06/01/2016 10:16 am ET Updated Jun 02, 2017

A Legal Introduction to Memorandums of Understanding, Letters of Intent, and Term Sheets

Preliminary negotiations result in a variety of tentative pre-contract documents being produced. This comment briefly introduces three common variations. Always consult an experienced attorney in specific contract negotiation and contract preparation situations.

While the terms are frequently used imprecisely and interchangeably, a "memorandum of understanding" generally involves an informal understanding between two parties (sometimes even governments) concerning parallel approaches to a situation. A "letter of intent" outlines the parties' intentions and desires in a contract negotiation. A "term sheet" is a listing of bullet points outlining the specific provisions to be included in a formal agreement. In particular, a letter of intent may be used to protect intellectual property and negotiation privacy (non-disclosure provisions) and to provide a framework for concluding the negotiation.

A commonly reoccurring litigation issue is whether or not the provisions of a pre-contract document are mandatory and binding. One must be very precise concerning the obligation, or lack thereof, to negotiate in good faith or to create a binding agreement. The fundamental problem is that the pre-contract document's provisions are either meaningful (consequently binding) or meaningless.

An "agreement-to-agree" is frequently interpreted as not requiring that an actual agreement be concluded. It, at most, imposes an obligation to negotiate in "good faith." Best practice is to resolve all issues in the current negotiations. An agreement-to-agree just pushes conflicts into the future after time and resources have been invested in the project. Is the intent of the pre-contract document to finalize some negotiated provisions of a broader overall agreement? If so, one approach is to state in the pre-contract document that certain provisions, in specified sections, are intended to be binding and other sections are non-binding guidelines for additional negotiations.

A variety of other issues must be considered in preparing a pre-contract document. Who are the parties to the agreement? Do the individual signatories have authority to act? A future corporate entity may not be legally bound by the agreement of a promoter. Agents or representatives frequently have sufficient apparent authority to enter into binding commitments.

Is there a period of exclusive negotiation between the parties during which no outside offers will be entertained? What is the timeline and is there an agreement termination date? What information is to be shared and will this information remain confidential even if the agreement or negotiation process ends? What practical remedies are there for the unauthorized disclosure of confidential information? Agreement language is not self-enforcing. There is an enormous amount of detail to consider and document. Consult an experienced attorney.

Precisely state what changes in either of the parties' circumstances or external economic, social, and political realities will allow a party to exit negotiations or otherwise invalidate the agreement. State what assumptions underlie the agreement and that their change invalidates the agreement. For example, perhaps one must secure financing at no more than 1.25% above the prime interest rate for the transaction to be viable. Is regulatory approval required and, if so, by what date? An oil and gas transaction might be conditioned on a specified benchmark crude price remaining above $50 per barrel, for example. What are the tax consequences of this transaction? Be thoughtful, creative, and specific.

Should a negotiation standard or an attempt to obtain approvals standard be specified in the agreement? If so, for example, should it be "reasonable," "commercially reasonable" (considers trade custom), or "good faith." The obligations that these terms impose may be already defined by judicial decisions in a given jurisdiction. Exercise due diligence. Is a dispute resolution procedure to be included? Is the agreement to be incorporated into a larger negotiation or series of documents?

An experienced attorney will review the court decisions in a given jurisdiction in order to create appropriately detailed language. Simply copying language from a randomly located form is a recipe for disaster.

While often the reported decisions state that no binding contract exists, the following court decisions illustrate situations in which a preliminary pre-contract document was held to be a binding contract. The factual background is presented in shorthand fashion. Refer to the text of the court's opinion, available on LexisNexis, for all the details.

1. An oral agreement and letter of intent case. Turner Broadcasting System, Inc. v. McDavid (Court of Appeals of Georgia, 2010). A jury verdict of $281 million was affirmed for the buyer because of a breach by the seller. Among other evidence, the jury was presented the seller's internal memo to announce the sale to employees and plans for a press conference announcing the sale. A negotiator assured the buyer that the "deal was done" and the seller's board of directors approved the sale. The jury was allowed to resolve the factual question of whether the parties had reached a verbal agreement in spite of their failure to sign a written agreement. While the letter of intent clearly stated that only a signed agreement would be binding, it also had expired on a prior date by its own terms. The only sections stated to survive the expiration date were the confidentiality provisions.

