Using Letters of Intent in Real Estate Leasing Transactions

Everyone wants to do the deal, but no one is ready to sign the lease. Zoning approvals, construction plans, financing, and a host of other issues need to be firmed up before the lease will be signed, but it is a lot of time and expense to go through if there's no agreement on the essential terms of the relationship. Hence, the Letter of Intent (“LOI”). An LOI is intended to, and should, give assurances to the parties, fix the agreed-upon terms of the deal, provide information and assurances to third parties, and provide a framework for further negotiations and the definitive agreement. It can, however, also be a minefield of potential problems and an invitation to litigation. This article reviews some of those problems and suggests ways to accommodate the parties' needs while avoiding the most common dangers.

Is a Letter of Intent Necessary?

LOIs are appropriate for ascertaining issues of significance to one or both parties. If the parties cannot agree on the significant issues that are often included in an LOI, such as co-tenancy provisions, opening and operating covenants and exclusives, they are unlikely to spend the time and money to negotiate and prepare a final lease or investigate the feasibility of the transaction. Nevertheless, before entering into an LOI, one should think carefully about whether it is truly necessary. Too often, LOIs are viewed by the disappointed party as a binding agreement that the other party has breached, while the withdrawing party views the LOI as merely a prelude to negotiations. If circumstances are such that an LOI is required, the LOI should be reviewed by counsel to ensure that the language protects the parties' interests.

Contents of the Letter of Intent

Binding Nature of Agreement. First, it is important to determine whether the parties intend the LOI to create a binding and enforceable contract, ie, whether the terms of the LOI can be enforced in court to require the parties to enter into a definitive agreement. Courts generally look to five different factors in determining whether an LOI is intended to be binding: 1) the language of the agreement; 2) the context of the negotiations; 3) the existence of open terms; 4) partial performance; and 5) the necessity of putting the agreement in final form. Arcadian Phosphates, Inc. v. Arcadian Corp., 884 F.2d 69, 72 (2nd Cir. 1989).

Courts have almost uniformly recognized that “the first factor, the language of agreement, is most important.” Id. Thus, to avoid placing yourself in the hands of a judge or jury, care should be taken to make clear in the LOI what provisions, if any, are intended to be binding, and what provisions are not. The inclusion of a Statement of Non-Enforceability is the best way to set forth the parties' aim.

Option 1:

Except for those items set forth in Section ___, this Letter of Intent is not an enforceable agreement among the parties, but rather a preliminary nonbinding statement of intent that sets forth the general terms for the negotiation of the terms of the Definitive Agreement [not expressly stated in this Letter of Intent.]

Option 2:

Notwithstanding that either or both of the parties hereto may expend substantial efforts and sums in anticipation of entering into a Definitive Agreement, this Letter of Intent is not a contract, and neither party intends that the preliminary understandings contained herein represent our final agreement as to the transaction described herein. The provisions of this letter are subject to, and conditioned on, the negotiation and execution of a definitive and final agreement. Either party is free to withdraw from the negotiation of the transaction described herein prior to the execution of the Definitive Agreement and without liability to the other party.

Option 3:

The paragraphs and provisions of this letter, with the exception of those provisions in Section ___ hereof, do not constitute and will not give rise to any legally binding obligation on the part of any of the Parties hereto. Moreover, except as expressly provided in Section ___ or as expressly provided in any binding written agreement that the Parties may enter into in the future, no past or future action, course of conduct, or failure to act relating to the potential transaction described herein will give rise to or serve as a basis for any obligation or other liability on the part of the Parties.

Negotiation in Good Faith. An LOI can either require good faith negotiations or disclaim them. It is important to set forth in writing the nature and scope of any good faith requirement (or absence thereof) as the law varies from jurisdiction to jurisdiction with regard to whether such an obligation is implied in any agreement. Thus, particularly with national tenants and/or national landlords, each of the parties may have a different understanding of what their future obligations are under an LOI. This issue is resolved by making explicit the good faith obligations of the parties.

Option 1:

The Parties shall have no liability to each other if they fail to enter into a Definitive Agreement unless there is a breach of a binding provision of this Letter of Intent or unless a party chooses not to enter into the Definitive Agreement in violation of its duty to act in good faith.

Option 2:

This Letter of Intent is not an agreement to negotiate. The parties do not intend to be obligated to use their best efforts or to reach agreement on the definitive and final contract. The parties do not intend to be obligated to negotiate in good faith to reach agreement on the definitive and final agreement.

