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  • 1. Author: Herr Schmitt E-Mail: christoph.schmitt@hlfr.de Version: May 2002 The "Letter of Intent": An Often Misunderstood (Contractual) Convention The letter of intent is a common instrument in industry. Legal transactions among companies are no longer conceivable without them. Nearly every businessperson has concluded a letter of intent at least once or has come into contact with one in some way. Despite the frequent use of this instrument, the structural requirements are often misunderstood, leading to heavy indemnity claims. It is therefore necessary to point out the potential risks and problems with this instrument. The German translation of the term "letter of intent" is "Absichtserklaerung," literally "declaration of intent." Such declarations are often issued in the run up to agreements, when the parties are aware that a need for negotiation still exists. Letters of intent contrast with preliminary agreements, which differ from the former in that the latter are binding. Doubts can arise regarding the delineation of these two instruments, however, if drafted imprecisely or in a legally inexpert fashion. A letter of intent can exist as a single unilateral declaration or two unilateral agreements not issued in relation to each other. An actual letter of intent, however, is always non-binding. Yet despite being designated a "letter of intent," a binding agreement can arise, even though a letter of intent was intended, if the formulations represent a binding agreement for a third party. Legally, a letter of intent can have a wide range of meanings. In most cases, the term "letter of intent" reveals a confirmation of a previous oral agreement. It then represents a written commercial confirmation and—as if often unknown—the rules corresponding to this legal institution must thus be observed. Extreme caution must be exercised when drafting and using a letter of intent to avert undesired binding effects. A danger exists, for example, that ambiguous formulations will create a binding effect that was not actually foreseen. Vice versa, it is possible to fail to generate a binding effect, even when intended. It is urgently recommended to obtain qualified legal advice to prevent this from happening.
  • 2. The following purposes may in principle be pursued with a letter of intent: • protection and promotion of the negotiating atmosphere: To protect and promote the negotiating atmosphere, certain rules of conduct may be agreed which enable greater trust among the parties from the outset (e.g. omission of parallel negotiations with third parties). • agreements on contractual management: General or even highly specific covenants can be reached concerning further action, including detailed organizational plans for the period prior to the conclusion of the main agreement. • anticipated division of risk: To facilitate the continuation of negotiations for one party, the other party can assume early on the risk which it would actually have to take on after concluding the agreement (e.g. assistance in the obtainment of credit). • early partial performances: If it becomes evident that the main agreement is not going to break down but cannot be concluded as a result of details still to be clarified, it is possible for part of the performance to be rendered early (e.g. award of partial orders). • internally effective purposes: In some cases, a letter of intent is sent to the later counter-party to a main agreement, the letter of intent merely being issued for purposes of interest to the sender (e.g. corporate image). One can only warn against letters of intent issued merely to pursue a company's internal purposes, given that substantial indemnity risks can arise through any liabilities in the declarations, particularly based on ill-conceived legal formulations. In light of the wide range of structural options and the related danger of creating a binding agreement, a party should consider well whether the letter of intent is expedient for the goals being pursued in the specific case. In cases of doubt, it is better not to declare anything than to be exposed to the risk of misinterpretation by the persons who have to assess the letter of intent, thus creating a binding effect. Such misinterpretations arise above all from the imprecision inherent in the formulation of letters of intent. The "vantage point of the recipient" forms the criterion for assessing a letter of intent and its legal validity. It is therefore important to structure the letter of intent in as comprehensive a fashion as possible and to accept qualified advice so that no doubts can arise concerning formulations which are initially not obvious to a businessperson with average knowledge of the law. Otherwise, under certain circumstances heavy indemnity claims can arise because the counter-party to the agreement is worthy of protection. A letter of intent thus establishes performance or indemnity claims if a binding effect was intended from the vantage point of the recipient. Claims can arise, for example, from the agreement itself or culpa in contrahendo.
  • 3. If, despite the above-mentioned risk, one opts to make a non-binding but concrete declaration concerning a few items, only those elements should be incorporated whose performance can be guaranteed in all cases. It is further important that liability concerning the declaration and the trust of the adverse party be exclusively ruled out. Publication vis-à- vis third parties should also be prohibited. Here too it is expressly recommended once again to seek legal advice so as not to be exposed to the above-mentioned (e.g. indemnity) risks. Even in cases with foreign references, one should always question whether a letter of intent is necessary. Otherwise, a risk exists of having to conduct litigation abroad, which is to be avoided in all cases because of the unfamiliar legal system and the high costs of foreign lawyers and heavy legal costs associated with foreign litigation. If one concludes that a letter of intent is needed, it must always be observed to assure proper documentation that some form of record is kept, whether as internal records, declarations via fax, e-mail, Internet, letters, registered letters (with return receipt), delivery by courier with confirmation, or mutually signed documents. The greatest security is offered by a uniform document signed by both parties or a registered letter with return receipt. It should be noted with respect to the latter alternative, however, that such a registered letter is normally perceived by business partners to be highly impolite. This option should not be selected particularly if a main agreement is to be concluded. Instead, priority should be given to a document signed by both parties. The period in which the obligations are to apply should also be specified. If the absence of such a covenant, a breach would only be seen as a breach of conduct leading to an indemnity claim. No performance claim will be derivable. If the main agreement must be concluded in writing, the letter of intent must also be made in writing. Summary: • A letter of intent is recommendable if the main agreement cannot yet be concluded, though an agreement should be made for the security of one or both parties with respect to the further negotiations. • A letter of intent is not recommendable if only internal purposes are to be pursued with it.
  • 4. • With regard to all of the other above-mentioned purposes pursuable with a letter of intent, the necessity of such a letter must be weighed in each specific case based on the anticipated advantages and potential risks. Undesired binding effects can be averted through drafts by qualified lawyers. Undesired ties and legal disputes can be avoided by internalizing the above-mentioned problems and rules of conduct. Qualified legal advice is of decisive importance for ruling out the above-mentioned risks. Once a letter of intent has been concluded without having obtained legal advice beforehand, it is often only possible to limit heavy damage. Businesspeople can contribute to the success of letters of intent through careful timing. Schedules should contain all items to be clarified and the respective deadlines, whereby financial, technical, organizational and legal issues should be considered. If these points are observed and if businesspersons work closely together with their legal advisors in drafting letters of intent, then nothing stands in the way of a letter of intent forming a satisfactory start of a successful business relationship.