Letters of intent can be confusing. Are they contracts? Are they binding? When should they be used? It’s important to know when to use letters of intent because they can be valuable tools that can save time and money. We receive these questions all the time, so here are some concepts that will help.

What Is A Letter Of Intent?

A letter of intent (i.e. an “LOI” or a term sheet) is a document that provides the basic terms of a transaction. It can be as simple or as complex as the parties desire. As shown below, LOIs can be contracts or not. They can be binding, non-binding or binding in some ways and not binding in others.

Letters Of Intent Are Contracts – Sometimes

A letter of intent is only a contract if the parties exchange consideration. Consideration can be money or it can be an exchange of promises, like “I’ll buy your company if you represent that it’s good.” As this example demonstrates, it is easy to make something a contract, even if it is not intended. Because it can be so easy, we always recommend using an express statement that the LOI or term sheet is not binding if it is not intended to be binding.

Letters Of Intent Are Binding – Sometimes

As shown above, letters of intent are often contracts, and if that is not desired, you need an express statement showing that the LOI is not binding. However, the parties often want some parts of the term sheet to be binding and some not binding. You can do this. To make it happen, we often use a statement in the LOI stating that certain sections are binding and others are not. The most common binding parts of a letter of intent are confidentiality and no-shop provisions. Thus, you can state that the letter of intent is generally not binding, but the parties promise each other to keep information secret and not to entertain other buyers for a certain amount of time while a fully binding and expansive purchase agreement is negotiated and signed.

When To Use Letters Of Intent

Here are some guidelines that we use to decide when to use a letter of intent. The choice is pretty simple, which is whether to insert the step of negotiating a letter of intent or whether to skip that step and just negotiate a purchase agreement. If you are really short on time, skip the LOI and go straight to negotiating the contract. It takes time to negotiate the letter of intent first. However, the LOI can sometimes actually save time because it can allow the buyer and the seller to discuss the points that are most important before the contract is prepared. Then, when the attorney, accountant or broker drafts the contract, the buyer and seller know the points that mean the most to the deal. Likewise, if a third-party (like a broker, lawyer, or accountant) is negotiating the contract after the LOI is prepared, that third-party has less to argue about because the term sheet can be used as a reference to keep everyone on the same page. Keeping everyone involved in the deal focused can then save money because the third-party negotiators are not altering the key deal points agreed upon by the buyer and seller.