Beware the 'non-binding' letter of intent

How do you think the president of Getty Oil felt when he received a call telling him that Texaco had won a $10.6 billion (yes, with a "B") judgment against Getty for breach of a "non-binding" Memorandum of Agreement? The facts of that case are relatively complex, but the point is that businesspeople will often prepare a "non-binding" letter of intent or memorandum of agreement prior to conferring with their attorney. Litigators often refer to letters like these as "letters of intent to litigate." That alarming name arises from the fact that, unless very carefully drafted, the letter of intent or memorandum of agreement can be construed as a binding agreement (which is basically what happened in the Getty Oil case). Although I generally would suggest that you call an attorney with experience in commercial transactions to draft or review your letter of intent, in many cases the economics of the transaction will not allow that luxury.

So, this article points out a few issues that will help keep you from getting a phone call like the one the president of Getty Oil received. The key points are:

1. Most letters of intent provide both binding and non-binding sections. For example, it might contain a confidentiality or exclusive negotiation section. So, the letter should explicitly state which sections are to be enforceable.

2. The non-binding portions of the letter of intent should avoid mandatory words like "will" or "shall" in favor of words that contemplate fulfillment of conditions like "would." For example, the clause "Buyer will pay $10,000" should be re-written as "Buyer would pay $10,000." The word "would" is consistent with the idea that, if something else happens (i.e., signing a final, formal document), then the buyer would take the action called for.

3. The letter of intent should state as clearly as possible that it is non-binding (other than those portions that are intended to be binding), that no verbal representations of any person will change the non-binding nature to binding and that the only thing that will form a binding agreement is the final, formal agreement signed by the parties.

4. Stick to the basic business points. If the letter states an intention to reach a final agreement or to negotiate in good faith or goes into too much detail about the terms, in some circumstances the letter of intent could be held to be binding in whole or in unintended part.

Despite point 3, businesspeople should be extremely careful about what statements they make and actions they take before and after signing the letter of intent. Despite what a written agreement says about amendments only being in writing, courts have found that the words and actions of parties subsequent to that written agreement may amend the part of the document that says amendments must be in writing. So, until the final, formal agreement is signed, avoid saying things like "this is a done deal" or taking actions that could be construed as partial performance of an agreement (e.g., making a deposit).

Being a lawyer, I still think the letter of intent approach is hazardous. On the other hand, I also understand the benefits of reducing the basic business terms to writing.

For those deals that do not justify attorney involvement at the letter of intent stage, keeping the above points in mind when drafting a letter of intent will keep you out of most of the problems associated with a "letter of intent to litigate."

Craig Etem is a shareholder with Lionel Sawyer & Collins and works in the business law department of the firm's Reno office. Contact him through lionelsawyer.com.