When two or more people enter into a contract to do business together, letters of intent or ‘heads of agreement’ are used to indicate the terms of their contractual relationship. While the term ‘letter of intent’ does not have legal significance, care must be taken when drafting these are the courts will often treat them as contracts that can be enforced.
One clause often included in a letter of intent which is legally binding is a confidentiality clause, which states that confidential information acquired during negotiations will not be disclosed to third parties or used in any other way.
Why use a letter of intent?
Letters of intent are often used for both parties to reassure the other of their intentions in the deal, and to provide guidance on how the deal will be done.
They can also be used when a third party is brought into the deal to help them in their decision-making. Letters of intent can also be submitted to authorities such as the Inland Revenue, to agree that a particular way of structuring a deal will not cause tax problems for example.
Problems which might occur
Unless a letter of intent is carefully drafted, it can create a contract which is enforceable in the courts. Using the phrase ‘subject to contract’ for example, which normally implies that contractual relations will be created later, is not always effective.
In the past the courts have decided that work which was conducted following a letter of intent should have been paid for even when the contract did not arise.
There may also be a ‘loss of face’ if negotiations between the parties fail and details of the agreement have been disclosed to other parties. Moreover, the existence of a letter of intent can have tax implications, as it could suggest that an ‘arrangement’ was in effect, which can mean that tax payable is reduced, which could be significant in terms of business sales and management buyouts, for example.
What should be included?
Letters of intent should usually include the following clauses:
- a statement of the law under which the letter is drafted;
- a statement that the letter is not binding, or clear identification of any sections that are intended to be contractually binding;
- any provisions for non-completion (e.g. where one side must do work to progress the deal, and whether they will be compensated for this);
- a ‘lock out’ clause, in which the parties agree not to have negotiations with competitors for a period, is common;
- a ‘confidentiality’ or non-disclosure clause which defines to whom disclosure of terms can be made (if anyone).
In construction agreements, the courts have issued guidance that letters of intent are most useful when issues such as the scope and price of the works, the completion date and main contract terms have been agreed, or there is dispute over them is unlikely.
Letters of intent are also useful when works need to be started before formal contractual documentation is in place.
For more information on letters of intent, please contact us or call 0800 024 1976.