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LETTER OF INTENT: IS IT ENFORCEABLE?

contract attorney san diegoWe previously discussed here why businesses and individuals might wish to have an attorney draft a Letter of Intent. This article focuses on the question of whether and when a Letter of Intent [1] is an enforceable contract.

It often happens, when negotiating business deals, that one or both of the parties wants some assurance that their negotiations are serious and will ultimately result in a binding contract rather than a waste of valuable time.  This is especially so when the parties reach the point where they have agreement on the principal elements of an agreement, such as price, for example, when negotiating a real estate sale, but need to finalize various details. In such circumstances, parties may wish to document the seriousness of their negotiations, and the integrity of their intent to proceed with the deal, barring unforeseen obstacles, by memorializing their intentions in a “Letter of Intent”. Usually, a Letter of Intent specifically states that it is not intended to serve as a binding, final contract, but rather as a non-binding expression of intent to contract in the future, and to cooperate while negotiations continue.

But what happens when, after signing such a document, one of the parties backs out of the deal?  Is the Letter of Intent enforceable?   It depends: Sometimes “Yes”, and sometimes “No”.  As usual, the “devil is in the details”, and an understanding of the applicable legal principles is critical in protecting your interests.  The smart business person will seek the representation of an experienced business lawyer when negotiating important contracts and using Letters of Intent.

California Contract Law

  1. Essential Elements of Contract

Whether or not a signed Letter of Intent is a binding contract depends on whether it includes the “essential elements” of a contract, as set forth in California Civil Code §1550, which provides:

  • 1550. Essential elements

It is essential to the existence of a contract that there should be:

  1. Parties capable of contracting;
  2. Their consent;
  3. A lawful object; and,
  4. A sufficient cause or consideration.

There is abundant California case law interpreting this provision, and the law of contracts generally, and the term “consent” means not only that the material terms of the contract are sufficiently specified and agreed, but also that the parties intend, by signing the agreement, that they are or will be bound to perform. Usually, however, Letters of Intent state that they are not intended to bea “final, binding agreement”, but rather a statement of their intent to enter such an agreement in the future. This, of course, can make it difficult to enforce a Letter of Intent.

But the title of the document, whether it is “Letter of Intent”, or “Memorandum of Understanding”, is not alone controlling. Rather, it is whether the “essential elements” of a contract are included in the document. The following statement by a California Court of Appeals makes this point clearly:

A letter of intent can constitute a binding contract, depending on the expectations of the parties. (Mann v. Mueller [1956] 140 Cal.App.2d 481, 487, 295 P.2d 421; see also Gavina v. Smith [1944] 25 Cal.2d 501, 504, 154 P.2d 681.) These expectations may be inferred from the conduct of the parties and surrounding circumstances. (See City of Santa Cruz v. MacGregor [1960] 178 Cal.App.2d 45, 53–54, 2 Cal.Rptr. 727.)

California Food Service Corp. v. Great American Ins. Co. (1982) 130 Cal.App.3d 892, 897 [182 Cal.Rptr. 67, 70].

  1. The Element of “Consideration”; Bilateral vs. Unilateral Contracts

The essential element of “consideration” is critical to understanding contract law.  In simplest terms, “consideration” means “something of value”.  There can be no contract until and unless both parties give “consideration”, i.e. “something of value”.

Usually, this “consideration” is a legally binding promise to perform, as such performance is described in the written contract, or otherwise understood between the parties.  Where each party gives a promise as its consideration, such contracts are said to be “bilateral”, i.e. supported by mutual promises of future performance.

However, “consideration” can also consist of performance by one of the parties.  Where one party offers an agreement, and the other party accepts, and signals its consent by rendering the requested performance, a binding contract is formed by that performance. This is known as a “unilateral” contract. The distinction between unilateral and bilateral contracts is well settled in the law. Section 12 of the American Institute’s Restatement of the Law of Contracts states as follows:

A unilateral contract is one in which no promisor receives a promise as consideration for his promise. A bilateral contract is one in which there are mutual promises between two parties to the contract; each party being both a promisor and a promisee. This definition is in accord with the law of California. Chrisman v. So. Cal. Edison Co., 83 Cal. App. 249, 256 P. 618…In the case of unilateral contracts no notice of acceptance by performance is required. Section 1584 of the Civil Code provides: ‘Performance of the conditions of a proposal * * * is an acceptance of the proposal.’ See Cuthill v. Peabody, 19 Cal. App. 304, 125 P. 926; Los Angeles Traction Co. v. Wilshire, 135 Cal. 654, 67 P. 1086.

Davis v. Jacoby (1934) 1 Cal.2d 370, 378-79 [34 P.2d 1026, 1029-30].

Where parties involved in negotiations have signed a Letter of Intent, it frequently happens that, before a “final agreement” is signed, one or both parties takes actions which might reasonably be construed as “performance”. In that instance, if the other party ultimately backs out of the deal, and refuses to enter a final contact as was contemplated in the Letter of Intent, the performing party might be able to successfully argue that the Letter of Intent, along with other circumstances including its performance, is evidence of a binding unilateral contract.Indeed, when entering a Letter of Intent, both parties should understand that, if they act unfairly and violate the spirit of the agreement, the other side may in fact be able to use the Letter of Intent to support a viable contract claim.

  1. The Doctrine of Promissory Estoppel

Even where a party cannot prevail in proving that a Letter of Intent forms the basis of an enforceable contract, unilateral or bilateral, it may provide grounds for seeking to enforce “performance” under the equitable theory of “promissory estoppel”.

The elements of a promissory estoppel claim are “(1) a promise clear and unambiguous in its terms; (2) reliance by the party to whom the promise is made; (3)[the] reliance must be both reasonable and foreseeable; and (4) the party asserting the estoppel must be injured by his reliance.” ’ ” (Jones v. Wachovia Bank (2014) 230 Cal.App.4th 935, 945, 179 Cal.Rptr.3d 21.)53 *1179

Daniels v. Select Portfolio Servicing, Inc. (2016) 246 Cal.App.4th 1150, 1178-79 [201 Cal.Rptr.3d 390, 416-17]

If a party to a Letter of Intent reasonably relies on that letter, and promises included in it, or in other statements made by the other party in the course of the negotiations, the injured party may have a good claim for promissory estoppel to enforce the Letter of Intent.

CONCLUSIONS

Letters of Intent, while typically not intended to be final, binding contracts, can help protect parties from frivolous, time wasting negotiations.  Depending on how they are written, and the specific provisions they contain, their interpretation may be aided by reference to contemporaneous dealings and communications between the parties. A party which refuses to proceed in good faith as contemplated in the Letter of Intent may be vulnerable to legal claims for breach of contract, promissory estoppel, breach of the implied duty of good faith and fair dealing, or even fraud.

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[1] “Memorandum of Understanding” or “MOU” are other terms used interchangeably for “Letter of Intent.”

By | 2016-12-14T11:17:50+00:00 June 27th, 2016|Contract law|Comments Off on LETTER OF INTENT: IS IT ENFORCEABLE?