of Intent ("LOI"), also known as Memoranda of Understanding
and Memoranda of Agreement, are a device used to signal parties'
agreement to the basic structure of serious negotiations to
close a deal. An LOI typically comes into play after a round
of initial discussions and after the signing of a Confidentiality
Agreement and a second round of more serious discussions about
the proposed transaction.
of a Letter of Intent
Commitment to Each Other and to the Deal :
Signing a letter of intent, from a business perspective, indicates
that each party has obtained senior management's approval
to work towards closing the proposed business transaction
and that the parties have moved into a stage of serious negotiations.
Commitment to the Deal for Others to See :
After signing a letter of intent, the parties usually issue
a joint press release announcing the event. This is usually
to provoke a positive reaction in the stock market to the
news and some times to send a message to competitors in the
Commitment to a Time Line : An LOI will set
forth a time line for negotiations, including a deadline for
closing the deal and what will occur if the parties fail to
meet the deadline.
Partial Performance and Authorization of Expenditures
: After signing a letter of intent, parties will
often begin due diligence for the transaction and/or preparation
of a formal estimate regarding the transaction. Research and
preparation of such documents involves expenditure of significant
funds for the time and materials of employees designated to
perform these tasks. Senior management will usually authorize
spending such funds based on signing the letter of intent,
although rarely will the LOI specify that there is any way
to recoup these funds if the deal does not close.
Confidentiality : If not already agreed to
in a Confidentiality Agreement, each party will agree to keep
the transaction and information exchanged in negotiations
confidential in an LOI.
Legal Functions of a Letter of Intent
and Writing a Letter of Intent
Letters of Intent, legally, are the worst of all worlds. Writing
a letter of intent is not to be taken lightly. In law, you
either have a contract or you don't. LOI's are the legal equivalent
of "almost pregnant". Letters of Intent emphatically
state that that they are not formal agreements and then often
proceed to set forth agreed terms of the proposed transaction.
Given this paradox, if the deal goes sour, one party can argue
that those agreed-upon points were, in fact, agreed upon -
or, in fact, a binding contract and, in some cases, furthermore,
that the party relied on the LOI and has monetary damages
based on such reliance.
his is the legal problem with a Letter of
Intent - you can't legally state you agree to something and
then state that you don't in the same document. If the LOI
is held to be binding by a court, you have a contract with
general essential terms but without the many terms you would
normally want in final agreements - a liability limit, warranty
waivers, detailed payment and stock terms, etc. If upheld
in court, you have the worst possible contract to work with
- one in which either the court or the parties will have to
work out all the details when the parties are at odds with
If, when drafting an LOI, the author tries
to remedy this ahead of time, by putting as much detail as
possible into the Letter of Intent, so if upheld by a court
the important clauses will be there, then that author risks
greatly increased the odds of a court upholding the document
as binding contract because so many of the essential terms
LOI's are to be used with great caution and,
whenever possible, in conjunction with serious consultation
with your attorney. Nevertheless, they are a reality of the
A Letter of Intent
Not long ago, in very early 1984, Getty Oil and Pennzoil signed
a "Memorandum of Agreement" for a complex investment
and stock transaction whereby Pennzoil would purchase Getty
Oil stock. The Memorandum set forth general terms of the investment
that had been reached in conversations and that the Memorandum
was subject to the approval of the Board of Getty Oil. The
Memorandum was to expire if not approved at the January 2
meeting of the Board and was signed by persons who made up
the majority shareholders of Getty Oil.
After some negotiations between Pennzoil
and the Board of Getty Oil during that Board meeting which
ran for several days, the Board approved the transaction.
On January 4, 1984 , both parties issued press releases with
"agreement in principle" to the terms of the Memorandum.
On January 4, Getty Oil and Texaco began
discussions for Texaco's purchase of Getty Oil, while at the
same time the officers of Getty Oil and Pennzoil ratifies
the agreed-upon terms of the Memorandum and the lawyers for
each began preparation of final agreements.
On January 5, the Board of Getty Oil accepted
a better stock offer from Texaco and voted to withdraw its
negotiated counter-offer to Pennzoil that had been announced
as agreed in principle with Pennzoil.
On January 6, Texaco issued a press release
that Getty Oil and Texaco would merge. Pennzoil protested
and Getty Oil filed suit for a declaratory judgment that it
was not bound by any contract with Pennzoil. The final agreements
for the merging of Texaco and Getty Oil were signed on January
6 - 8.
There, of course, is a long legal opinion
about this case that focuses on the intent of the parties
as determined by their acts and communications. The court
scrutinized not only the Memorandum, but also the wording
of the press releases and other documents.
In the end, Getty Oil was found to be in
breach of the Memorandum of Agreement - the document the parties
had viewed as a letter of intent. At what point in the story
did it change from a letter of intent to a final agreement?
Very hard to tell.
Pennzoil ended up with $10.6 billion (later
settled for $3 billion) from Texaco for interfering in its
deal with Getty Oil.
Moral of the story - watch out if you're using or writing
Letters of Intent - be cautious, don't let your press releases
(and mouth) get ahead of the deal, and consult your attorney.