By Erin K. Tenner, attorney
What Makes a Letter of Intent a Binding Agreement to Buy and Sell? There are two concepts in the law that can turn an unenforceable agreement to agree into a binding agreement. The first concept is called “reliance.” The law of reliance basically states that if you make a promise to someone, even if they do not give you anything in return for the promise, and they tell you they are going to rely on your promise, and as a result are damaged when you do not keep your promise, you are responsible for their damages.
At least one California Court stated that a reliance argument could be used to make the case that a Letter of Intent was a binding agreement to negotiate in good faith. For example, if a buyer enters into a Letter of Intent and spends a lot of money on attorneys fees and due diligence only to find that the seller had changed his mind, the buyer could argue that he relied on the seller’s agreement to negotiate in good faith and that the failure to do so caused the buyer to unnecessarily incur expense that the seller should be held responsible for reimbursing.
A Letter of Intent can also become a binding contract if the contract is partially performed. Even an unwritten agreement can become an enforceable contract if the parties begin to perform. The argument is that the performance is evidence of the agreement of the parties to complete the transaction. There are certainly defenses to such an argument, but there are circumstances under which this argument could prevail.
For example, if after signing a Letter of Intent a buyer begins performing due diligence, the argument could be made that the parties began to perform the contract to buy and sell because the seller allowed due diligence and the buyer began performing the due diligence (which is more often performed only after a binding purchase agreement is signed.) Once performance begins, the intent of the parties to go through with the transaction can be established by the performance.
A buyer who enters into a letter of intent and then begins due diligence and wants to hold a seller to the Letter of Intent may be able to do just that by using both a reliance and partial performance argument.
Protect Yourself From a Claim that Your LOI is Binding. Here’s how. Even a formal binding purchase agreement has conditions to closing. Conditions to closing are things that must happen otherwise the party who was to benefit from the thing happening does not have to complete the transaction. The person will generally have no liability for walking away – unless the agreement says otherwise. Put a condition in your LOI and it will more likely be non-binding. Provide a condition that a formal agreement will be prepared with warranties and representations and additional conditions to closing and until it is, either party may terminate, the transaction at any time for any reason or no reason.
If, on the other hand, you want to make sure your Letter of Intent is a binding agreement to negotiate in good faith, say so in your LOI.
In either case it is a good idea to make sure your LOI includes a drop dead date. If the parties have not reached a formal agreement by a date certain, the agreement should provide that it terminates unless both parties agree to extend it. Without that language, a seller could be unable to sell to another more reasonable buyer or a buyer could be left with the uncertainty of not knowing if the transaction still has legs and whether they are free from potential claims of failure to negotiate in good faith if they walk away.
Erin Tenner is a transactional attorney who represents auto dealers throughout the state of California in buying and selling auto dealerships. Erin can be reached at 818-707-8410.