INTRODUCTION
Letters of intent are pre-contract documents. They take many forms and go by different names, including term sheets, memoranda of understanding, commitment letters, and award letters[1] (this paper will use the term “letter of intent” to refer to all such pre-contract documents). Companies use letters of intent as a versatile tool to meet the needs of their business transactions. Letters of intent can memorialize the progress of negotiations, bind the parties in an agreement, or impose a duty on the parties to negotiate open terms in good faith.
Unfortunately, when negotiations between the parties break down, letters of intent are often at the center of litigation.[2] In perhaps the most famous example of litigation around the enforceability of a letter of intent, Pennzoil won a judgment against Texaco for $10.5 billion, and Texaco was forced to seek bankruptcy protection.[3] Despite the legal risks, companies continue to use letters of intent. Within many companies, supply chain management is on the front lines of negotiating contracts and letters of intent.
The purpose of this paper is to provide guidance on letters of intent for legal counsel supporting supply chain management. Part I reviews the law surrounding letters of intent. Part II examines supply chain’s use of letters of intent. Finally, Part III provides recommendations for supply chain’s use of letters of intent.
I. LEGAL REVIEW
The common denominator throughout almost all letter of intent litigation involves two questions: Is the letter of intent binding? If so, what are the rights and obligations of the parties?[4] To answer these questions, this part examines the following topics: (1) the basic elements of a contract; (2) the different types of letters of intent based on their binding nature; (3) subjective and objective standards for determining the parties’ intentions; (4) literal and comprehensive approaches within the objective standard; (5) incomplete terms and the obligation to negotiate in good faith; (6) common provisions in letters of intent; and (7) the statute of frauds.
A. Elements of a Contract
A contract is a legally enforceable promise – that is, a manifested intention to act or refrain from acting in a specified way as a commitment to the other party.[5] A contract requires a manifestation of mutual assent between the parties to some bargained-for exchange (known as consideration).[6] The manifestation of mutual assent can be oral or in writing, or even inferred through conduct which may include beginning or completing performance.[7] If a court determines that a letter of intent satisfies the elements of a contract, then the letter of intent may be binding. However, even if the letter of intent is a contract, it may be subject to a panoply of classical contract defenses such as the statute of frauds[8] (discussed later) and the parol evidence rule.[9][10] If the letter of intent is not a contract but nonetheless induced action or forbearance of the other party, it may be subject to a claim of promissory estoppel,[11] except that letters of intent which contain language that is expressly nonbinding may prevent plaintiffs from establishing reasonable reliance.[12]
Ultimately, classical contract analysis may be insufficient to determine the binding nature of a letter of intent – some courts do not classify letters of intent in a simple black-and-white dichotomy of contract versus non-contract, wholly binding versus not binding whatsoever. Rather, courts may find that the letter of intent is not a contract and yet still obligates the parties to negotiate in good faith.[13] Also, courts may may go beyond the language of the letter of intent to examine factors such as the context of negotiations and customary practices.[14]
B. The Binding Nature of Letters of Intent
In evaluating the binding nature of a letter of intent, courts generally recognize three possibilities. First, the letter of intent can be a binding contract with all necessary terms.[15] The parties are bound in recognition that a contract was reached, even though the parties anticipated further formalities.[16] “Such an agreement is preliminary only in form—only in the sense that the parties desire a more elaborate formalization of the agreement. The second stage is not necessary; it is merely considered desirable.”[17] This category is commonly referred to as a Type I agreement.[18]
