Reasons Why You Should Prepare a Letter of Intent
In the world of commercial real estate brokerage, it is common practice to initiate a transaction with a “Letter of Intent” (LOI) as opposed to starting off a deal with a contract document.
The practical reason for using this precursor to a contract is more common sense than anything else. Because of the complicated issues in drafting a commercial contract, brokers are not equipped in many situations to construct such a contract.
To do so could be construed as “the unauthorized practice of law” and jeopardize the broker’s license. Aside from that, paying legal fees to have an attorney draft a contract could be a waste of money before creating a meeting of the minds on basic business terms.
In professional sales, when a buyer or tenant is ready to move on a property, a mechanism is needed to keep the momentum of the deal moving forward without undue delay. The LOI often is the tool to make this happen.
So, the LOI has become the conventional way to initiate a commercial or industrial real-estate transaction or even a transaction involving the sale of a business, with or without real estate. The format of the LOI isn’t standardized, but it is critical that the language be concise, unambiguous and most important, non-binding.
Broker’s aren’t as sensitive to the “unauthorized practice of law” issue when drafting an LOI because of the “non-binding” aspect and because most LOIs specifically state that the deal will not be binding unless and until the attorneys agree on an acceptable contract.
A lot of deals never make it past the LOI stage, as parties fail to come to an agreement on terms more often than they agree. It’s a bummer for us brokers, but that’s what often happens in the real world.
The adrenaline starts flowing when a buyer or tenant instructs us to draft up an LOI, which also can be called a “Memorandum of Understanding” or “Agreement in Principle.”
Most often, the terms in an LOI are not meant to be binding on the parties, although the courts have held that certain provisions can be binding, such as an agreement to negotiate in good faith during a specific period of time.
An agreement to take the property off the market while a contract is being drafted is another provision that courts have considered as binding. It is recommended by the legal experts that any component of the LOI intended to be binding be set off in a separate paragraph and made clear.
Key components of an LOI are:
1. Names of the parties to the transaction
2. The property or business address and description
3. Offer terms such as purchase price, down payment and financing sought, contingencies including due diligence period, closing date, other deal points and clauses, and finally who will draft the formal contract if and when the LOI is accepted, and by what date.
4. Language specifying what clauses are non-binding and which are binding.
5. Signature and date lines.
Brokers like to add language relative to who they represent in the transaction (i.e. buyer, seller or both as dual agent). The fact that there is a broker in the transaction should be spelled out, as well as whose obligation it is to pay the broker’s commission.
So the LOI is a blueprint or outline for the basic business points in a commercial real-estate transaction. If orchestrated without the involvement of the attorneys, once completed, it can help the drafting attorney to know how to structure the purchase or lease agreement.
The most peculiar aspect of the LOI is its “non-binding” intent.
The buyer or tenant says I want to buy or lease your place, but you can’t hold me to it. It does seem almost contradictory on the surface, but the process works.
The buyer or tenant can test the temperature of the seller or landlord by floating a set of business terms that would be acceptable. If the seller or landlord “bites”, a possible deal is in the making.
The LOI gets negotiated and then the final contract gets negotiated. Seems like a lot of work to make a deal. And to think, they used to do deals on a handshake.
By Bruce Kaplan – a senior broker associate with Premier Commercial Realty in Lake in the Hills.