Is a Letter of Intent Binding?

"Proud lock" by Holly Victoria Norval is licensed under  CC BY 2.0 no changes made.

"Proud lock" by Holly Victoria Norval is licensed under  CC BY 2.0 no changes made.

Letters of intent can serve an important business and legal purpose.  In the business context, it helps to solidify a deal if the parties are able to flesh out its salient terms.  From a legal perspective, the benefits can cut both ways.  Letters of intent, because of their brevity, have resulted in a tremendous amount of litigation.  The terms of the deal are usually laid out in a rudimentary fashion, often overlooking important ramifications that the parties ignored in the haste of getting something in writing.  If a party deems the letter favorable to it, it will seek to enforce; if unfavorable, it will claim the letter is non-binding.

Indeed, the question that most often arises is whether the letter of intent is binding, or not.  The short answer is that courts give great deference to the intent of the parties.  So if a document says it is not binding, New York courts will give great deference to the parties’ intent that it be not binding.  Where unclear, a court will examine the content of the document, as well as the parties’ behavior, to determine whether the letter is binding.

The factors that New York courts look at to determine whether a letter of intent (or term sheet, or memo of understanding etc.) is enforceable are: (1) the parties’ explicit statements to be or not to be bound; (2) partial performance by one party; (3) whether there is nothing left to negotiate; and (4) whether the subject matter is complex requiring a more lengthy contract.

In Dunhill Sec. Corp. v. Microthermal Applications, Inc., 308 F. Supp. 195 (1969), Plaintiff underwriter filed a claim against defendant corporation for breach of contract and quantum meruit based upon a letter of intent in connection with the corporation’s proposed issuance of stock.   The parties had executed a letter that set forth a preliminary understanding in regard to a proposed offering of common stock by the corporation.  The corporation subsequently sent a letter to the underwriter terminating any understanding after the corporation discovered that proceedings had been brought against the underwriter by the Securities and Exchange Commission. 

The court examined the letter and concluded that it stated that the parties did not intend any liabilities to emanate from the letter.  The court specifically examined a paragraph in the letter which stated in “the clearest possible terms that the parties did not intend any liabilities to emanate from the letter.”  This language in question is included here:

Since this instrument consists only of an expression of our mutual intent, it is expressly understood that no liability or obligation of any nature whatsoever is intended to be created as between any of the parties hereto. This letter is not intended to constitute a binding agreement to consummate the financing outlined herein, nor an agreement to enter into an Underwriting Agreement. The parties propose to proceed promptly and in good faith to conclude the arrangements with respect to the proposed public offering and any legal obligations between the parties shall be only those set forth in the executed Underwriting Agreement. In the event that the Underwriting Agreement is not executed and/or the purchase of the securities is not consummated, we shall not be obligated for any expenses of the Company or for any charges or claims whatsoever arising out of this letter of intent or the proposed financing or otherwise and, similarly, the Company shall not be, in any way, obligated to us.

The court further found that there was not likely to have been an intent to enter into a binding contract because the custom of the industry was not such that a letter of intent created a binding agreement.  The court ultimately granted summary judgment in favor of the corporation on the underwriter’s claims for breach of contract and quantum meruit.

But what if the letter has no “non-binding” type of language?  In those circumstances, it is necessary to examine the parties’ original intent when executing the document.  “A primary concern for courts in such disputes is to avoid trapping parties in surprise contractual obligations that they never intended.”  See Teachers Ins. Annuity Asso. v. Tribune Co., 670 F. Supp. 491 (1987).  In Teachers, the court identified two distinct types of preliminary contracts with binding force. 

One occurs when the parties have reached complete agreement on all terms that require negotiation.  The agreement is deemed merely “preliminary” because the parties state they will subsequently enter into a more formal agreement; but preliminary is not synonymous with non-binding.  Under such circumstances, the parties have reached a full agreement and the letter is enforceable.  See V’Soske v. Barwick, 404 F.2d 495, 499 (2d Cir.), cert denied, 394 U.S. 921, (1969) (“the mere fact that the parties contemplate memorializing their agreement in a formal document does not prevent their informal agreement from taking effect prior to that event. . . “).

The other occurs when the parties express mutual commitment to a contract on agreed major terms, with the recognition that there remains open terms to be negotiated.  The fact that there remains open terms, however, does not mean that there is no binding agreement.  Rather, there is a binding commitment on both ends to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.  See Teachers, at 498.

When analyzing a letter of intent, the first and foremost factor to consider is therefore the plain language of the letter and whether the parties unequivocally considered the letter binding, or non-binding.  If non-binding language is absent, the factors cited in the Teachers court, and listed above, are of greater relevance.  If the letter is deemed binding, then the analysis must focus on whether the letter represents a fully negotiated agreement, or rather a preliminary agreement with a good faith obligation to negotiate the remaining terms.  The former requires execution, and the latter, further negotiation.

As is evident from the discussion above, the subject matter is ripe for litigation precisely because it is difficult to generalize about a letter of intent’s legal effect, without examining a whole host of factors extraneous to the letter itself. 

For any questions regarding the above, please feel free to contact Olivera Medenica at OMedenica@Medenicalaw.com.