Hello everybody. When negotiating purchase agreements of for very large apartment complexes or transactions including a single sale of multiple apartment buildings, buyers and sellers (or their brokers) often start out exchanging letters proposing and counter-proposing terms and conditions of the deal. Those communications form the basis for entering into a detailed, lengthy formal contract which documents all of the major and minor terms of the deal.
The mutually acceptable provisions in the many letters are frequently consolidated into a single letter or document which summarizes the points upon which the parties agree. That summary typically includes only the material terms and conditions of the proposed transaction, such as price, financing, entitlement periods, securing of governmental approvals, inspections, applicable contingencies, and the like. Provisions which the bargaining parties believe are less significant, or at least will be relegated to custom (such as the appropriate division for payment of the escrow company’s fees and the payment of the documentary transfer tax), may be left for documentation in the finalized purchase agreement.
The consolidated summary of the buy/sell provisions is known as a “letter of intent” (“LOI”) and is signed by the buyer and seller.
My column this month discusses the nature and legal effect of an LOI. In that regard, I have in mind that the parties have verbally, or by an exchange of correspondence, tentatively agreed upon the significant terms of the transaction and thereafter reduced them in a single document which precedes a formal contract.
Parties typically believe that their letter of intent is not a legally enforceable agreement. Instead, they consider the letter to be merely a summary of the major terms of the transaction which are then to be included in a full, and often lengthy, contract which is signed by both parties.
Use of a letter of intent in large transactions may be beneficial because it is less expensive and more expedient to draft an LOI than the complete contract. (This is particularly true with the negotiation and the drafting of commercial leases.) If the parties are not able to agree on the material terms of the deal, they may save thousands of dollars in legal fees which might be incurred in connection with the drafting of a full contract.
Problems arise with letters of intent where the LOI itself contains provisions stating that the parties agree to one thing or another. For example, an LOI may state that the parties agree to negotiate with each other to work toward a fully documented contract. Or it might say that the LOI contains all of the material terms of their “agreement” with the remaining terms to be supplied in the finalized document. Significantly, when a letter of intent acknowledges that an agreement has been reached on the material terms, a court may enforce the LOI as a contract, even though the less important terms were to be supplied at a later time.
The California Court of Appeal explained in Harris v. Rudin 74 Cal.App. 4th 299: “Whether a writing constitutes a final agreement or merely an agreement to make an agreement depends primarily on the intention of the parties. In the absence of ambiguity this must be determined by a construction of the instrument as a whole. The objective intent as evidenced by the words of the agreement, not the subjective intent, governs our interpretation.” (Pg. 307)
In Harris, the court determined that the use of the words “initial draft” in the letter alone was not conclusive as to the intent of the parties. The court concluded that because the letter of intent purported to set forth the essential terms of the agreement and contained a signature block for acceptance, the document might be construed to be a contract rather than simply an agreement to agree in the future.
On the other hand, letters of intent which demonstrate that they are nothing more than an “agreement to agree” in the future are unenforceable. However, one needs to be careful about that concept because if the LOI provides that the parties agree to continue to negotiate the terms of a transaction, but if one of the parties thereafter fails to do so, the other party may sue for damages for that breach, as in Copeland v. Baskin Robins 96 Cal.App. 4th 1251, where the Court of Appeal held that a party to a commercial transaction can sue for breach of an agreement to negotiate even if the parties never reach a final agreement.
In other words, if the LOI sets forth some of the terms of the transaction and also provides that the parties agree to negotiate the remaining terms, each party must thereafter do so in good faith, lest he be exposed to damages for that breach. (As an aside, proving those damages in Court may be an impossible task, although further discussion of proof of such damages is beyond the scope of this article.)
The essential material terms and conditions for a valid contract of sale and purchase of real property include the following:
- The identification of the property, generally by street address or legal description;
- The names of the buyer and seller;
- The price for the purchase;
- The terms of payment of the price, including any contemplated financing;
- The time period for the performance of the transaction, or the date for the close of escrow.
- A recital that the document is agreed to by both parties; and
- The signature of the parties on the document.
