Letters of Intent in Commercial Lease Negotiations
Anyone who has been involved in a real estate transaction, whether professional or layperson, has no doubt been frustrated by the complexity of the leasing or sale process.
“Gone are the days when our ancestors sat around a fire and bargained for the exchange of stone axes for bear hides. Today the stakes are much higher and negotiations are much more complex. Deals are rarely made in a single negotiating session. Rather, they are the product of a gradual process in which agreements are reached piecemeal on a variety of issues in a series of face-to-face meetings, telephone calls, e-mails and letters involving corporate officers, lawyers, bankers, accountants, architects, engineers and others.” (Copeland v Baskin Robbins USA, 117 Cal. Rptr. 2d 875, 884-885)
Landlords and tenants generally rely on letters of intent to bring some efficiency and structure to lease negotiations. Frequently, they are drafted by brokers, who are skilled at evaluating business opportunities and strategically negotiating business terms, but who may not be as experienced in the nuanced drafting of legal documents. Unfortunately, a casually drafted letter of intent, or over-anxious principals, can unintentionally create an additional layer of complexity and liability to a leasing transaction. The purpose of this article is to outline some important considerations and concerns in the use and drafting of letters of intent in the commercial leasing context.
In the commercial lease context, letters of intent are written documents that outline or memorialize certain hypothetical terms to which the landlord and tenant have committed or acknowledged will be addressed in the final agreement. A letter of intent may be nothing more than a term sheet. On the other hand, depending on the complexity of the transaction, a letter of intent may be a multi-page letter or memorandum outlining some or all essential deal points. At their best, letters of intent facilitate efficiency and speed as well as reducing the cost of preparing final documents. At their worst, they become an obstacle to deal making or, heaven forbid, the unintended memorialization of an incomplete agreement between the parties.
What and How Much Detail Should be Included?
Letters of intent can be brief, including only basic terms, or quite detailed. Whether to negotiate many of the terms or simply agree to an outline of key terms is a strategic decision that will depend on the complexity of the transaction, whether one or both sides have particular needs and who the parties are. When the parties try to create a comprehensive letter of intent, they risk losing the efficiency that is its primary purpose.
Letters of intent generally include the basic terms such as the description of the premises, the identity of the landlord and tenant, the base rent, security deposit and the lease term. They may also include the permitted uses, assignment and subletting, tenant improvements and guaranty provisions. If a party requires a specific term or provision, that party should carefully consider whether it would be better to start the negotiations with a less detailed letter of intent or if it would be better to broach the potential deal-breaking provision before making a significant investment in negotiations.
To Bind or Not.
Letters of intent can be binding, non-binding or include some binding provisions. The typical commercial lease letter of intent will include some or all of the essential terms of the yet-to-be-drafted lease. In most cases, the parties intend for the letter of intent to be a non-binding document that serves as an outline for the lease agreement, and in theory should help to expedite the process.
Binding letters of intent are uncommon in most lease situations, although there are some exceptions. If one of the parties, typically the tenant, feels that the lease offers a particularly good opportunity, or if the tenant is about to spend significant sums on due diligence or design work, the tenant may want to “lock-in” these terms by drafting a binding letter of intent. Landlords are likely to be less interested in this, as they may have to forego more lucrative offers that present themselves after the execution of the letter of intent, but while the lease is still being negotiated.
Nevertheless, there are some provisions that are usually best made binding. For example, covenants of confidentiality, access to certain information, prohibitions on further marketing or acceptance of offers, obligation to negotiate in good faith, performance deadlines or agreements to pay for certain pre-agreement costs, if included, should be binding. If these provisions are made party of an expressly non-binding letter of intent, they should be drafted in such a manner as to recognize their binding affect. Alternately, some of these issues may be best dealt with in a separate, binding agreement such as an early access agreement.
Is it Binding?
