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It is becoming more and more commonplace in real estate transactions for parties to use a Letter of Intent (LOI) (sometimes called a “Term Letter”) before negotiating and drafting a commercial lease. The LOI can serve as a negotiating device that addresses the proposed transaction and that essentially attempts to reach some sort of written understanding as to where the relationship between the parties is heading. In the best of circumstances, it facilitates a transaction by securing a written, mutual commitment to the significant issues and concerns of both the tenant and landlord prior to the commencement of serious negotiations. In the context of a lease, the landlord, the landlord’s broker or the tenant’s broker typically prepares such letters. Legal counsel will occasionally be asked to review such letters before execution, but not often. Nevertheless, it is important for attorneys involved in negotiating lease transactions to be aware of the benefits and potential risks when using a letter of intent. While LOIs can save money and time, without proper understanding, an LOI can create problems and unforeseen consequences due to the inherent shortfalls associated with this negotiating tool. THE MANY BENEFITS OF USING AN LOI First, as noted above, an LOI can be a very useful device in facilitating a real estate lease transaction. As the LOI focuses on the material terms, it helps parties psychologically commit to the transaction, provides a launching point to begin negotiation on key deal points and can save time, as well as a lawyer’s drafting fees, by providing a skeleton of a deal on which full documentation can be based. As an example, a tenant may have as a priority the need to secure an exclusive use or a co-tenancy requirement before negotiating further. With an LOI, the tenant can get, at the minimum, a commitment from the landlord that these needs have been addressed. Further, an LOI can give a party needed comfort in reaching the goal of the transaction. For example, suppose there is a tight lease market and a tenant wants some assurance of a commitment by the landlord. An LOI can help to quickly secure space in such a market, until lease negotiations can be finalized. In another situation, a landlord or tenant may only want to enter into negotiations if there is a preliminary covenant of confidentiality between the parties. Still another situation might be where the parties want to make sure that if the negotiations fail, the various costs expended during the negotiation process will be properly allocated. With an LOI, these costs can be agreed on and allocated upfront. POTENTIAL PITFALLS For all of these benefits however, an LOI can be a major pitfall for an unsuspecting attorney and his client. While parties generally assume that an LOI is only a prelude or foundation to a transaction and is not a binding contract, an LOI can nevertheless create legal obligations that the parties may not have contemplated. In the past, courts, especially in California courts, have found that an LOI, no matter how carefully drafted to state that it is a nonbinding recitation of key deal points, can be found to be otherwise. (See, e.g., Seaman’s Direct Buying Service Inc. v. Standard Oil Co., 686 P.2d 1158 (Cal. App. 3d 1984). The problem here is that an LOI is, and historically has been, a device typically intended to memorialize only the most essential terms of the deal. Recently, however, particularly in large transactions, parties tend to use an LOI of considerable detail. If the LOI starts to look more like a contract, including such key aspects of the deal as operating expense exclusions or detailed gross-up provisions, the risk increases that a court may determine that the LOI is a contract. As such, an LOI (or whatever label the parties give it) generally will fall into one of two categories of construction: (i) a letter that serves to gauge each party’s commitment to the deal before the expense and delay of full-blown drafting, or (ii) a letter that contains all essential deal terms which are not subject to further negotiation�i.e., a binding and enforceable contract. Still further are situations where, although there is no binding contract, an LOI may force the parties to adhere to the doctrine of good faith and fair dealing, or allow another party to recover under equitable considerations such as promissory estoppel. DETERMINING WHETHER THE LOI IS A BINDING CONTRACT So what affects the enforceability of an LOI as a binding contract? An LOI has no inherent legal significance that will automatically make it binding or nonbinding. Because of this, the enforceability of an LOI is based on contract law and will primarily depend on an analysis of the intent of the parties and the wording of the document. The general rule of contract law is that in order to establish an enforceable contract, the parties must agree on all essential terms, and those terms must be definite, complete and unambiguous. The intent underlying an LOI can be inferred from (1) the language of the LOI, (2) the context of the negotiations, (3) the existence or nonexistence of open terms, (4) whether there has been partial performance, and (5) what is customary for a similar type of transaction. Generally, if a party desires the LOI to be nonbinding, the most common way would be to include in the LOI a disclaimer, such as the sample disclaimer provided in the sidebar. � Language. In addition, courts have found other language contained in an LOI used in a lease or purchase and sale transaction that did not create an enforceable obligation. For instance, in Rennick v. O.P.T.I.O.N. Care Inc., 77 F.3d 309 (9th Cir.1996), the 9th U.S. Circuit