Second, the letter of intent can be partially binding with a duty to negotiate. Although this type of letter of intent has open terms and is not a contract, it nonetheless creates a binding obligation on the parties to continue negotiations in good faith towards the goal of executing a final contract.[19] “The parties can bind themselves to a concededly incomplete agreement in the sense that they accept a mutual commitment to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.”[20] Although the parties are not obligated to reach their ultimate contractual objective, the parties are barred from renouncing the deal, abandoning negotiations, or insisting on conditions that do not conform to the preliminary agreement.[21] This category is commonly referred to as a Type II agreement.[22]
Third, the letter of intent can be completely nonbinding. This type of letter of intent is nothing more than a document simply memorializing the current state of negotiations with no obligations on the parties whatsoever.[23]
Note that a finding of a Type I or a Type II agreement can yield different results depending on the jurisdiction. Some jurisdictions refuse to enforce Type II agreements, and consider such agreements to negotiate as non-binding “agreements to agree.”[24] Courts in Georgia, Hawaii, Kentucky, Massachusetts, Minnesota, Nebraska, Tennessee, Texas, and Virginia do not enforce Type II agreements and only enforce Type I agreements.[25] Other jurisdictions enforce both Type I and Type II agreements as binding. This includes courts in California, Delaware, Illinois, New York, and Washington.[26]
To determine which category a letter of intent falls under, courts examine the intentions of the parties.[27] In fact, the primary factor of all letter of intent analysis is the intentions of the parties.[28] Intent is the “touchstone” upon which letter of intent litigation hinges.[29]
C. Subjective and Objective Standards for Determining the Parties’ Intentions
Depending on the jurisdiction, courts use either an objective or subjective standard to determine the parties’ intentions.[30] In jurisdictions that use a subjective standard, the parties’ intentions are considered a question of fact, not a question of law, and courts thus defer the question to the jury to determine.[31] In jurisdictions that use an objective standard, courts look at “what a reasonably prudent person in the same position would have understood as to the meaning of the agreement.”[32] The parties’ intentions are considered a matter of law, and intent is referred to the trier of fact only if a court determines that the document is ambiguous as a matter of law.[33]
Under the objective standard, statements of the parties’ intentions carry the greatest weight.[34] In Teachers Ins. and Annuity Ass’n of America v. Tribune Co, the court noted there is a “strong presumption against finding binding obligations in agreements which include open terms, call for future approvals, and expressly anticipate future preparation and execution of contract documents.”[35] Some courts rely exclusively on the language of the letter of intent (the “literal” approach), while other courts are willing to look beyond the language and consider the entire transaction, including the surrounding circumstances of the negotiations (the “comprehensive” approach).[36] The literal and comprehensive approaches are discussed below.
- Objective Standard: The Literal Approach
Courts taking the literal approach have held that not even a handshake to “formalize the deal” outweighs strict contract language.[37] Rather, courts rely exclusively on the language of the letter and look to clear statements indicating a binding or non-binding effect.[38] These are organized into four broad categories[39] of letters of intent based on the intentions expressed by the parties:
(1) Expressly Non-Binding: One or both parties expressly states the intention not to be bound until the formal contract is executed.[40]
(2) Unresolved Terms: The parties identify one or more specific matters which are still in negotiation and must be resolved before an agreement can be reached.[41]
(3) Core Agreement: The parties express definite agreement on all necessary terms but are silent on other matters often included in similar contracts.[42]
(4) Expressly Binding: The parties expressly intend the terms to be a binding agreement or contract.[43]
These categories are commonly referred to as “Corbin’s categories.”[44] If a letter of intent falls within the first or second category, courts generally do not consider it binding; but if it falls in the third or fourth category, courts generally consider it a binding contract.[45] For example, in Hunneman Real Estate Corp. v. Norwood Realty, Inc., the letter of intent contained language that was explicitly binding.[46] The court held the letter of intent fell into the first category:
