause
- A Confidentiality Clause
- A Closing Date
I’d recommend reading his article to get an understanding of how these terms interact.
Finally, I’d like to point out that the smaller the transaction in economic terms, the less legal time a client can afford to pay for to get the deal done. In these cases, not only is it advisable to try to avoid having to negotiate both a LOI and a contract, it may require using standard form "asset purchase agreements" or "stock purchase agreements." Some states, like Wisconsin, have well tested forms developed by bar associations or realty groups which cover such agreements. The Wisconsin bar has developed the WB-16 and WB-17 entitled "Offer to Purchase Business with Real Estate" or "Offer to Purchase Business without Real Estate" respectively.