What is a letter of intent?

In its most simple form, a letter of intent (LOI) is an agreement to agree in the future. Since an LOI is generally considered to be an informal agreement, it often takes the form of a letter or memorandum. Essentially, an LOI is preliminary negotiations, an effort to determine if the parties are serious about entering into a potential transaction in the future memorializing the basic agreement of the parties.
Under Wisconsin law, an agreement to agree does not create an enforceable agreement. Meaning, in Wisconsin, an understanding and intent to reach an agreement in the future is not legally enforceable.

Commercial benefits

In commercial transactions, an LOI is an invaluable tool, a negotiation instrument used to determine if parties agree on key aspects of a possible deal. The use of an LOI greatly reduces the premature drafting of offers or leases, because it’s an opportunity to see if the parties can even agree on the most basic business and economic issues without an intention to be bound. 

While the majority of LOIs successfully open the door for the parties to negotiate and often conclude in consummating a commercial offer to purchase or lease, there is a danger to this method — the more the LOI looks like a contract, the greater possibility a court may determine it is a contract. And while it is commonplace for a commercial agent to assist parties in preliminary negotiations by way of an LOI, the practitioner is strongly encouraged to utilize an LOI drafted by an attorney. 

LOI risks

The use of an LOI is not without risk. LOIs should be used with the greatest of care. A seemingly harmless modification to an LOI can turn it into a legal contract or create an unintended legal obligation. With just one misstep, an LOI can accidentally become the exact opposite of its desired effect: a contract or enforceable agreement. 

Due to the unique nature and purpose of an LOI, there is no state-approved or WRA-created LOI form. Most commonly, parties create the LOI with assistance of their commercial agent or attorney, setting forth preliminary terms as a negotiation tool to see if the parties are serious or in close proximity to agreeing to the major business and economic issues of the transaction. 

While it is commonplace for commercial real estate agents to assist parties during the preliminary negotiation process by way of an LOI, practitioners should be mindful of the risks associated with such a role. In addition to the possibility of inadvertently creating an enforceable contract or obligation, real estate licensees must observe the specific regulatory limitations imposed for the practice of real estate. 

Chapter REEB 16 of the Wisconsin Administrative Code regulates the extent to which real estate licensees are allowed to practice law by the use of certain approved contractual forms. Exceeding the authorized practices found in the rules can subject a licensee to DSPS discipline and charges of unauthorized practice of law.

Arguably, the process of assisting parties during the preliminary negotiations by use of an LOI does not fall under the purview of REEB 16 because the parties are not creating a contract when entering into an LOI. But licensees utilizing LOIs must remember that the slope into creating a contract or other enforceable obligation is fast and slippery. 

In addition, real estate licensees must be mindful of the limitations of their license, including their ability to draft contracts. In 1961, in a narrow 4-3 decision, the Wisconsin Supreme Court confirmed the real estate licensee’s limited right to practice law in a real estate transaction. In State ex rel. Reynolds v. Dinger (1961), the Supreme Court held that when a licensee uses the state-approved forms to accomplish the intent of the consumer, it is the practice of law and provides a useful benefit to the public. A real estate licensee’s role is to complete offers and other contracts for their clients and customers using preprinted forms. A real estate licensee can handle all of the negotiations, which could potentially include an LOI between buyers and sellers as well as assist with arranging financing, inspections and closings. A real estate licensee cannot provide legal or tax advice, unless that real estate licensee is also an attorney. Only an attorney can advise the parties as to their legal rights under the terms of the transaction documents. As in each real estate transaction, different circumstances create a unique set of facts, and while LOIs are commonly used in commercial transactions, there are appropriate times to enlist the services of legal counsel. 

Practice pointers

An LOI must be clear that the parties are simply expressing an interest and do not intend to create a contract or become bound until a contract is signed in the future. If the LOI is simply an agreement to negotiate further in the future, the document should expressly state that the parties are not bound until a formal contract is executed. 

The intent of the parties should ultimately determine the enforceability of an LOI. Intent may be ascertained from: (1) the language of the LOI; (2) context of negotiations; (3) the existence or nonexistence of open terms; (4) partial performance; and (5) the custom for similar types of transactions. One of the most direct ways to show the intent of the parties is not to create a binding agreement is the inclusion of a disclaimer in the LOI. Such a typical disclaimer may read:

“This letter is not contractually binding on the parties and is only an expression of the basic terms and conditions to be incorporated in a formal written agreement. This letter does not obligate either party to negotiate in good faith or to proceed to the completion of an agreement. The parties shall not be contractually bound unless and until a formal agreement is executed by the parties, which must be in form and content satisfactory to each party and its counsel in their sole discretion. Neither party may rely on this letter as creating any legal obligation of any kind.” 

However, parties must be mindful that the inclusion of such a disclaimer alone may not be sufficient to declare that the LOI is nonbinding. The actions of the parties and circumstances after signing the LOI may contradict the disclaimer and demonstrate that the parties view the LOI as a binding contract, thus providing sufficient evidence that the intention was to create a binding contract. 

For example, the parties should take actions consistent and in conformance with the language of the LOI. Examples of inconsistent actions could include allowing a potential buyer or tenant to make improvements on the property without notice that the buyer or tenant is doing so at its own risk. For instance, permitting a potential commercial tenant to install fixtures relating to the business the tenant plans to open after execution of a lease may be an action inconsistent with the language of the LOI. If such activity appears to be occurring or is going to occur, the parties should stop all activity and immediately consult legal counsel. 

In general terms, the following are topics commonly addressed in commercial LOIs:

• Address or description of the property
• The parties
• Purchase price
• Earnest money/security deposit
• Contingencies
• Closing/possession
• Brokerage fees
• Other covenants, terms or conditions
• Confidentiality 
• Exclusivity
• Duration
• Nonbinding disclaimer

One element distinctly missing from the above list is a good faith obligation. An obligation of good faith generally arises once a contractual relationship has been created. The obligation to negotiate an LOI in good faith may prevent a party from renouncing the deal, abandoning the negotiations or insisting on terms that do not conform to the LOI. Therefore, many attorneys advise against including an obligation to negotiate in good faith. 

Parties should also be cognizant to avoid oral promises. Regardless of whether the LOI creates a contract or obligation, if an oral promise is made in connection with an LOI, a party may make a claim of promissory estoppel. In general terms, a party making a claim of promissory estoppel is attempting to say that the party relied on the oral promise made by the other party and was harmed by relying on said promise. 

The role of an LOI is undeniable in a commercial transaction. Its purpose and power is unmatched in the daily negotiations that are a regular and needed part of the commercial real estate industry. The role of the commercial agent is integral in helping the parties achieve this preliminary step, however it is not without risk, and this article is an opportunity to remind agents of those potential hazards and ways to continue in their role without placing the parties or the licensee at risk.

Cori Lamont is Director of Regulatory Affairs for the WRA.