Here, the intent of the parties to be bound by the letter of intent is not left to inference from the terms of their agreement but is twice expressly stated in prominent parts of the letter of intent. Where intention is clearly stated or evident, the analytical focus generally turns to whether the inchoate or unresolved aspects of the parties’ agreement are “essential” or “material.”[47]
Letters of intent which state they are subject to completing a formal agreement fall into category two because the parties pointed out a specific matter on which they must yet agree before negotiations are concluded.[48] In Interway, Inc. v. Alagna, the letter of intent stated that the “purchase is subject to a definitive Purchase and Sale Contract to be executed by the parties.”[49] The court held that if the parties stipulated execution of a formal agreement as a condition precedent, then no contract arises until that formal agreement is executed.[50] In Empro Mfg. Co., Inc. v. Ball-Co Mfg., Inc., the court stated that the parties structured their agreement “subject to” a later agreement “manifested an (objective) intent not to be bound.”[51]
When the letter of intent does not contain an explicit clause for or against a binding agreement, courts will examine whether the parties agreed on all material terms[52] or may infer the parties’ intentions from the language.[53] In Falls Garden Condominium Ass’n, Inc. v. Falls Homeowners Ass’n, Inc., the court determined the parties did not expressly state whether the parties did or did not intend to be bound, nor did the parties call out any specific matters requiring further discussion, thus ruling out Corbin’s categories one, two, and four.[54] The court held the letter of intent fell into category three and was therefore enforceable.[55] In 20 Atlantic Ave. Corp. v. Allied Waste Industries, Inc., the court held that when a letter of intent contains language contemplating the execution of a final written agreement, “a strong inference is made” that the parties do not intend to be bound by earlier negotiations or agreements until the final terms are settled.[56] In contrast, in Kelly v. Rio Grande Computerland Group, the court held “a letter of intent may be binding even though it refers to the drafting of a future, more formal agreement . . . A party not wishing to be prematurely bound by a letter agreement is advised to include a provision clearly stating that the letter is nonbinding . . .”[57]
- Objective Standard: The Comprehensive Approach
Courts that take the comprehensive approach usually evaluate multiple factors, most commonly the five factors laid out in Teachers Ins. and Annuity Ass’n of America v. Tribune.[58] These factors are as follows: (1) The language of the letter of intent; (2) open terms remaining to negotiated; (3) the context of negotiations; (4) partial performance; and (5) whether it is customary to finalize the particular form of letter of intent into a formal contract before it is considered binding[59]
Although courts applying the comprehensive approach give the most weight to the first factor (the language of the letter of intent), the other factors can lead the court to conclude the letter was a contract.[60] For example, the court in NAP, Inc. v. FRAJAC held:
Although the letter did state that its terms would not be effective until a formal agreement was executed, this language is not strong enough to counter other indicia of an intent to be bound. In the first place, there was other language in the letter that suggested that it was immediately binding . . . Moreover, no material terms remained unresolved. And, there is no evidence that future negotiations on major terms were contemplated. Extensive performance by both parties also strongly indicated a binding commitment to the terms of the letter. This performance went beyond mere adherence to those terms. It bespoke an understanding by the parties that they were bound.[61]
It is important to note that depending on whether a court analyzes a letter of intent under a literal or objective approach, it may reach a very different conclusion. Had the court in NAP, Inc. v. FRAJAC analyzed the letter of intent using a literal approach, the provision which made the terms of the letter of intent conditional on reaching a formal agreement would have likely placed the letter of intent into Corbin’s category two, and the court would have held it nonbinding. In this way, the judicial standard for reviewing letters of intent in any given jurisdiction becomes a silent term in letters of intent.