Court of Appeals held that a provision stating that the “signatories to this letter confirm their intent to continue good faith discussions directed toward the creation of formal written contracts that, upon approval by the board of Directors of each party, will be executed to establish the following arrangements, and do such other things as may be required in connection therewith . . .,” did not indicate that the parties intended their LOI to be binding. Similarly, in J&W Enterprises v. TM Marketing Inc.,1997 WL 343121 (1997), the Minnesota Court of Appeals found that the language “[f]inal acceptance and lease drafting will be based upon financial/credit approval by [J&]” did not give rise to an enforceable contract. In contrast, courts have also found some LOI provisions to be indicative of an intent to create an enforceable obligation. In a case decided by the Third Circuit in 1986, Channel Home Centers, Grace Retail v. Grossman, (795 F.2d 291), the language “. . . Please acknowledge your intent to proceed with the leasing of the captioned store under the above terms, conditions and understanding by signing the enclosed copy of this letter and returning it within ten (10) days from the date hereof” was held to create a binding contract. In another case, however, an LOI stating that its terms “were binding . . . upon full execution hereof and shall not be altered in the lease” but that “no contract shall exist until a formal lease is executed” was found not to be enforceable. Peoria Associates Limited Partnership v. Best Buy Co. Inc., 995 F. Supp. 823 (N.D. Ill. 1997). � Surrounding Circumstances. Language alone, however, is certainly not dispositive. The surrounding circumstances, including the conduct of the parties after the LOI is signed, can be important. For example, in Midtown Realty Inc. v. Hussain, 712 So.2d 1249, (Fla. DCA 1998), the court did not find the existence of a binding contract when, after the parties executed the letter of intent, they continued to negotiate over the proposed purchase and sale contract. � Equitable Considerations. However, even if it is determined that the intent of the parties did not raise the LOI to the level of a contract, under contractual equitable considerations, an LOI may still impose the obligation to negotiate the terms of the proposed contract in good faith if the parties so intended. Case law has consequently supported this concept of good faith and fair dealing to the extent that it would probably prevent a party from renouncing the deal, abandoning negotiations, or insisting on terms that do not conform to the original agreement. � Promissory Estoppel. Lastly, even if an LOI creates neither a lease nor an obligation to negotiate a lease, an oral promise made in connection with the LOI may support a claim under the doctrine of promissory estoppel. To support a claim of promissory estoppel, a party must show that there was a clear and unambiguous promise, reliance by the party in question, the reliance was both reasonable and foreseeable, and the party was injured due to this reliance. There are also circumstances where neither party desires to enter into a lease, yet still desire some provisions to be binding. In these situations, the parties may create an LOI that is partially binding. A common situation is where the parties impose an obligation of confidentiality so that the terms of the deal or a party’s financial statements do not become public. Another situation is where the costs of preliminary due diligence, such as environmental or engineering reports, need to be allocated among the parties. Often a party will want an indemnification for damage occurring during this due diligence. In all of these situations, the parties may draft a letter of intent in such a way so as to create a binding obligation in a limited context where such obligations survive the LOI. In these cases, it is critical for parties to make it very clear in the LOI the extent to which their legal obligations are limited. So what should one remember when drafting or negotiating a LOI? At the outset, whether you are an attorney or a party to the transaction, be very certain you are aware of what you wish to accomplish with the Letter of Intent. Is the LOI simply a term sheet or is it serving as more, such as a contract to lease? The more you are aware of your own or your client’s desires going into negotiations involving a letter of intent, the better this tool will be able to serve you. The following are some points to remember: � If the parties do not intend the LOI to be binding, it is crucial for all correspondence and drafts to contain a statement to the effect that the document is not intended to create a binding agreement and is only for discussion purposes; it is not enough to state that the parties intend to sign a more formal agreement. � Because conduct can play a role in determining whether an LOI is binding, the parties should avoid inconsistent acts that could reasonably be construed as creating a contract, so that the issues involved in promissory estoppel do not arise. � With respect to the obligation of good faith and fair dealing, if the parties do not want to be bound to an obligation to negotiate, language such as “the parties will use every reasonable effort to reach a final goal” should be avoided. � The parties may choose to carve out binding provisions in an LOI that is otherwise nonbinding; such provisions include those pertaining to cost allocation, duty of confidentiality, choice of governing law, and indemnification for damages incurred. Ira Feinstein is a member of D’Ancona & Pflaum, L.L.C. in Chicago. Paul Lukitsch is an associate with the firm.

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