A Matter of Intent
A goodly amount of legal commentary crosses my desk--law reviews, law journals, and a variety of law-related newsletters. Much of this material is overly pedantic or otherwise not of great interest to practitioners. A notable exception is the latest issue of Real Property, Probate and Trust Journal, the quarterly academic publication of the ABA’s Section of Real Property, Probate and Trust Law. Literally all of articles are worthy of a read even by a busy practitioner.
In future postings, I will discuss a number of the articles. The article that I want to turn my attention to first, Thomas C. Homburger’s and James R. Schueller’s "Letters of Intent–A Trap for the Unwary,” is of special interest because its focus, letters of intent, are used so frequently and, probably, just as frequently misunderstood, that the article should be obligatory reading for practitioners.
Homburger and Schueller identify three types of letters of intent: (i) those that create an enforceable contract to consummate the intended transaction, (ii) those that create an obligation to negotiate in good faith, and (iii) those that simply set forth a term sheet and that, therefore, do not create enforceable contracts. Their article makes a convincing case that one should decide which of the three categories one intends a letter of intent to fall into.
One aspect of the topic that came as a bit of surprise to me was the possibility that a broker could argue that it had earned its commission once the letter of intent had been executed. Just such an argument was raised in the case of The Fischer Organization, Inc. v. Landry’s Seafood Restaurants, Inc., decided earlier this year by the Court of Special Appeals of Maryland. The broker’s argument in that case was rejected because the Court found that the terms set forth in the letter of intent did not match the terms in the brokerage contract that would have entitled the broker to a commission. However, the fact that the case was brought at all should serve as a signal for caution both in drafting letters of intent and brokerage contracts.
In an opinion delivered last year, Burback Broadcasting Co. of Delaware v. Elkins Radio Corp., the Fourth Circuit discussed the difference between the two types of enforceable letters of intent identified in the Homburger/Schueller article. Quoting Corbin (“Letters of intent have lead to much misunderstanding, litigation, and commercial chaos.”), the Court sustained a judgment in favor of the intended purchaser seeking to enforce the letter of intent, holding that the letter created an enforceable obligation to negotiate a contract in good faith. The intended seller’s attempt to alter various agreed upon terms of the deal was held to constitute a breach of its obligation to negotiate in good faith the various components that the letter of intent left open.
Homburger and Schueller suggest language that can allow a party an out if the negotiations on the open items reach an impasse. There seems to me to be an inference that this suggested language leaves an escape hatch that is somewhat larger than the Court in Burback Broadcasting would allow. Thus, Homburger and Schueller suggest that rejecting a contract after conducting a full due diligence review is probably acceptable. I am not certain that the Burback Broadcasting Court would agree. The opinion in that case seems to indicate that the escape hatch is available only if there are good faith differences as to specific open items that prevent the ultimate consummation of the deal.
Since it is the job of the practitioner not merely to allow a client to win litigation, but to avoid it in the first instance, it is helpful to make it clear what is really intended. Thus, if the letter of intent would allow a prospective purchaser to back out if the due diligence review caused it to rethink the deal, the letter of intent should state that the purchaser need only go forward to closing if it determines, in its sole discretion, to go forward on the terms stated after making its review.