D. Incomplete Terms and the Obligation to Negotiate in Good Faith
Letters of intent are often incomplete in some respect, leaving courts to decide whether to fill in terms, if at all. Most courts are reluctant to fill in terms that are absent from the letter of intent.[62] If the missing terms are material, courts usually decide a contract was not formed.[63] Even if a letter of intent appears to include all material terms, courts will generally not recognize a contract if the actions of the parties indicate at least one term has not been settled.[64] Some courts, however, may recognize a contract or at least an obligation to negotiate in good faith in letters of intent which contemplate continued negotiations.[65]
Where a letter of intent leaves one or more terms open and subject to negotiation, courts may nonetheless consider the letter a binding contract if the parties agreed on the material terms.[66] Material terms are those which are sufficiently significant that altering them would affect the decision of a reasonable person in the position of one or both parties to enter into the agreement.[67] Materiality is imprecise and flexible.[68] Courts examine each contract separately to determine the material terms because they differ from contract to contract.[69] Price is usually a material term, however, an agreement could fail to specify the dollar amount or a computational formula and still be sufficiently definite “if the amount can be determined objectively without the need for new expressions by the parties,” such as by a reference to an extrinsic event, commercial practice, or trade usage.[70]
In Milex Products, Inc. v. Alra Laboratories, Inc., the defendant argued that the absence of a price in the proposal rendered it unenforceable as a contract and demonstrated that the parties did not intend to be bound.[71] The court disagreed and held that § 2-305 of the UCC expressly provides that price is not a required term of an enforceable contract.[72] The court held that the parties could agree to negotiate price at a later time and still have a binding contract.[73] “The contract prepared by Alra refers to a ‘negotiated price.’ Thus, we are of the opinion that there was sufficient evidence . . . that the parties did intend to conclude the contract even in the absence of a settled price.”[74]
Where a letter of intent stipulates the parties will negotiate in good faith, some courts enforce good faith negotiation as a binding obligation.[75] For example, in Flight Systems, Inc. v. Electronic Data Systems Corp., the court held:
An agreement to negotiate in good faith is a contract . . . Therefore, the plaintiff states a cause of action for breach of this duty when he alleges facts which, if proven, demonstrate that (1) both parties manifested an intention to be bound by an agreement to negotiate in good faith; (2) the terms of the agreement were sufficiently definite to be enforced; (3) consideration was conferred . . . and (4) the agreement was breached by bad faith conduct.[76]
However, even when courts impose a duty to negotiate in good faith, they will not require that the parties actually reach an agreement.[77] In Midwest Mfg. Holding, L.L.C. v. Donnelly Corp., the court determined that a letter of intent which prohibited the parties from negotiating with others during the life of the letter was “merely an agreement to negotiate, not a promise that those negotiations would be fruitful.”[78] The court held there was no obligation to consummate the sale.[79] In fact, even where a party is obligated to negotiate in good faith, it could raise its price if it did so based on market conditions.[80] The holding in Venture Associates Corp. v. Zenith Data Systemsprovides an illustrative example:
Not having locked itself into the $11 million price, ZDS was free to demand as high a price as it thought the market could bear, provided that it was not trying to scuttle the deal . . . or to take advantage of the costs sunk by Venture in the negotiating process . . . ZDS would not be acting in bad faith to demand that amount from Venture even if it knew that Venture would not go so high. ZDS would be acting in bad faith only if its purpose in charging more than Venture would pay was to induce Venture to back out of the deal.[81]
As previously noted in Part I.B., some jurisdictions do not recognize good faith negotiations contemplated by letters of intent as binding obligations. For example, in Richie Co., LLP. v. Lyndon Ins. Group, Inc., the court considered the letter of intent to be only a summary of the parties’ negotiations and an agreement to agree – an expression of willingness to enter into a binding agreement at a later time – and thus unenforceable.[82] “[The] letter creates merely an agreement to negotiate in good faith. Under Minnesota law such an agreement is unenforceable where the agreement evidences nothing more than an intention to negotiate in the future.”[83]
E. Common Provisions in Letters of Intent and their Impact on Enforceability
