It's a common question for many business owners: what's the difference between a letter of intent (LOI) and a formal contract? When should you use one instead of the other? Perhaps the most important difference is that while a Letter of Intent may contain legally binding agreements, the letter itself is not a formal commitment to the transaction being negotiated.



Letters of intent usually come into play during the negotiation phase of a deal ? whether it's a joint venture, a partnership or an agreement to render services. They are often used to show good faith in the negotiations process, assuring each party that the other(s) are committed to a successful outcome. In many transactions, the signing of an LOI signifies the official beginning of the negotiations process, and, as discussed later, may preclude the agreeing parties from carrying on simultaneous negotiations with others.

Contracts, on the other hand, formalize the transaction and signify a legally binding commitment to carry out the transaction as described in the letter of intent.

The Anatomy of a Letter of Intent

An LOI can vary in structure based on location, transaction type and local business norms, but there are a few features that are generally common to most. Some companies sell excellent templates to use as Letters of Intent that can be customized with the details of a specific transaction; it's important to use a reliable company in order to ensure the accuracy and legality of the documents in question.

Terms and Conditions

Letters of intent are used to clearly define the terms and conditions of the pending transaction, to ensure that everyone understands them and agrees to them. For instance, in a transaction involving the development of a software program, it can lay out the responsibilities of each side, as well as their stake in the overall venture.

LOIs of this type will often cover aspects such as confidentiality provisions, ownership of the final product, marketing and advertising responsibilities and revenue splitting. This ensures that everyone knows and is satisfied with what they will be agreeing to if a formal contract is signed.

No-Shop (Exclusive Negotiations)

A Letter of Intent also often provides a clause (often called a ?no shop? clause) that guarantees exclusivity during the negotiations phase; in other words, neither party may enter into negotiations with outside parties for the transaction in question. A no-shop clause typically covers a set period of time, often 30 to 45 days, after which the parties can decide whether or not to continue negotiations or back out completely.

Conditions to Close

Another common aspect of a LOI is the ?Conditions to Close? section, which details the conditions that must be in place in order for the deal to go forward. This can involve anything from the sign-off by senior management, to the securing of required consents and approvals.

How is it Different from a Contract?

So how is as Letter of Intent different from a contract? An LOI, in essence, says ?If we both agree to do this, this is what we'll agree to,? yet it does not bind either party into actually carrying out the negotiated transaction. For instance, in the case of a joint venture, the LOI could be used to say ?If we launch an overseas venture together, we will incorporate a new company, named ?New Company, Inc.?, and each co-venturer will hold an x% stake in the venture.? This does not obligate either party to actually undertake the joint venture, but certain conditions contained within the LOI, such as exclusivity or confidentiality clauses, would be legally binding regardless.

When an LOI leads to a successful agreement, the terms and conditions are often carried over into a formal contract. The signing of a contract signals the beginning of the formal relationship, and both parties commence with the delivery of their respective responsibilities. Unlike a Letter of Intent, a contract is a legally binding document.

Clarity of Intent

It's important to note that it is not necessarily required for a document to be signed in order for it to be legally binding. To avoid being bound by a contract before signing it, there should be language that clearly states that the agreement is only formalized on the written signatures of all parties involved. Omission of such a provision could leave a party liable to obligations under the contract if it is found that a contract had been entered into in good faith, and that the signatures were just a formality.

When drafting or signing a Letter of Intent, it is important to ensure that the language contained within it explicitly states that it is not a contractual agreement to carry out the negotiated transaction. Where language is vague or misleading, a signed LOI could be held up as evidence of a contractual agreement.

If you're headed into business negotiations with another party, a Letter of Intent is an important and powerful tool for negotiating the terms of a proposed transaction. For high quality, professional Letters of Intent, as well as an extensive variety of other legal documents and business forms, visit www.megadox.com. MegaDox has been providing quality business and legal documents since 1999, with a focus on accuracy, ease of use, and affordability.

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