Agreed Upon Terms for the Definitive Agreement. Obviously, the main purpose of the LOI is to set forth in writing the terms of the relationship that have already been agreed to by the parties. This usually includes such items as the location, rent, length of lease, option periods, and construction allowance. However, take care to use words that are contingent, such as “would” rather than words that appear to be binding, such as “will” or “shall.” For example, it is preferable to state that the “Shopping Center would lease to Retailer … ” rather than “ Shopping Center will lease to Retailer.”

Terms Yet to be Agreed Upon. In addition to referring to notions such as “standard provisions, representations and warranties,” consider making clear the major items that have not been agreed upon. If the deal is never consummated, evidence of material terms not agreed upon would be evidence that the LOI was not intended to be binding as to the final deal.

Conditions and Contingencies to Definitive Agreement. Identify contingencies that must be met before there will be a definitive agreement, including any necessary approvals, financing contingencies, marketing due diligence, and the like.

Binding Terms. Even if the parties do not intend to be bound to enter into a definitive agreement, most LOIs will nevertheless contain provisions that are intended to be immediately binding. These may include a confidentiality provision, a “no shop” clause, a provision setting forth the cost allocation for preliminary efforts, due diligence obligations, and a drop-dead date. A public company should also consider a “fiduciary out” clause, which expressly allows the company to enter into a “higher and better” offer if presented.

It is recommended that any and all binding terms be grouped together in a separate section of the LOI. In this way, the parties can be clear as to which items are intended to be enforceable and which items are not.

Extra-Contractual Considerations

Once the LOI is signed, the parties should still take care to preserve the rights for which they have negotiated. Thus, it is important to avoid inconsistent oral or side letter representations as they may create exactly the binding contract a party wished to avoid by the LOI. Similarly, parties should not advise others that a binding agreement exists, and care should be taken to ensure that any side letters or agreements with third parties (eg, an agreement with a landlord approving of a sublease or assignment) expressly state that there is no binding agreement between the parties. Finally, if the deal does not go through, it is important to document all bases for any decision not to go to final agreement.

Conclusion

LOIs are both useful and necessary in today's leasing environment. However, they also present myriad issues that might land the parties in court. Hence, careful consideration and precise drafting are as important for an LOI as they are for a definitive agreement.

Everyone wants to do the deal, but no one is ready to sign the lease. Zoning approvals, construction plans, financing, and a host of other issues need to be firmed up before the lease will be signed, but it is a lot of time and expense to go through if there's no agreement on the essential terms of the relationship. Hence, the Letter of Intent (“LOI”). An LOI is intended to, and should, give assurances to the parties, fix the agreed-upon terms of the deal, provide information and assurances to third parties, and provide a framework for further negotiations and the definitive agreement. It can, however, also be a minefield of potential problems and an invitation to litigation. This article reviews some of those problems and suggests ways to accommodate the parties' needs while avoiding the most common dangers.

Is a Letter of Intent Necessary?

LOIs are appropriate for ascertaining issues of significance to one or both parties. If the parties cannot agree on the significant issues that are often included in an LOI, such as co-tenancy provisions, opening and operating covenants and exclusives, they are unlikely to spend the time and money to negotiate and prepare a final lease or investigate the feasibility of the transaction. Nevertheless, before entering into an LOI, one should think carefully about whether it is truly necessary. Too often, LOIs are viewed by the disappointed party as a binding agreement that the other party has breached, while the withdrawing party views the LOI as merely a prelude to negotiations. If circumstances are such that an LOI is required, the LOI should be reviewed by counsel to ensure that the language protects the parties' interests.

Contents of the Letter of Intent

Binding Nature of Agreement. First, it is important to determine whether the parties intend the LOI to create a binding and enforceable contract, ie, whether the terms of the LOI can be enforced in court to require the parties to enter into a definitive agreement. Courts generally look to five different factors in determining whether an LOI is intended to be binding: 1) the language of the agreement; 2) the context of the negotiations; 3) the existence of open terms; 4) partial performance; and 5) the necessity of putting the agreement in final form. Arcadian Phosphates, Inc. v. Arcadian Corp., 884 F.2d 69, 72 (2nd Cir. 1989).

Courts have almost uniformly recognized that “the first factor, the language of agreement, is most important.” Id. Thus, to avoid placing yourself in the hands of a judge or jury, care should be taken to make clear in the LOI what provisions, if any, are intended to be binding, and what provisions are not. The inclusion of a Statement of Non-Enforceability is the best way to set forth the parties' aim.

