A Letter of Intent Can be a Dangerous Thing

February 14th, 2008

I’ve been reading DC Toedt’s notes on “350 Things I Wish I Knew as a First-Year General Counsel”. He has a number of very good, practical observations about how to be an effective attorney- and not a “Sales Prevention Department”.

One that made me laugh was to remember that “the most useful function of a letter of intent—arguably its only proper function—is to establish that the parties do not intend to enter into a contract at that time.”

In other words, it’s a contract to say that there is no formal contract. The comment is hyperbole, of course- the parties do intend to enter a contract at a future time or they wouldn’t bother with the LOI to begin with, but there is a lot of truth to it at the same time.

I ‘ve definitely seen deals go bad between the LOI and the final agreement. Most LOIs say explicitly that they are non-binding, but having the signed piece of paper can have some kind of placebo effect that gives people undue confidence in the strength of a relationship.

I actually had one client that got a signed LOI, proceeded to hype it for all it was worth and told a bunch of investors that the final agreement was a mere formality. The investors chose to wait for the final agreement before committing, and when the other side backed out it was very embarrassing for everyone. I don’t think the company ever recovered.

So yes, letters of intent are great to have. Just don’t bet the company on one.

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