What is a Letter of Intent?
A Letter of Intent (LOI), sometimes called ‘heads of agreement,’ is a document where one party shows their interest in doing business with another. It outlines the main terms of a possible deal before they negotiate the details and the final contract is drafted.
What is the purpose of a Letter of Intent?
Letters of Intent serve as initial agreements between two parties to outline the broad details of a deal before finalising specifics.
Letters of Intent can outline the basic terms of an agreement before the finer details are agreed through negotiation. An LOI can also be used to show that two parties are in talks to make a deal, like a merger or joint venture.
Overall, letters of intent aim to:
Clarify the main points of a deal that requires negotiation
Protect all parties involved
Announce the nature of the deal.
Letters of Intent are often used to reassure parties in a deal about their intentions and provide strategic guidance.
Who uses LoIs?
LoIs are commonly used in big business transactions. They are usually written by a company’s legal team or small business solicitor to outline plans, for example in mergers and acquisitions, stating how a firm intends to acquire another company through cash or stock deals.
Common scenarios for using Letters of Intent include:
Buying or selling businesses, shares in a business, property, or goods;
Forming a partnership between individuals or businesses;
Outlining wishes for children if both parents die;
Negotiating a lease;
Applying for government grants;
Working with contractors.
What is included in a Letter of Intent?
Letters of Intent usually include:
A brief statement mentioning the legal framework under which the letter is written;
Party information;
Obligations of both parties;
Preconditions that must be met before finalising the agreement - e.g. due diligence by one of both parties;
Clarity on which parts of the letter are legally binding;
Actions required if one party faults to complete agreed tasks and whether compensation will be provided for work done;
Agreement not to negotiate with competitors for a specific period (lockout clause);
Agreement on key elements including scope, price, and main contract work;
When work should begin, even if that’s before the final contract is signed;
A target date for the finalisation of the agreement;
Details of which party is responsible for drafting the agreement;
Descriptions of items and purchase price (for buying or selling);
Purpose of the business (for partnerships);
Property type, rent, and repair responsibilities (for lease negotiations).
Letters of Intent may include clauses about conditions for the deal to proceed or be terminated by a certain deadline. Many LoIs also include confidentiality and no-recruitment clauses to protect sensitive information and prevent poaching of employees.
What are preconditions for a Letter of Intent?
Preconditions are conditions that must be met before the agreement can be finalised. These preconditions might involve the drafting of specific documents or getting approvals from external agencies
Sometimes if one or both parties are companies, it’s necessary to check their Articles of Association and any other Shareholders’ Agreements to see if shareholder approval is necessary before entering into the proposed agreement.
Both or one party may wish to carry out due diligence to look into each other and identify any potential risks.
Is a Letter of Intent legally binding?
Whether or not a Letter of Intent is legally binding depends on how it’s written and the actions taken by the involved parties. While the term ‘Letter of Intent’ doesn’t hold legal weight in and of itself, courts often treat them as enforceable contracts, so they must be drafted carefully.
One common legally binding element in a Letter of Intent is the confidentiality clause, which makes sure no confidential information is shared with third parties outside of negotiations.
Using LoIs as interim contracts
When a LoI is legally binding, following the instructions means agreeing to the contract. This is usually temporary (aka an interim contract) and will be replaced by a final agreement later on. When a final contract is reached, it often applies to the relationship retroactively. However, if no final contract is reached, the terms of the temporary contract stay in place.
LoIs are often used when the other party is asked to start work before the contract is finalised. For example, a business might give a letter to a contractor that instructs them to start work before the final agreement is discussed and reached.
The reason for this is working out the final details of a contract can take quite a while. But it’s not always in the best interests of all parties to delay in getting started. Therefore, a Letter of Intent gives the recipient the confidence to engage with the other party by outlining the agreed-upon terms, payment details, and assurances that the contract will be finalised eventually.
Therefore, if the terms outlined in the Letter of Intent allow for it, it can act as a temporary agreement that permits the parties involved to begin working together while they thrash out the final details of a contract.
Working beyond an interim contract
Sometimes, contractors may continue working beyond the end date of an interim contract, with the expectation a final contract will follow. However, if no final contract comes forth, the situation may get a bit more complex games.
Possible outcomes include
The contracting continuing with the interim contract terms applicable if no final agreement is reached;
The parties agree to new terms, even without a formal final contract;
The contractor can successfully claim payment for work done through quantum meruit if there’s no final contract and no implied agreement on new terms.
Potential risks of using a Letter of Intent
If not carefully written, Letters of Intent can cause unexpected legal obligations. For example, if work starts before a final contract using an agreement through a Letter of Intent, if one party pulls out of that agreement they may still have to compensate the other work party completed before the deal falls through
Even if marked as “subject to contract,” LoIs may still be seen as binding agreements in court, leading to disputes.
By and large, the biggest risks of using a Letter of Intent come down to its interpretation and the actions of the parties involved. For example, if one party were to share confidential details shared in a letter of intent with an unauthorised third party, it could cause harm to the reputation of the other business.
What’s more, HMRC may also interpret certain arrangements outlined in Letters of Intent as tax reduction strategies. This could lead to tax complications or scrutiny from tax authorities if, for example, the arrangements in the LOI are for no other purpose than that of reducing tax liability.
What happens after a Letter of Intent is signed?
Once both parties have signed a Letter of Intent they may carry out necessary due diligence, or go on to negotiate the terms of the final agreement before signing it. In some circumstances, they may do both at the same time.
How to reply to a Letter of Intent
When responding to a Letter of Intent, you need to decide if you agree with the terms first and address any concerns or changes needed. If there are issues, you can negotiate before moving forward.
Usually, you can show your agreement by signing and returning the letter, verbally agreeing, or starting the work as requested. There’s no set method of replying to or accepting, a Letter of Intent, rather the key is to communicate whether you accept the terms of adjustments that need to be made before moving forward.
Can you back out of a Letter of Intent?
It is possible to back out of a Letter of Intent. But if one person doesn’t follow the terms outlined in the letter, the other party can take legal action for breach of contract in some cases. The consequences of backing out can vary from financial penalties for any work already completed, to lawsuits, to damage to reputation.
Therefore, it is always best to understand the implications of a Letter of Intent before agreeing to it, and if you’re not sure find a solicitor to support you in making an informed decision.
Does a Letter of Intent need to be signed?
A Letter of Intent is typically signed by both parties. Alternatively, it can be turned into a formal agreement called a ‘Heads of Terms,’ which essentially services the same purpose.
Create a Letter of Intent online with Lawhive
If not carefully written, a Letter of Intent can unintentionally create a legally enforceable contract. Simply using phrases like "subject to contract" may not prevent this. Courts have ruled that work done after a Letter of Intent should be paid for, even if a formal contract doesn't materialise.
There's also a risk of reputational damage if negotiations fail after details have been shared. Additionally, tax implications can arise from the existence of a Letter of Intent, potentially affecting the amount of tax payable in business transactions like sales or buyouts.
At Lawhive, our small business solicitors are here to help you draft or review Letters of Intent to ensure you understand the full implications of what you’re agreeing to and any potential risks. For more information, get a free case assessment and no obligation fixed-fee quote from our legal assessment team today.