Whether a letter of intent is binding or not may ultimately be determined by a court; therefore care should be taken in the drafting. Courts will look to the parties’ expectations and intent to determine whether a letter of intent is binding or non-binding. If the parties intend that the letter of intent will be non-binding until the execution of final documents, the letter should include certain statements indicating their intent. First, a disclaimer of any binding intent, except for specific carve-out provisions. Second, a statement that there shall be no binding agreement, until the execution of the formal written lease. Although this is a good start, these statements may not be enough to ensure that the non-binding letter does not become a binding agreement.
Indications of Intent to Bind.
Courts have found that the parties’ intent in executing a letter of intent can be determined in a number of ways, including the language used in the letter of intent and by considering the parties’ conduct. First, courts will look to the language of the letter of intent itself. The drafting party should take care in choosing terminology and use of tense. A letter of intent should generally not, for instance, be referred to as the “lease” or “accept” a final proposal. Use of the subjunctive suggesting that an agreement has not yet been reached is preferred. The choice of words and word tense can be a significant written indication of intent. Another indication is whether the letter of intent contains all the essential terms and the specificity of those terms. Because an agreement cannot be formed where an essential term is missing, it is important as an initial step to include language stating that the letter of intent does not include all of the essential terms, if it is indeed meant to be non-binding. Given that precious few terms are essential to form a lease (identity of landlord and tenant, description of the premise, lease term and amount of rent and time and manner of payment) a provision stating that the letter of intent does not include all of the essential terms contemplated by the parties should be included.
The parties’ conduct may provide further indications of their intent, despite language disclaiming its binding effect. If the parties perform as if they have an agreement, a binding contract may be found. Partial performance may be sufficient. For example, taking possession of the premises and paying rent may be sufficient, even if other terms such as procuring insurance, assignment of lease, etc., have not been fulfilled. For this reason, a statement disclaiming partial performance as an indication of the letter’s binding effect should be included.
Does the Letter of Intent Impose A Duty of Good Faith and Fair Dealing?
It is generally accepted that agreements to agree are unenforceable. However, in Copeland v Baskin Robbins, USA the California Court of Appeals considered whether one can enter into an agreement to negotiate, and if so, whether a duty of good faith and fair dealing applies. The Court determined that an agreement to negotiate is an enforceable contract, distinct from an unenforceable “agreement to agree”.
The obligation to negotiate can be an express term of a letter of intent or it can be implied. In Copeland, the agreement to negotiate was not an express provision of the letter of intent. In fact, it was implied from nothing more than a provision in which Baskin Robbins agreed to negotiate a separate co-packing agreement.
Agreements to negotiate, like all contracts, impose a duty of good faith and fair dealing. The duty to negotiate in good faith does not mean that the parties must ultimately reach an agreement, but rather, their efforts must be made in good faith. In Copeland, Baskin Robbins became liable for its failure to negotiate in good faith when it unilaterally terminated the negotiations.
A party can find itself liable for reliance damages for its failure to negotiate in good faith. These damages can include out-of-pocket damages and may or may not include lost opportunity costs. However, expectation damages are not a remedy. In order to avoid this potential liability, the letter of intent should include an express disclaimer of any agreement to negotiate or to negotiate in good faith, unless it is the parties’ intention that such duty applies.
Proceed with Caution
Letters of intent are incredibly valuable tools which can aid both landlords and tenants in controlling lease negotiations and efficiently drafting lease agreements. However, as this article suggest, they come laden with traps for the unwary, and opportunities for liability that are not obvious. Attorneys – as well as both landlords and tenants – should proceed very carefully to insure that a letter of intent actually expresses the intention of the parties.
Elva D. Harding represents commercial landlords and tenants in commercial leasing negotiations and transactions. If you have questions about letters of intent or commercial leasing contact Elva at (925) 215-4577; firstname.lastname@example.org.
This article is published as a service to Harding Legal’s clients and friends. It should be viewed only as an overview of the law, and not as a substitute for legal consultation.