The Letter of Intent

The Letter of Intent

A letter of intent or “LOI” (sometimes called a letter of understanding or “LOU”, or memorandum of understanding or “MOU”) is a non-binding expression of the primary business terms in which parties intend to move forward with negotiating and consummating a lease.  The LOI is a critical document because all subsequent legal and other business negotiations depend on the terms in the LOI remaining consistent.

LOIs are most commonly negotiated by principals and their brokers without assistance from attorneys.  Accordingly, I often do not see the LOI from my clients until it has already been signed.  From my perspective, the most important aspect of the LOI is the clause that states the LOI is non-binding.  The LOI usually contains all of the terms necessary to form a lease: the length of the term, the rent amount, the location of the property, and the signature of the parties to the lease.  Without the non-binding clause, either party could argue that the LOI is in fact a binding lease agreement.   Following is a sample non-binding clause to insert in every LOI:

This letter is intended solely as a preliminary expression of general intentions and is to be used for discussion purposes only. The parties agree that this letter is not intended to create any agreement or obligation by either party to negotiate a definitive lease agreement and imposes no duty on either party to continue negotiations. The parties intend that neither shall have any contractual obligations to the other with respect to the matters referred herein unless and until a definitive agreement has been fully executed and delivered by the parties.

Following are practice pointers for principals and brokers negotiating LOIs:

1. Authority.  Make sure the persons entering into the LOIs will ultimately have the authority to sign the binding lease agreement.  If not, there is risk that a deal has not been reached.  Attorneys, brokers and the other party will all become very frustrated if the terms in the LOI change after lease drafts have been circulated.  I recently fully negotiated a lease for a landlord client in which the tenant’s office manager negotiated the LOI and lease terms on behalf of the tenant.  When the final lease was circulated for signature, the principal of the tenant started asking for reduced rent, renewal terms, early termination options, etc.  All of the prior negotiations were based on the terms in the LOI remaining consistent, so adding these significant deal points at the last minute undermined the entire negotiation process.  This means more attorneys’ fees and more time spent by brokers to work out a new deal.

2. More is not always better…  Some brokers try to negotiate every key lease provision in the LOI, including exclusive use provisions, assignment provisions, insurance and indemnity requirements, etc.  I have seen 10 page LOIs (in contrast to the typical 2-3 page LOI).  Brokers think this will save their clients in attorneys’ fees and lease negotiation time.  First, negotiation of these provisions tends to bog down the negotiation of the business terms.  Second, whatever the parties agree to the LOI, the parties should be prepared to live with that language in the lease.  It becomes difficult to change after-the-fact, and I hate to waste some of my negotiating leverage undoing improperly worded terms in the LOI.  Third, the broker must be experienced in negotiating these lease provisions and not rely on form language to do the work.  To be safe, the LOI can address several terms, but should include language allowing some wiggle room such as “final language to be negotiated in the lease agreement.”

3. … but cover every important business term.  Several important business terms often are left out and cause stoppages in negotiations.  Business terms are deal specific, but following are business terms that commonly cause problems if not negotiated in the LOI: (a) determination of fair market rent for renewal options.  The LOI should include whether the renewal rent will be determined by landlord, CPI index increases, appraisal, arbitration, etc.  This is a perfect example where the LOI could make a simple statement regarding the determination method, with “final language to be negotiated in the lease agreement.”  (b) payment of tenant improvement allowance.  The LOI typically provides the amount of a TI allowance, but does not address whether the landlord will pay the allowance up front, pay the contractor as the improvements are made, or pay the allowance after completion of the improvements. (c) responsibility for maintenance items, especially HVAC, roof and parking areas.

Prior to using any language or concepts from this blog entry, consult with an attorney.

Ryan Rosensteel is a real estate and construction attorney licensed in Arizona.  You can contact him at ryan.rosensteel@azbar.org.