What are Letters of Intent?

Letters of Intent are very common in business transactions and help organisations to avoid misunderstandings right from the initial stages of a deal or transaction. Other commonly used names for letters of intent include heads of terms, term sheets, and memorandums of understanding.

As you can probably imagine, the detailed terms and conditions involved in a commercial transaction can be very complex. To aid the process in allowing the two organizations to reach a formal and final commercial agreement, a letter of intent is frequently used. Heads of Terms can be a great way for organizations to agree the high-level commercials of a deal, and provide a roadmap to get to the deal, without yet undergoing the expense of having formal legal contracts drawn up.

Letter of Intent

Are Letters of Intent Legally Binding?

Whether or not a letter of intent is legally binding should be stated on the first page of the agreement. To this affect you will often see “subject to contract” written on the first page, however, you can’t rely in all instances to not be legally binding. Also, whilst the entire Heads of Terms may not be legally binding, some items of it may be, and should be explicitly stated as such, for example, it is common to specify that confidentiality should be maintained, or to specify the jurisdiction where breeches of contract should be heard.

Advantages of Letters of Intent

The main advantages of a letter of intent are as follows:

  • Their creation can bring to light and then clarify any misunderstandings or potential misunderstandings early in the deal process, before both organizations begin to invest large sums of money involving layers etc in a formal process.
  • They provide an early opportunity to introduce some binding terms, such as non-disclosure.
  • They can lay down a staged schedule to reach a formal deal that both sides agree on and are happy with.
  • They increase the confidence of both organizations to move forward.

Disadvantages of Letters of Intent

The main disadvantages of letters of intent are as follows:

  • They can become legally binding under certain circumstances when this was not the intention of the organizations.
  • By agreeing to a letter of intent at an early stage in the process you may hinder your ability to negotiate a better deal late in the process.
  • If a long time is taken to agree a letter of intent, then this may effectively result in the deal being negotiated twice, with the heads of terms merely being some kind of initial compromise agreement.
  • Both competition and international law may be applied to the letter of intent.

Summary

In summary, heads of terms can be very useful for clearing the path and schedule towards complex deals between organizations. Obviously, you need to be mindful of their pitfalls and do not need to use them for simple transactions.

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