The Importance and Dangers of Letters of Intent
November 23 2021
Despite a global pandemic and a bingo-card full of natural disasters and calamities, the commercial real estate market has been extremely active over the past two years. While there are some signs that activity will be less frenetic in the upcoming year, most commentators project continued growth, development and overall volume. Many of our clients are already eyeing next year’s targets, beginning the negotiation process with the hopes of getting these deals under contract in the first quarter of 2021. Given these efforts, we thought it might be helpful to offer a friendly reminder regarding the importance and dangers of letters of intent.
A letter of intent is “the preliminary understandings of parties who intend in the future to enter into a contract.” These documents can be a convenient way for parties to memorialize and confirm the parameters of their transaction before proceeding to a final agreement. Letters of intent are typically non-binding, providing that the document is merely a summary of critical terms and is not actually enforceable against the parties until it is reduced to a final, signed contract. These types of provisions are generally respected by California courts, as a letter of intent that unambiguously states that it is not intended to be binding will not be construed as binding.
However, even though the letter of intent may include a non-binding provision, a letter of intent may create legal obligations for the parties, including the obligation to negotiate in good faith. All contracts in California contain the implied covenant of good faith and fair dealing, meaning that the parties must act in good faith to perform their obligations consistent with the intent of the agreement. In the letter of intent context, “[a] court will enforce a ‘contract to negotiate the terms of an agreement.’ But a party is liable under such an agreement ‘only if a failure to reach ultimate agreement resulted from a breach of that party’s obligation to negotiate or to negotiate in good faith.’”  This means that even if a letter of intent is non-binding, a party can still be held liable for breaching that agreement if it does not negotiate in good faith. If one party has a change of heart or finds a better deal and terminates negotiations after a letter of intent is signed, that party may be liable for failing to negotiate in good faith.
For these reasons, parties should exercise great care in drafting letters of intent. A provision providing that the letter of intent is non-binding should clarify that this means the parties can refuse to agree for any reason or no reason at all, and that neither party has any obligation to negotiate in good faith. Moreover, parties should carefully explain their reasons for declining a proposed transaction or ultimately rejecting the transaction after a letter of intent is signed. While letters of intent serve as important tools for deal-making, they should not undermine the flexibility each party has to negotiate outstanding terms or decline to proceed with the proposed arrangement.