I am working on a transaction on behalf of the seller. The buyer would like to agree to a letter of intent. What are the legal ramifications of such a letter?
While letters of intent can be a constructive step towards reaching a contract, they have pitfalls, especially for sellers and landlords.
Parties frequently use letters of intent as a first step towards negotiating a more comprehensive contract or lease. Most letters of intent purport to flesh out many of the basic terms of the “deal.” Both sides use the letter to memorialize their agreement on some issues, while leaving the remaining issues (and the details of their agreed upon issues) to future negotiations and drafting. Before both sides invest time, expense, and lost opportunities pursuing a comprehensive contract, they wish to memorialize their points of agreement.
In general, there are two types of letters of intent: ones in which the parties agree that the letter has no binding effect whatsoever (the “Courtship Letter”), and ones in which the parties agree the letter will bind them for some finite period, unless a more formal and complete agreement is reached by the deadline (the “Trial Engagement Letter”).
The Courtship Letter avoids the ambiguities of verbal communication, especially communication among the several players in commercial transactions – including promoters of deals, their investors, multiple brokers, and lawyers. The magnitude of the transaction and the expense and time commitment necessary to consummate a contract must justify the effort invested in the Courtship Letter which binds no one. In addition to the benefits of the Courtship Letter, the Trial Engagement Letter temporarily binds the parties, adding extra “cement” to the deal.
However, letters of intent, especially Trial Engagement Letters, can hurt parties – especially sellers. Through the doctrine of equitable conversion, the law gives a buyer an interest in the real property prior to closing. When the buyer contends that the seller has breached the agreement, the buyer may assert the interest and record a notice of the action (a lis pendens) in the real estate records. The lis pendens will inhibit the owner’s ability to sell, lease, or refinance the property while the litigation progresses.
Misunderstandings arise even among well-intentioned and sophisticated parties. Less scrupulous parties may falsely assert verbal agreements. Recognizing this, the law, through the “statute of frauds,” generally requires contracts which create an interest in real property to be written and signed by the owner of the property against whom the contract will be enforced.
Among other things, the statute of frauds is designed to protect sellers from unfounded contract claims and lis pendens from buyers. A letter of intent can be sufficient to remove the statute of frauds’ protection for owners. The recent case of James H. Moore & Associates Realty, Inc. v. Arrowhead at Vail, 23 Colo. Law. 1922 (Colo. App. 1994) demonstrates this concern.
Moore claimed that, in July of 1989, it entered into a verbal agreement to buy three lots from Arrowhead and that this agreement was reflected in a letter of intent containing the following clause:
Unless an Agreement of Purchase and Sale shall be entered into within 30 days of the date of full execution hereof, incorporating the terms as stated herein with such modifications as shall be mutually acceptable to the parties hereto, this Letter of Intent shall become null and void and of no further force or effect. The parties agree to deal in good faith to secure execution of an agreement of Purchase and Sale upon such terms and conditions as are set forth herein within such thirty (30) day period. [Emphasis added.]
The letter of intent was never executed by Arrowhead, but the Court treated it as though it had been executed because in a letter to its attorney, Arrowhead referenced the letter and requested that its terms be incorporated into a formal agreement. Through October of 1989, Moore and Arrowhead exchanged several drafts of a formal agreement, but no contract was signed by the parties. In April of 1990, Moore learned that Arrowhead was negotiating to sell the same property to another developer, and filed a lawsuit and lis pendens against the property. Moore contended that the parties, either expressly or through their conduct, had waived the condition for a more formal agreement.
The trial court granted summary judgment dismissing Moore’s claims without the need for a trial. The Colorado Court of Appeals reversed, finding that a genuine question of fact existed so that it was improper to dismiss the claims without a trial. In spite of the 30 day termination date in the letter of intent, and though the seller never executed it, the Court of Appeals subjected the owner to the buyer’s claims. The Arrowhead decision will make it almost impossible for sellers to defeat contract claims from buyers prior to trial. To defeat the seller’s motion for summary judgment, the buyer need only submit an affidavit asserting facts suggesting that the seller, either expressly or through its conduct, waived the condition of obtaining the more formal agreement by the deadline. Unable to quickly defeat the buyers in a lawsuit, and facing the debilitating effects of a lis pendens against their property, sellers could find themselves at a significant disadvantage negotiating the post letter of intent details of a contract.
To avoid the effect of Arrowhead, your seller should consider adding language to the letter establishing that no verbal agreements, nor conduct by the parties, shall be effective to waive the condition of the more formal agreement. The language, perhaps explicitly referencing Arrowhead, can make it clear that the requirement can only be satisfied and the deadline only extended upon express written mutual agreement.