Is a Letter of Intent Binding? What to Know Before You Sign One

Golf course handshakes are no longer the best way to do business. Contracts, written out with clarity, are essential to protecting your business. Yet, when you are not at the contract phase just yet, but still need to formulate some details, you could use a letter of intent.

Understanding a letter of intent, no matter the transaction, is critical. Not always a legally binding agreement, but in some situations, it could interfere with future decisions you make. Here’s what you need to know.

What Is a Letter of Intent (LOI)?

A letter of intent (LOI) is a written, non-binding document. It specifically outlines an agreement that is in principle between two or more parties. Typically, this document occurs before legal agreements are finalized, and both parties are still working on coming to a conclusion or final agreement.

A letter of intent is typically a part of a business transaction. It may be in relation to mergers or acquisitions. It can help with joint venture fact-finding. It may also be a letter of intent to purchase or sell real estate. A letter of intent for business typically includes very specific information:

• The names of all involved parties with contact details
• A description of the transaction
• The proposed terms as they are right now
• A timeline for a decision or transaction completion to take place
• A confidentiality clause

A letter of intent for business purchase, for example, outlines the goal of a party to purchase a business, when and for how much, along with proposed terms and conditions.

How Does a Letter of Intent Differ from a Contract?

A letter of intent is different from a formal contract. Some of those differences include:

• Legally binding: Contracts are legally binding. A letter of intent is typically not.
• Scope: The scope of the transaction is very detailed and complete in the contract. In an LOI, it’s likely to be more of a basic outline.
• Intent: The goal of a contract is to formalize a transaction and move both parties towards the signing of the document. An LOI is more of an opportunity to get parties moving towards decisions.
• Timing: Most letters of intent are used during the negotiation phase. A formal contract happens once the deal is done and agreements are made.

A letter of intent for business transactions of any type is often the initial or first step towards getting to the contract.

Are Letters of Intent Legally Binding?

The big question many people have is, “Is a letter of intent binding?” “If I enter into this agreement, am I stuck?” The bottom line is no, these are not legally binding agreements. It is more of a stepping stone to getting to that formal agreement that will be a legally binding contract. However, certain individual sections of an LOI may be binding, such as confidentiality between the parties, covenants to practice good-faith negotiations, and exclusivity provisions, for starters. 

For example, writing a letter of intent to merge your business with another company could create an opportunity to have conversations and discuss the good and bad of such transactions. It would allow you to come to the table with negotiators and discuss how you could make this process work. However, a letter of intent for buying a business – or for any transaction – is not legally binding.

When Would a Letter of Intent Be Enforced in Court?

The letter of intent format is critical to get right if you do not want to enter into a formal agreement. Here is why.

A letter of intent – even if it is labeled as such – submitted to the court could be considered binding in a lawsuit. The court may enforce the agreement as spelled out within that documentation. That may seem like a contradiction to what you already know. The difference here is that the court needs to understand the desired outcome.

If the court determines that both parties intended the document to serve as a binding agreement at the time that it was signed, then it will be. The court will determine if the language within the document is ambiguous. If there is no ambiguity in the document, the intentions of the parties are based solely on the language within that document.

In situations where the terms are ambiguous or could be interpreted in more than one way, that could work as evidence that the court does not believe the LOI is legally binding. More so, in some states, the court will allow extrinsic evidence – information and evidence not actually contained within the document – to serve as a component of determining intent.

Binding vs. Non-Binding Clauses

There is often a lot of legal jargon in such documents, which is why it is critical to have an attorney guide you through the process of creating them. Consider what a binding contract is, or a binding clause within a document. To be binding, the following must apply:

• There is an offer: There is acceptance of that offer. The offer must be under the terms without any changes.
• Consideration: Some type of value must be exchanged between the parties.
• The intent to be bound is mutual to both parties and is intended to be as such.
• Capacity is clear: Those who are signing the LOI or contract must be legally able to do so, meaning they have to have the right to make such decisions, be of the right age, and have the mental capacity to do so.
• The terms have to be legal: To be binding, it cannot include any actions or activities considered illegal in the state where it is being applied.
• Formal: The contract should be in a formal format that meets the state’s requirements.

As you learn how to write a letter of intent, you will need to keep each of these areas in mind. It becomes essential to formulate information and details in a form that’s accurate to the state’s laws.

A non-binding clause may not be a formal agreement. This is when both parties are not legally required to fulfill the terms of the agreement. Most of the time, these documents serve as a statement of intent but do not provide for all of the above-listed requirements to create a formal obligation.

Is It Possible to Sign a Letter of Intent Too Early?

Knowing when to sign a letter of intent is important. In some situations, a business may be encouraged to sign an LOI early. For example, it may seem that doing so demonstrates to the owner that you are serious about the transaction. 

Some believe that early signing is critical to ensure a buyer spends time and resources reviewing the opportunity. However, if you sign an LOI early in the process, you are likely to sell that property for less than you should and with weaker (or less protective) rules than you deserve. Unless the buyer has a significant amount of information about your business, as well as a good understanding of the growth opportunities it offers, they will low-ball you, and that could mean that you agree to too little.

How to Protect Yourself Before Signing a Letter of Intent

If you are using a letter of intent to purchase business shares or to sell your own business, there are several things to keep in mind that could protect you:

• Ensure your customer contracts have a successor clause, which means obligations to the contract remain even if ownership changes.
• Management team members must fully understand the legal process and the stage it is at any given time.
• Get financials audited and complete pre-diligence efforts to protect your business.
• Always disclose risks and do so early on in the transaction.
• Negotiate down the due diligence period to reduce the risk of backing out.

Most importantly, throughout this process, hire an attorney. The letter of intent to buy a business is a critical decision that will carry long-term implications. You must know what you are stating, whether it is legally binding, and what your rights are before you enter into a formal contract. 

That is where an attorney can help you.

Know What You’re Agreeing to Before You Sign a Letter of Intent

A letter of intent to buy a business needs to be thorough and detailed enough to meet the expectations you have and the law has. Most importantly, you need to be sure it is protecting your rights, no matter what side of the transaction you are on. Contacting a lawyer is a critical component of that process and the best way to protect your interests.