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The Risk of Intent in Your Letter of Intent

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By:  Richard Herold

Although the press frequently reports cavalierly on the execution of a “letter of intent” (“LOI”), as if it is a meaningless document, a LOI can be enforced if the parties intend to be bound, which turns primarily upon a close review of the language of the LOI and, sometimes, the surrounding facts and circumstances.

 First and foremost, under Arizona’s statute of frauds at A.R.S. §44-101(6), to have an enforceable agreement to sell real property, it must be in writing and signed by the “party to be charged” (i.e., the party you want to sue or hold accountable under the agreement).

 Second, a LOI is generally a writing which documents just the parties’ preliminary understanding.  It is typically considered an agreement to agree to more, it often provides merely the initial framework for the parties’ negotiations and the later, more comprehensive, purchase and sale agreement.  The LOI generally will explicitly provide that the parties do not intend to be bound until certain conditions (such as inspecting the premises and satisfying a financing contingency) are met and a more comprehensive purchase and sale agreement is negotiated and signed.  Where there is such an “express nonbinding clause,” the court should honor it without looking to the surrounding facts and circumstances for guidance, as the seminal case handed down by the Arizona Court of Appeals ruled.  Johnson Int’l, Inc. v. City of Phoenix, 192 Ariz. 466, 967 P.2d 607 (App. 1998).  In Johnson, over more than 2½ years the Plaintiff spent substantial sums of money to develop the design plans for the development and management of a golf course and recreational area, but the LOI (also there referenced as a “Memorandum of Understanding”) expressly provided that it was not binding until approved by the federal government’s Bureau of Reclamation and memorialized in a final, signed contract.  The Johnson Court ruled that there was no enforceable contract.

 Third, a LOI can, however, be binding and enforced by the parties if it is clear that the parties intended to bind themselves to the terms of the LOI, and the LOI includes all material terms of the transaction.  If the parties expressed their intent to be bound even in the absence of more comprehensive documentation, the LOI can be enforced as written if signed by the party “to be charged.”  Id. 

 Fourth, there is yet another option, a grey middle ground, which should be aggressively avoided, where the court may find that the parties have entered into an enforceable contract – but only to negotiate in good faith to reach a future agreement.  In Rennick v. O.P.T.I.O.N. Care, Inc., 77 F.3d 309, 314 (9th Cir. 1996), a franchise case relied on in part by the Johnson court, the parties’ agreement contained a nonbinding clause but also contained an enforceable agreement to “continue good faith discussion directed toward the creation of a formal written contracts that, upon approval by the Board of Directors of each party, will be executed….”  While this was an enforceable agreement to continue talking in good faith, avoid this fundamentally fuzzy area as the right to enforce a contractual duty to negotiate in good faith provides little clarity for decision-making given the unknown boundaries of such “good faith.”

 In conclusion, when parties execute a LOI, they must focus carefully on the language of the LOI and expressly state whether they intend to be bound or not, and, if not, what conditions must be satisfied to give rise to a future binding agreement.  Casual drafting, or review, of a LOI can result in a suit for breach of contract, for specific performance, to recover lost earnest money, and, in some cases, for an award of reasonable attorneys’ fees and costs for the prevailing party in any contract action as authorized by A.R.S.§§12-341 and 341.01.