What are letters of intent?
A Letter of intent (LIO) is a letter between two businesses, which provides the basis for a future or proposed agreement. This can also be drafted as an agreement between two businesses (Heads of terms), rather than a letter. However, the effect of these two documents is the same.
It can be used in any context to record negotiations and discussions, where the outline or detail of the terms of a future agreement have been agreed upon. It is not necessary for the negotiations to have been completed, they may be ongoing.
However, you should remember that this letter is not a substitute for a contract. It is important that you sign a legally enforceable agreement before you start doing things under it.
What’s covered in a letter of intent?
An LIO will typically cover the following issues:
details of the proposed agreement
the target date for signing
key obligations of the parties under the proposed agreement
who will produce the first draft of the agreement
On the one hand, the party who produces the first draft of the agreement will have more control over the document; however, if you don’t have professional representation, you may prefer to amend a document drawn up by the other party.
An LIO will also cover pre-conditions to signing the agreement. These may include the production of certain key documents and approval by an external agency (eg export control or safety certification). If the parties are companies, check the articles of association and any Shareholders’ agreements to see if you need the approval of shareholders. If the parties are partnerships, you may need to get the approval of the partnership - see the Partnership agreement.
One of the most common pre-conditions is the satisfactory completion by one or both sides of a due diligence exercise. This is an investigation of the other party, to find out any key risks to the proposed transaction, which can then be dealt with in the agreement.
Are letters of intent legally binding?
The advantage of this is that the parties are not bound by the negotiations themselves. If one party decides to pull out, there is little that can be done to continue the negotiations. This is why it is essential that the Letter of intent or Heads of terms contain the words 'Subject to contract'. However, some terms are legally enforceable; these include the following:
confidentiality - if the parties have not signed a Confidentiality agreement, the agreement will create legally enforceable obligations of confidentiality between the parties
non-solicitation provision - this prevents the parties from poaching each other’s employees and customers. The provision must be reasonable both in scope and time
- exclusivity provision - this prevents the parties from negotiating with anyone else for a period of time. The use of a time limit is a good way of putting pressure on the parties to progress the negotiations. The time limit should be reasonable, given the nature of the transaction in question.