Letters of intent (LOI) frequently are used to in commercial real estate transactions to help the buyer and seller set forth the basic terms of the transaction before they enter into a real estate contract. LOIs can be valuable tools in a commercial real estate transaction, but if they aren’t carefully written, they can create a binding contract.
A real estate contract can be as simple as a one-page, written document which says 1) what property is being bought and sold, and 2) how much the buyer is paying for the property. LOIs nearly always contain both of these terms. An LOI also may describe the amount of earnest money, name of escrow agent, length of the due diligence period, closing date, and other additional terms of the transaction which are important to the buyer and seller.
Since LOIs are in writing and have the basic terms required for a real estate contract, they are vulnerable to being considered enforceable contract. Some things to avoid are:
- Contract Language – Certain words, such as “offer”, “acceptance,” or “agree” may imply that the buyer and seller have a contract. Also, use of strong words like “must” or “shall” (e.g., saying “buyer will pay $10,000,000 to purchase the property”) can make the LOI look like an enforceable contract.
- Including an Agreement to Take Action – An LOI may include a requirement that the buyer and seller take future action, even if it is simply “negotiate in good faith” on the terms of a real estate contract. Although that might not require the parties to close on the real estate transaction, the language creates a contract requiring the parties to work together to try to reach agreement. If one party simply changes its mind about doing the deal and refuses to negotiate, the other party might be able to collect damages.
- Conditional Language – Sometimes, a LOI may have conditional language that turns it into what is known as a conditional offer to purchase the real estate. For example, the LOI may state that "upon signing, the seller shall be deemed to have accepted these offer terms." Without more in the LOI, the seller's signature could result in an acceptance and binding contract.
The buyer’s and seller’s actions also can lead to an enforceable contract under the following circumstances:
- Change in Position – If one party to the LOI changes its position to its detriment in reliance on a requirement in the LOI, that may create an enforceable real estate contract.
- Admitting there Is a Contract – By acting like they have a binding real estate contract, the parties can create a binding contract. Examples include issuing news releases stating that the real estate “will be purchased” or sending e-mails that refer to the LOI as a “final agreement on terms.”
- Partial Performance – Courts may enforce an LOI as a binding contract where the parties have partially performed a real estate contract. This is not common, but possibly could happen if the seller handed over possession of the real estate to the buyer without a lease.
To protect themselves, commercial real estate investors do the following:
- Have a Form: Have a real estate attorney prepare a standard form LOI tailored to the party’s typical requirements, so it is ready when needed.
- Stick to the Form: Real estate transactions can be fast-paced and may not allow time to consult with an attorney before an LOI is issued and signed, but changes to a form LOI could create problems. An experienced real estate attorney can create an LOI form (or forms) that includes suggested alternate language to cover the most common needs. By thinking these options through and creating forms in advance, the parties can minimize the likelihood that the form will need to be changed “on the fly” to address a unique need of a particular deal.
- Disclaim: The LOI should include a statement that the parties do not intend to create a contract. The parties also should, by their behavior and communications, consistently disclaim the existence of a contract until a real estate contract is signed. Statements such as “Until we have a contract…” or “Since we don’t yet have the property under contract…” can be helpful.
- Don’t Act Like There is a Contract: Until a formal real estate contract is signed, the parties shouldn’t make announcements about a pending sale, start due diligence, or take other actions consistent with there being an enforceable contract. If a party wants, for instance, to start due diligence before the contract is signed, the parties should include a provision in the LOI that taking the anticipated actions will not be interpreted as forming a contract or entitle any party to damages or other legal remedy.
LOIs are not always as simple as they appear, and this article describes only a few of the possible pitfalls. Buyers and sellers should work with an experienced real estate attorney to assure that LOIs facilitate a smooth transaction without unintended consequences.
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