Option 1:

Except for those items set forth in Section ___, this Letter of Intent is not an enforceable agreement among the parties, but rather a preliminary nonbinding statement of intent that sets forth the general terms for the negotiation of the terms of the Definitive Agreement [not expressly stated in this Letter of Intent.]

Option 2:

Notwithstanding that either or both of the parties hereto may expend substantial efforts and sums in anticipation of entering into a Definitive Agreement, this Letter of Intent is not a contract, and neither party intends that the preliminary understandings contained herein represent our final agreement as to the transaction described herein. The provisions of this letter are subject to, and conditioned on, the negotiation and execution of a definitive and final agreement. Either party is free to withdraw from the negotiation of the transaction described herein prior to the execution of the Definitive Agreement and without liability to the other party.

Option 3:

The paragraphs and provisions of this letter, with the exception of those provisions in Section ___ hereof, do not constitute and will not give rise to any legally binding obligation on the part of any of the Parties hereto. Moreover, except as expressly provided in Section ___ or as expressly provided in any binding written agreement that the Parties may enter into in the future, no past or future action, course of conduct, or failure to act relating to the potential transaction described herein will give rise to or serve as a basis for any obligation or other liability on the part of the Parties.

Negotiation in Good Faith. An LOI can either require good faith negotiations or disclaim them. It is important to set forth in writing the nature and scope of any good faith requirement (or absence thereof) as the law varies from jurisdiction to jurisdiction with regard to whether such an obligation is implied in any agreement. Thus, particularly with national tenants and/or national landlords, each of the parties may have a different understanding of what their future obligations are under an LOI. This issue is resolved by making explicit the good faith obligations of the parties.

Option 1:

The Parties shall have no liability to each other if they fail to enter into a Definitive Agreement unless there is a breach of a binding provision of this Letter of Intent or unless a party chooses not to enter into the Definitive Agreement in violation of its duty to act in good faith.

Option 2:

This Letter of Intent is not an agreement to negotiate. The parties do not intend to be obligated to use their best efforts or to reach agreement on the definitive and final contract. The parties do not intend to be obligated to negotiate in good faith to reach agreement on the definitive and final agreement.

Agreed Upon Terms for the Definitive Agreement. Obviously, the main purpose of the LOI is to set forth in writing the terms of the relationship that have already been agreed to by the parties. This usually includes such items as the location, rent, length of lease, option periods, and construction allowance. However, take care to use words that are contingent, such as “would” rather than words that appear to be binding, such as “will” or “shall.” For example, it is preferable to state that the “Shopping Center would lease to Retailer … ” rather than “ Shopping Center will lease to Retailer.”

Terms Yet to be Agreed Upon. In addition to referring to notions such as “standard provisions, representations and warranties,” consider making clear the major items that have not been agreed upon. If the deal is never consummated, evidence of material terms not agreed upon would be evidence that the LOI was not intended to be binding as to the final deal.

Conditions and Contingencies to Definitive Agreement. Identify contingencies that must be met before there will be a definitive agreement, including any necessary approvals, financing contingencies, marketing due diligence, and the like.

Binding Terms. Even if the parties do not intend to be bound to enter into a definitive agreement, most LOIs will nevertheless contain provisions that are intended to be immediately binding. These may include a confidentiality provision, a “no shop” clause, a provision setting forth the cost allocation for preliminary efforts, due diligence obligations, and a drop-dead date. A public company should also consider a “fiduciary out” clause, which expressly allows the company to enter into a “higher and better” offer if presented.

It is recommended that any and all binding terms be grouped together in a separate section of the LOI. In this way, the parties can be clear as to which items are intended to be enforceable and which items are not.

Extra-Contractual Considerations

Once the LOI is signed, the parties should still take care to preserve the rights for which they have negotiated. Thus, it is important to avoid inconsistent oral or side letter representations as they may create exactly the binding contract a party wished to avoid by the LOI. Similarly, parties should not advise others that a binding agreement exists, and care should be taken to ensure that any side letters or agreements with third parties (eg, an agreement with a landlord approving of a sublease or assignment) expressly state that there is no binding agreement between the parties. Finally, if the deal does not go through, it is important to document all bases for any decision not to go to final agreement.

Conclusion

LOIs are both useful and necessary in today's leasing environment. However, they also present myriad issues that might land the parties in court. Hence, careful consideration and precise drafting are as important for an LOI as they are for a definitive agreement.