“THAT’S NOT WHAT I INTENDED!”: Navigating The Complex Landscape of Letters of Intent
In the realm of contract law, few documents are as often used, overlooked, and misunderstood as letters of intent (“LOIs”). Despite their varying formats and terms, LOIs primarily serve to outline the basic structure of a deal and express the parties’ intent to continue negotiations.
But despite the ubiquity of LOIs, there is often disagreement between the parties about their legal status, prompting caution among lawyers. The well-known case of Texaco, Inc. v. Pennzoil, Co., exemplifies the high stakes involved, as an LOI was deemed a binding contract, resulting in a staggering $8.5 billion damages award against Texaco. (729 S.W.2d 768 [Tex. App. 1987]).
This article delves into the complexities of LOIs and how they are interpreted by courts, with a specific focus on the perspectives of New York and Delaware.
Understanding the nuances and potential liabilities of LOIs is crucial, and seeking guidance from legal experts well-versed in contract law is necessary to protect an LOI parties’ interests.
Understanding LOIs
LOIs are typically considered “Type II preliminary agreements,” which are binding to the extent they reflect agreement on specific major terms (while leaving room for further negotiation on other terms). This flexibility is advantageous when the parties want to solidify their agreement on specific major terms without committing to all issues upfront, and provides an opportunity to refine the remaining provisions during the negotiation process. In contrast, “Type I Agreements” cover all issues and are fully binding (IDT Corp. v. Tyco Grp., S.A.R.L., 54 A.D.3d 273, 275[1st Dept. 2008]).
Disclaimers are Insufficient to Avoid a Binding Contract
Disclaimers stating that an LOI is “nonbinding,” or not a contract are usually insufficient to prevent a court from holding that an LOI is binding. To properly discuss disclaimers, it is necessary to discuss the duty to negotiate in good faith. When it comes to performing the contract, every party of every contract has an implied duty of good faith and fair dealing to cooperate with the contract.
Statements within an LOI stating that its terms are non-binding or not a contract are not sufficient alone to disclaim the formation of a Type II preliminary agreement or the duty to negotiate in good faith (Cambridge Cap. LLC v. Ruby Has LLC, 565 F. Supp. 3d 420, 445 [S.D.N.Y. 2021]). Even an extensive disclaimer stating that no obligations or agreements exist may not be enough to negate the binding nature of an LOI, especially if an exclusivity provision is included.
Breach of exclusivity provisions often leads to liability in LOI cases. Parties may find themselves legally accountable if they violate exclusivity clauses outlined in the LOI.
Choice of Law: New York and Delaware Differ on Expectation Damages
It is crucial to note that Delaware and New York have differing perspectives on the recoverable damages in LOI cases. This makes it important for parties to carefully consider Choice of Law.
In Delaware, expectation damages can be awarded based on what would have occurred if the deal had gone forward – which can significantly increase a damages claim. This includes damages based on lost profits of the business that would have resulted from the agreement that can be shown with reasonable certainty, even if these estimates are somewhat speculative (SIGA Techs., Inc. v. PharmAthene, Inc., 67 A.3d 330, 350–51 [Del. 2013]; SIGA Techs., Inc. v. PharmAthene, Inc., 132 A.3d 1108, 1128-29 [Del. 2015]). Delaware Courts allow more leeway to prove expectation damages based on an equitable principle that a “breaching party cannot avoid responsibility” by arguing that “expectation damages are speculative because they come from an uncertain world created by the wrongdoer.”
On the other hand, New York generally limits damages to reliance damages. These damages include costs incurred during due diligence, out-of-pocket expenses on lawyers or advisers, and under specific circumstances, the cost of cover to pursue an alternative deal instead of the one outlined in the LOI (Cresco Labs N.Y., LLC v. Fiorello Pharms., Inc., 178 N.Y.S.3d 425 [N.Y. Sup. Ct. 2022]).
Furthermore, New York allows recovery based on specific “liquidated damages” stated in the LOI, such as “no-shop” or break-up fees (Cresco Labs N.Y., LLC v. Fiorello Pharms., Inc., 178 N.Y.S.3d 425 [N.Y. Sup. Ct. 2022]; FCS Advisors, Inc. v. Fair Fin. Co., 378 F. App'x 65, 67–68 [2d Cir. 2010]).
Implications and Recommendations
Understanding the legal implications of LOIs is essential for both parties involved in a deal. Proper drafting, including clear disclaimers or exclusivity provisions, can help avoid disputes, unnecessary costs, and potential liabilities. Before drafting and/or agreeing to the terms of an LOI or similar preliminary agreement, parties should consult with lawyers who focus on LOI contract law to ensure that an LOI accurately reflects the intentions of the parties about which terms should be binding and what damages are recoverable. If you have any questions about a Letter of Intent or other preliminary agreement, please contact partners Sam Lieberman (slieberman@sadis.com) or Paul Marino (pmarino@sadis.com)