One lesson is to continually emphasize in written and oral communication that only a signed written agreement is binding and to have this language in the letter of intent specifically stated to survive its expiration.

2. A loan commitment letter and terms sheet case. Teachers Insurance v. Tribune Co. (District Court, Southern District of N.Y., 1987). An exchange of letters indicated that the parties had made a "binding agreement" to borrow and lend and a two page term sheet contained all of the basic economic terms. The borrower refused to complete the transaction for disputed unwritten reasons that might have included a decline in interest rates or the unavailability of offset accounting. The trial judge concluded that there was a binding agreement due to the "binding agreement" language and the detailed terms sheet, ever though some minor detailed remained open to negotiation.

One lesson is to include in the document all conditions that either must be met prior to the condition becoming binding or that allow a party to withdraw without penalty from the negotiation. Beware of the phrase "binding agreement." Condition the term sheet provisions on specified mandatory pre-requirements being met.

3. A memorandum of understanding case. Findling v. Lossing (Court of Appeals of Michigan, 2011). A signed divorce memorandum of understanding (MOU) divided a jointly owned business and included a provision for the business that Lossing controlled to pay $600,000 for stock. Lossing also, under the terms of the MOU, was to sign a personal guarantee to pay the debt. Above the signature line, the MOU stated that the parties agree to "be bound by all its terms and conditions." The divorce judgment did not incorporate (specifically mention and include) the MOU, and subsequently the business entity owing the $600,000 filed for bankruptcy. Lossing never actually signed a separate debt guarantee agreement. The Court determined that the detailed ten page MOU was a binding contract and was non-dischargeable in bankruptcy as a debt owed to a former spouse and incurred in the course of a divorce. Lossing had breached the MOU and owed $600,000.

One lesson is again that a detailed unconditional document becomes a binding contract. Additionally, one should structure the transaction so that all pending documents are simultaneously signed, and be especially vigilant of the potential impact of a bankruptcy.

4. A mediation memorandum of understanding. Fidelity and Guarantee Insurance Co. v. Star Equipment Corp., (Court of Appeals, First Circuit, 2008). The parties were in mediation and the mediator prepared a handwritten document entitled "Settlement Memorandum of Understanding." The parties signed the brief document that specified, in part, a payment amount, a "release of all claims," conditioned upon "approval by appropriate municipal authorities" and "execution of customary releases and settlement agreement." The Court determined that the MOU was binding since the law favors the settlement of legal disputes and a subjective belief that it was not binding, or conversation concerning "working with them," does not overturn the clear language.

One lesson is not to sign a settlement agreement that does not contain all the conditions that one wants. Note that a handwritten agreement is as enforceable as a typed one.

5. Letters, physician recruiting agreement, and written and electronic mail. Jackson HMA, LLC v. Morales (Mississippi Supreme Court, 2013). A physician recruiting company contacted a physician on behalf of a hospital. The majority of the following documents were sent by the physician recruiter. An initial letter of intent indicated that it required "preapproval" by "Corporate." After additional negotiation, a second letter (lacking the phrase "letter of intent") was sent indicating the "terms of our offer" and stating that "[b]y signing and returning this letter you will confirm your commitment to entering into a contractual agreement...." Six days later a "Memorandum" was sent that restated the terms of the offer. Attached to the memorandum were several contracts including a "Physician Recruitment Agreement" that stated it would not be binding until "reviewed and approved in writing by Hospital's legal counsel." Email exchanges indicated an approval had occurred. When the contract was not approved, the physician sued. A jury determined that a contract existed and awarded damages of $2.275 million. The Mississippi Supreme Court said that the jury could determine from the conflicting evidence that there was a contract. However, the Court remanded the case concerning the damage calculation.

Inconsistent messages create a factual dispute that a jury may resolve. If there is not to be a binding contract, one must consistently say so. Note than employing an agent grants authority for that individual to bind you to agreements.

An experienced trial attorney may persuade juries that informal understandings or memos create a binding contract since the typical juror conducts her or his life in that manner without elaborate written and signed agreements, unlike a business.

This comment provides a brief and incomplete educational introduction to a complex topic and is not intended to provide legal advice. Always consult an experienced attorney in all negotiation, contract, and injury matters.