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Letters of Intent – Often a Trap for the Unwary

Wed, 10/24/2018 - 12:18 -- admin25

by John C. Dickey and Reid Johnson

A poorly drafted letter of intent (LOI) can result in unintended obligations and liabilities. This article explores how courts interpret LOIs and provides practical guidance for drafting to help ensure their enforceability.

Parties typically enter into a LOI when negotiating a possible transaction. LOIs often provide an outline of key business terms (e.g., purchase price and closing date), which are generally not intended to be binding on the parties. LOIs may also contain provisions that the parties intend to be binding (e.g., exclusivity, confidentiality, governing law and, notably, the non-binding nature of the letter).

Parties may run into unintended consequences if they execute LOIs that do not sufficiently specify which provisions are binding and which are not. For example, an LOI may state that it is “in regard to a potential transaction” but then include extensive and binding language regarding exclusivity, confidentiality, and dispute resolution. Such imprecise drafting could create confusion regarding the LOI’s binding nature.

Disputes often arise over whether parties have agreed to commit themselves to a transaction. In determining whether the parties intend to be bound, courts generally examine the following factors: (1) the actual words of the document; (2) the context of the negotiations; (3) whether the parties have partially performed their obligations; (4) whether there are any remaining issues to negotiate; and (5) whether the subject matter of the negotiations customarily involve definitive written agreements. See Enterprise Products Partners, L.P. v. Energy Transfer Partners, L.P., No. 05-14-01383-CV, 2017 Tex. App. LEXIS 6658, 2017 WL 3033312 (Tex. App.—Dallas July 18, 2017, no pet. h.); Texaco v. Pennzoil, 729 S.W.2d 768, 784 (Tex. App.—Houston [1st Dist.] 1987, writ ref’d n.r.e.).

Courts have generally held that the first factor above is the most important (i.e., the exact language used by the parties in the LOI). However, parties’ actions can undermine such express intent language in a LOI.In Enterprise Products Partners, L.P. v. Energy Transfer Partners, L.P., the court held that the parties’ actions created a partnership despite non-binding language in their LOI. In Enterprise, each party’s obligations under the LOI were expressly conditioned on the execution of a definitive agreement. Although no definitive agreement had been signed, the parties spent time and money on the venture, stated publicly that the venture had been formed, and marketed the venture to potential customers. When Enterprise later failed to consummate a contemplated venture with Energy Transfer Partners, L.P. (ETP), ETP brought suit, alleging that Enterprise breached its contractual obligations and fiduciary duties to ETP. Despite the express provisions in the LOI, the jury found that the parties’ conduct served to form a Texas law partnership, and that Enterprise had breached its fiduciary duty of loyalty to ETP by failing to consummate it. The award of $535 million to ETP is now on appeal.

In contrast, in WTG Gas Processing, L.P. v. ConocoPhillips Co., 309 S.W.3d 635 (Tex. App.—Houston [14th Dist.] March 2, 2010), the seller required potential purchasers in a competitive bid process to agree to a LOI in which competing bids from different potential purchasers could be considered until the seller and the winning bidder executed a definitive agreement. During the bid process, the seller sent correspondence indicating that the transaction documents were in final form. The losing bidder brought suit against the seller attempting to enforce the unsigned agreement. The court held that despite such confirmed final transaction documents, execution of the definitive agreement “was clearly a condition precedent to contract formation and not merely a memorialization of an existing contract.” The court also rejected that oral seller “we have a deal” statements were sufficient to give rise to an enforceable agreement in light of the clear and controlling expression of intent in the LOI and bid procedures.

Avoiding the Trap

The drafter of a LOI should take special care to include precise language that explicitly establishes the binding or non-binding nature of each LOI provision, as applicable. For example:

“This letter of intent does not contain all matters upon which agreement must be reached in order for the [Transaction] to be consummated, and it shall be non-binding with respect to all matters except for Sections [Exclusivity, Confidentiality, Fees and Expenses, Governing Law and this Section, Nature of Letter]. Additionally, and except as specifically provided above, while this LOI is evidence of each party’s intent to consummate a transaction, nothing herein should be construed to be a legally binding agreement until a definitive agreement is executed by the parties.”

Counsel should also advise clients to avoid engaging in conduct that unintentionally creates an enforceable agreement. Prior to definitive agreement execution, the parties should avoid (1) negotiating any third party agreements, (2) issuing premature public statements, (3) making misleading “we have a deal” statements, (4) marketing to any customers, or (5) otherwise representing that the transaction will close or has closed. Following these practices can help prevent a party from unintentionally entering into a binding agreement.

John C. Dickey is a partner and Reid Johnson is an associate at Barnes & Thornburg LLP and can be reached at john.dickey@btlaw.com and reid.johnson@btlaw.com, respectively.

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