Builders and Contractors Exchange
Weekly Bulletin: 2 March 2007
The Letter Of Intent And Memorandum Of Understanding: When Are They Binding?
By: Chris Ambrosio
Frequently, when parties are discussing a business transaction, they will document the basic terms in a letter of intent, or “LOI”. The LOI is sometimes called a memorandum of understanding, or “MOU”. LOIs are frequently used when companies are discussing a merger, asset sale, or joint venture or teaming arrangement. The LOI can be anywhere from one page to ten pages, and can contain a fuzzy outline of the deal or a very detailed description of the terms. It is important for both parties to know the significance of signing an LOI before signing it.
Generally, an LOI is drafted as a nonbinding summary of the basic economic and other business terms of the transaction. In an asset sale, these should include: the price to be paid; whether there are any factors that could increase or decrease the price before closing; the assets to be sold and those that are excluded; whether there is a due diligence period and, if so, how long; the closing date or the formula for calculating the closing date; whether an earnest money deposit is required; and other significant business terms. In a joint venture or teaming arrangement, the LOI should include: the scope of work allocated to each party; whether a new entity will be formed; the duration of the joint venture, in terms of time or number of projects; allocation of income and expenses; whether either party can engage in activities in competition with the joint venture; ownership of intellectual property and other assets that the joint venture may acquire or develop; and other significant terms.
The LOI usually features a prominent disclaimer stating that it is not a contract, and that neither side is committed to any obligations unless and until a formal contract is prepared, negotiated, and signed. What is the value of an LOI, then? First, it establishes the critical terms to be inserted into the formal contract, so that further negotiation on those points is no longer necessary. Second, it may contain some binding terms, such as a requirement that the parties must negotiate exclusively with each other and not market the transaction to others (a so-called “exclusivity clause”), or a requirement that the parties keep all discussions confidential. In this latter format, the LOI should state expressly which terms are binding and which are not. If there is no disclaimer and all the basic terms are otherwise set forth in the document, then the “LOI” may, in some cases, be a binding contract.
An LOI can be a helpful tool that parties may use to document basic negotiated points prior to going through the time and expense of preparing a formal contract. Care must be taken to draft it properly so that each side will know whether the deal is final or whether more formal steps are required.
Questions?
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This article is meant to bring awareness to this topic and is not intended to be used as legal advice.