Continuing our discussion of best contracting practices, today we discuss letters of intent (“LOIs”) and memoranda of understanding (“MOUs”). Businesses use these types of documents to summarize the terms of a proposed transaction to guide contract negotiations. The idea is to ensure both parties have alignment on the key business issues before moving forward with negotiation of a final agreement. The idea is a good one, but the execution is frequently flawed.
LOIs and MOUs are drafted to be signed by both parties, just like a contract. The problem is that the documents are generally not intended to create binding obligations between the parties (other than confidentiality and a few other basic terms), yet are drafted incorrectly, giving rise to potential liability if one of the parties decides not to move forward or if a final agreement cannot be negotiated. For example, recent cases have shown that LOIs and MOUs, if not properly drafted, can be seen as “agreements to negotiate.” The remedy for breaching an “agreement to negotiate” is recovery of reliance damages: out-of-pocket costs and lost opportunity costs.
In most instances, the use of a simple, unsigned “term sheet” can readily take the place of an LOI or MOU and avoid some of the inherent risks associated with such documents. If entering into an LOI or MOU cannot be avoided, consider the following suggestions:
-- If an LOI or MOU must be used, it should be carefully reviewed for legal issues
-- LOIs and MOUs should contain specific language to avoid being construed as an “Agreement to Negotiate”
-- Include a disclaimer that the letter or memo is non-binding and creates no contractual obligations (except for confidentiality, certain disclaimers and other limitations)
-- Each party shall be responsible for all costs and expenses associated with the negotiation
-- Include a specific limitation of liability
-- Include choice of law and arbitration provisions
-- Include specific ability for either side to terminate negotiations without cause
-- Include language that only a final written agreement between the parties will be binding, subject to appropriate due diligence
