Hemenway & Barnes AUTHORED LITERATURE

Letters of Intent Critical in Commercial Lease Negotiations
Banker & Tradesman Special Report,
Reprinted from the issue of May 29, 2000

By Thomas L. Guidi

Entering into a letter of intent is a critical step for the parties to a commercial lease or other business negotiation. Given the length and complexity of a commercial lease document, negotiating a commercial lease is a time consuming and expensive process. Most landlords and prospective tenants are not willing to devote the time and resources necessary to complete the negotiation of a commercial lease without some indication that their efforts are likely to be successful. Use of a letter of intent allows a landlord and prospective tenant to determine fairly quickly whether they agree on the essential business terms of a potential lease. Reaching agreement on the terms of a letter of intent is likely to give the parties the comfort necessary to proceed with negotiation of a definitive lease document.

There are two major points to keep in mind in drafting/negotiating a letter of intent for a commercial lease. First, in most cases the letter of intent should include all of the essential terms of the deal in order to avoid a subsequent breakdown of negotiations due to failure of the parties to agree on one or more critical points. Second, each party must determine just how binding they want the letter of intent to be. Unlike other legal documents entered into in a typical commercial real estate transaction, which are usually legally binding on the parties, a letter of intent generally can be crafted to be as binding as the parties want it to be.

Traditionally, a landlord and prospective tenant have preferred a fully binding letter of intent in which all of the material terms of the deal have been agreed to and which requires the parties to negotiate in good faith to achieve a final lease document. Such a letter of intent may be important to parties who want to move very quickly to strike a deal, or who are not comfortable risking the time or resources necessary to negotiate a lease without protection against the other party backing out, even at the last moment. However, in today's fast paced commercial real estate market, such letters of intent are increasingly rare.

A letter of intent can be worded in a manner so as to constitute nothing more than an expression of the parties' intent to continue negotiations. Massachusetts law is quite clear that absent, some other factor, a mere expression of intent its not binding. Even if a letter of intent expresses the intent to negotiate in good faith, if the letter of intent is not binding, it will not obligate the parties to do so. Although Massachusetts law imposes upon parties to a contract a duty of good faith, such a duty does not apply prior to creation of a binding agreement. Even an explicit agreement to negotiate in good faith may be negated by a general statement that the letter of intent is not binding on the parties or that the parties will not be bound unless and until they execute a lease document.

There are many circumstances in which the parties may not want the letter of intent to be binding upon them. A landlord may prefer the letter of intent, to be non-binding in case a prospective tenant with a more appealing space requirement or superior credit comes along. A tenant may desire a non-binding letter of intent if it does not want to be legally bound while it shops around for other available locations. Given a choice, each of the parties would probably prefer the letter of intent to be binding only upon the other party. This is a result often desired but seldom achieved.

Currently, the demand for commercial space is so strong and the supply so low that lease transactions are moving at a previously unimaginable pace. In this environment, proper handling of the letter of intent has become of utmost importance. A prospective tenant is now often in a rush to get a letter of intent executed lest another tenant snap up the space. The draftsperson (often the tenant's broker) must carefully craft the letter of intent to include just enough of the business terms to determine whether the parties will be likely to resolve any remaining issues, without bogging down the letter of intent process with too many details. This is a delicate balance that is not always easy to strike.

Getting too bogged down in details could cause the negotiation of the letter of intent to drag on to the point where the landlord may be inclined to back away and turn its attention to another of the prospective tenants who may be waiting in line for the space. In the negotiation of the more formal lease document, the parties often are willing to devote substantial time to discussing issues that would have caused them to lose patience had they been brought up during the letter of intent stage. Since such letters of intent often do not contain all of the material terms of the deal, they are necessarily of the non-binding variety.

However, absent some change in circumstances or new information about the landlord, the tenant, or the property, the parties generally honor such letters of intent as if they are legally binding. Thus, even in the face of a subsequent offer for more rent, a longer term, more space or even a better credit tenant, most landlords will not walk away from a deal in process, even if they could legally do so. Ethics and one's reputation in the commercial leasing community seem to mean something. On the other hand, prospective tenants have not recently faced similar temptations. With so little space available they are extremely hesitant to walk away from a promising deal, even if certain aspects of it are less than ideal.

Even though one or more of the parties to a commercial lease negotiation may be unwilling to bind themselves to the transaction at the letter of intent stage, both parties may desire at least a part of their agreement to be legally enforceable. For example, a landlord may not want the terms it offered to a prospective tenant disclosed to others. Prospective tenants are often required to provide financial statements and disclose to landlords other information about their business operations and products. The prospective tenant has a legitimate confidentiality concern as to those matters. Accordingly, it is common for a letter of intent to contain a confidentiality provision that is binding on the parties and survives a termination of the negotiations. Even if the parties have not worked out all of the important business issues at the letter of intent stage, they may want to bind themselves for a specified period of time to negotiate in good faith to try to reach agreement on a lease. These concerns can be addressed by providing that certain sections of the letter of intent will be binding while the rest will not.

Whatever form the letter of intent may take, it can greatly help facilitate the increasingly complex and often protracted commercial lease negotiation process. And given today's fast moving market, a letter of intent may be the only way in the door to the negotiation table.

THOMAS L. GUIDI is a partner in the commercial real estate practice at the Boston law firm of Hemenway & Barnes.

Reprinted with permission of Banker & Tradesman. This document may constitute advertising under the rules of the Supreme Judicial Court of Massachusetts.