This article has been written by Mansi Gehrana pursuing the Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho. This article has been edited by Kritika Sharma (Associate, Lawsikho) and Smriti Katiyar (Associate, Lawsikho).
What is a Letter of Intent?
According to Cheshire, Fifoot, and Furmston’s Law of Contract (Twelfth Edition, Pg. 43), it is stated:
“A letter of intent is a very commonly employed commercial device by which one party indicates to another that he is very likely to place a contract with him.“
A letter of intent is a prerequisite for entering into a contract. Parties often try to enter into a letter of intent for specifying upfront the key terms of the proposed contract. It outlines the understanding between the parties to the transaction which they propose to formalize into a legally binding agreement. Its non-binding nature makes the document more reliable as it does not provide any kind of assurance for entering into a contract in the future. A prior agreement to ‘enter into an agreement is neither enforceable under the Indian laws nor does it confer any rights upon the parties. A Letter of Intent (LoI) generally indicates a party’s intention to enter into a contract with the other party in the future. An LoI is never intended to bind the parties to enter into any contract. The paper is focused on the two-fold objectives of the LoI, sample clauses that are required to be put to make it a legally non-binding document, and the opinion of the courts regarding the legality of an LoI which differs from case to case.
Objectives of Letter of Intent
- Intention to negotiate- The letter of intent sets out the negotiation deals. Letter of intent paved a way for signing off further transactions between the parties. With an LoI, parties always thrive to negotiate on certain terms. There is always an intention to negotiate and reinforce pre-contractual liability while entering into the letter of intent.
- The basis for future agreements– Before the final agreement, parties have already specified the terms upon which the contract will ultimately be laid down. This will in turn help the parties in delimiting the terms of future negotiation as well because the terms on which the final contract will rest are specifically clear. When the terms for negotiation and the final contract are clear, the job of the parties will become easier.
- Building of the Trust- There are some contracts between the parties which require either prior approvals from the ministry or the government or which incurs high amounts of risks and capital expenditure. To tackle the situation, before entering into the final contract, a prior two-three months period is required to anticipate with qualified consent & build trust between the parties. The letters of intent never bind the parties to enter into contracts.
- No Contractual Obligations- The main purpose of an LoI is to enter into a legally non-binding document. The letter of intent is entered into and need not contain any specific contractual obligation. An LoI merely expresses an intention to enter into contact. If the conditions stipulated in the LoI are not fulfilled by the first party and if the conduct of the first party is otherwise not such as would generate confidence, the second party was entitled to withdraw the LoI. There was no binding legal relationship between both the parties.
Terms of the Letter of Intent
LoI is usually termed as non-binding. Until & unless the nature of the terms of the document differs from its usual course, these are termed as non-binding. By only putting the labeling tag as a letter of intent to a document cannot and should not absolve the parties from their contractual rights and obligations. In cases of disputes, the terms of the LoI are scrutinized by the courts whether there is an intention between the parties to enter into a final and binding contract or not. In the case of Rajasthan Co-Operative Dairy vs Shri Mahal Laxmi Mingrate it was held that although, letter of intent sometimes takes a hybrid form where certain terms such as confidentiality and exclusivity, governing laws, dispute resolution, etc. are agreed to between the parties. Where the letter of intent asserts that there is no binding contractual obligation between them, there is always an assumption in favor of its non-binding nature.
The basic difference between Letter of Intent & Memorandum of Understanding
Both the documents are signed for paving the way for further negotiation between the parties, but there is a slight line of difference between the two-
- The number of parties involved- The number of parties involved in an LoI is usually two while in an MOU there can be multiparty to a single transaction.
- Nature- An LoI is always non-binding in nature, except where the intention and terms differ, and hence it cannot be enforced in a court of law. The courts are in their usual practice, encountered with the binding & the non-binding nature of an LoI and the courts always head towards the terms & conditions, the intention of the parties. While the MOU is a legally sound and binding document. It can be enforced in a court of law in case of breach of the terms by any party.
- Uses- An LoI is signed only by the party who proposed to put the LoI for finalizing the deal between the parties, on the other hand MOU is signed by all the parties to the contract for laying down the map of the whole transaction.
Non-binding nature of Letter of Intent
LoI is usually non-binding in nature. LoI is only a prelude to purchasing, not the actual purchase order. These can be revoked at any time by either party or cancelled upon the fulfillment of the objective for which it was signed. In the case of the letter of intent issued by the government authorities, at any time the order remains in force can be cancelled based on intervening public interest. The government is allowed to change its stand and withdraw the offer if there is any intervening public interest involved. Public interest is always considered as a superior force upon the individual interest. The government is not allowed to alter its position or stand to put the other party in an adverse position.
In a recent judgment of South Eastern Coalfields Ltd. & Ors. v. M/s. S. Kumar’s Associates AKM (JV)– While upholding the law laid down in Dresser Rand S.A. v. Bindal Agro Chem Ltd. that a Letter of Intent is an intention of the party to enter into a contract in the future. The court on the binding nature of an LoI, emphasized that apart from the terms of the LoI, the court should scrutinize the nature of the contract, consideration paid, the time spent, and the conduct of the parties.
The court also reiterated that the requirements of the LoI were not fulfilled and no concluded contract was entered between the parties. At this stage of the contract, no binding relationship emerges between the parties. The totality and conclusiveness of the LoI can only be rendered binding where it is made clear from the terms & intention with which the LoI was signed. To make the LoI acceptable and binding, the intention must be clear but not vague as it differs from the usual course of business.
The court opined that in the case of Jawahar Lal Burman the contract was clearly stated to be completed by the acceptance of the documents and the formal acceptance would follow after the receipt of treasury receipt.
Sample non-binding clauses
- Non- binding clause- The language of the document should not imply the existence of a binding agreement. Sometimes, adding a timeline to the contract implies the existence of a conclusive agreement, avoiding usage of words such as acceptance, agreement, offer will be null and void, if not accepted within the stipulated or decided timeframe.
- Termination of negotiation and avoidance of good faith clause – This clause must specifically mention that the negotiations can be terminated at any time at the discretion of the party proposing to enter into an LoI. The party must avoid the insertion of the termination in good faith clause as it might sometimes prove to be repugnant to the interests of the party.
- The contract is not entered yet- The separate clause should mention that the further contract shall be entered only by signing off a written contract between the parties. This LoI cannot be equated with a written contract. The LoI can be terminated at any time and is not legally binding between the parties. These clauses are only illustrative but not exhaustive. These will absolve the parties from the liability associated with the LoI in case of revocation.
The easiest and most practical way of entering into the contracts is LoI. LoI sets the crux of the transaction for weighing the pros and cons of the transaction. Where the parties intend to make the LoI non-binding in nature, there should be a crystal-clear term mentioned in the document itself to make it non-binding in nature. The courts usually consider terms and intentions of the parties, whether they intend to enter into a legally binding contract or not. Where the contract involves a detailed procedure to be adopted for the contract performance, an LoI drawn for initiating the work on stipulated time until and unless the final contract is drawn up, is always considered binding in nature. Apart from the nature and contents of the contract for which the LoI was signed, the Hon’ble Supreme Court has moved a little bit further in taking into consideration the time taken by the contractor, and the actual work carried on. This judgment of the court has paved a long way regarding the validity of the LoI.
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