Where each of those seven elements is contained in the LOI, the LOI itself might then become itself a binding contract. That is perhaps best illustrated by a Superior Court action which I settled in favor of my “buyer” clients not too long ago. The basic facts were as follows: My clients and the owners of a single family residence in Irvine, California, jointly executed a single page document which summarized the terms and conditions for my clients’ purchase of the $1.4 million home. In the document, the property was described by street address, the names of the parties were set forth, the purchase price and $25,000 down payment were recited, escrow was to close about four months later and the seller was responsible for preparation of the “Buy/Sell Agreement.” The document was then signed as “agreed to this date” between the parties. Also, the document was entitled “HomeSale Agreement.”
After the sellers obtained an attorney to counsel them in connection with the transaction, they unilaterally cancelled the sale contending that the signed one page document was nothing more than a non-binding letter of intent, particularly because it was contemplated that the seller would prepare a full Buy/Sell Agreement.
My clients, who desperately wanted the house, engaged my firm to compel the sale by filing a lawsuit for Specific Performance, coupled with the recordation of a Notice of Pendency of Action (“Lis Pendens”).
The recordation of the Lis Pendens prevented the property owners from reselling their residence to another buyer during the pendency of the litigation. Also significant was the fact that because the signed single page document did not contain an attorney’s fees clause, the sellers recognized that they would spend tens of thousands of dollars in defending the case without any chance of reimbursement from my clients even if the sellers prevailed at trial.
Confident that they, rather than the sellers, would win the case, my clients refused to dismiss the case notwithstanding the persistent demands of the sellers’ counsel.
Faced with expensive attorney’s fees and questionable chances of prevailing, the sellers settled the case with my clients less than 30 days after we filed the litigation. In connection with that settlement, my clients and the sellers executed a detailed eight page contract on a standard C.A.R. form for the same purchase price and substantially the same terms as that set forth in the original one-page document. Thereafter, the transaction was consummated.
Recommendations
To avoid problems with whether or not a letter of intent is enforceable or even constitutes a binding contract, AOA members should implement one of two approaches when employing an LOI:
- Include language similar to the following at the end of the letter of intent:
“The parties acknowledge that this non-binding letter of intent (“LOI”) does not address all the essential and material terms of the transaction contemplated by the parties. Neither party may claim any legal rights against the other by reason of the existence of this LOI or by reason of actions taken in reliance upon this non-binding LOI. This LOI shall not be binding upon the parties and the parties understand that no binding agreement shall exist between the parties unless and until a fully executed contract is hereafter executed by the parties.”
2. Alternatively, unless this transaction is quite substantial or requires a great amount of negotiation, do not sign the letter of intent. Instead, agree verbally to the terms contained therein and then draft the complete contract for execution.
Concluding Remarks
In general, a letter of intent can constitute a binding contract depending on the intentions and expectations of the parties and the words contained in the document. What the courts will consider is whether the parties agreed to the material terms of the transaction in the letter of intent or whether they left some material terms for future agreement, thereby making it merely an “agreement to agree.” While “agreements to agree” are unenforceable, if the only remaining terms to be agreed upon are immaterial in nature, or can be supplied by custom, a court may issue a judgment enforcing the so-called letter of intent as a binding contract.
Letters of intent are wonderful vehicles for purposes of negotiating complex buy/sell transactions and commercial leases. If the parties elect to sign an LOI, be certain that it contains the appropriate language disavowing the fact that it constitutes an existing agreement.
Dale Alberstone is a prominent litigation and transactional real estate attorney who has specialized in real property law for the past 36 years. He has been appointed to periodically serve as a judge pro tem of the Los Angeles Superior Court and is a former arbitrator for the American Arbitration Association. He also testifies as an expert witness for and against other attorneys who have been accused of legal malpractice.
Mr. Alberstone has been awarded an AV rating from Martindale-Hubbell. An AV rating reflects an attorney who has reached the heights of professional excellence and is recognized for the highest levels of skill and integrity. You may Google “Dale S. Alberstone” for further background.
The foregoing article was authored on July 1, 2013. It is intended as a general overview of the law and may not apply to the reader’s particular case. Readers are cautioned to consult an advisor of their own selection with respect to any particular situation.
Address correspondence to Dale S. Alberstone, Esq., ALBERSTONE & ALBERSTONE, 1801 Avenue of the Stars, Suite 600, Los Angeles, California 90067. Phone: (310) 277-7300.