Some of the commonly used provisions in letters of intent and contracts can impact the enforceability of a letter of intent. If a contract has a merger or integration clause (which states the writing represents the complete and final writing between the parties), a letter of intent which precedes the contract may no longer have a binding effect; however, a contract’s merger clause may not override a letter of intent if the contract’s merger clause does not expressly address matters covered in the letter of intent.[84]
A letter of intent’s expiration can also impact enforceability. In Turner Broadcasting System, Inc. v. McDavid, Turner Broadcasting argued that the letter of intent contained an express provision that the parties intended to be bound only by a written agreement.[85] However, because the letter of intent expired, the court held that the parties no longer maintained an objective manifestation to be bound only by written agreement.[86] Further, the court held that if Turner Broadcasting intended for this provision to be effective after the letter of intent expired, then it could have used a survival provision as it did for the confidentiality terms.[87]
The use of an exclusivity provision “generally demonstrate[s] that the parties do not intend to be bound.”[88] This is because courts view the purpose of exclusivity provisions (also known as “no-shop” clauses) is to facilitate negotiations during a defined period of time.[89] The court in St. Joseph Hosp., Augusta, Georgia, Inc. v. Health Management Associates, Inc. put it succinctly: “There would seem little need for an exclusivity period . . . if the parties intended to be bound to a sale at the time the letter was signed.”[90]
Lastly, the use of a cost allocation provision in a letter of intent can serve as evidence that the parties did not intend to be bound.[91] The court in St. Joseph Hosp., Augusta, Georgia, Inc. v. Health Management Associatesconcluded that the letter of intent was not binding, partly because the letter of intent contained the following clause: “In the event a definitive Asset Sale Agreement is not executed, each of Seller and Purchaser will bear its own legal, accounting and other fees and expenses related to the proposed transaction . . .”[92] The court reasoned that there would have been no purpose for the parties to include the cost allocation provision if neither party could legally walk away from the transaction.[93]
F. The Statute of Frauds
A letter of intent which falls under the statute of frauds may not be enforceable as a contract unless it is signed.[94] Under the statute of frauds, certain types of contracts must be made in writing and signed by the bound parties.[95]This includes contracts for performance which cannot be fully completed within one year, suretyship, executorship, the sale of land, the sale of goods with a price of $500 or more, and the sale of securities.[96] However, for contracts that do not fall under the statute of frauds, the absence of a signed document does not preclude a court from finding that the parties entered into a contract. Courts in Delaware, Massachusetts, New York, and Texas have held that an email chain or even a single email may create a binding contract.[97] If there is sufficient evidence, courts may even enforce oral contracts.[98]
II. SUPPLY CHAIN APPLICATIONS
Letters of intent are used across nearly every industry, from banking and construction to pharmaceuticals and real estate. They are used for a wide range of transactions such as asset purchase agreements, mergers and acquisitions, commercial leases, and for the purchase and sale of goods and services. This part examines the use of letters of intent by supply chain management. First, it provides a brief background on the role of supply chain management. Second, it examines the reasons why supply chain management uses letters of intent. Third, it presents findings from interviews with supply chain professionals in the airline industry.
A. Background on Supply Chain Management
Within a company, supply chain management (SCM) is the organization which is responsible for procuring the various goods and services that its company needs in order to operate.[99] To achieve this, SCM solicits bids from other businesses that it identifies as potential suppliers.[100] Bid solicitation is usually conducted with a request for proposal (RFP) which sets forth the required specifications for the goods and services and the rules and timeline for submitting proposals.[101] The RFP package often includes a boilerplate contract to lay out the specific terms and conditions on which it will award any business.[102] After SCM receives proposals from the bidders, it evaluates the proposals based on price, quality, and other criteria it deems important.[103] SCM negotiates with bidders with the goal of minimizing cost and maximizing value.[104] If bidders do not accept all of the terms of the boilerplate contract as-is, then SCM’s negotiations will also include the contract language, and SCM will usually enlist the support of in-house counsel.[105] At the end of the RFP process, SCM will draft an award recommendation for internal review with the company’s impacted stakeholders (such as finance, operations, and engineering).[106] After SCM receives the necessary internal approvals, it informs the winning bidder and both parties then execute the contract.[107]Alternatively, SCM may opt not to award business to any of the bidders.[108]
B. Reasons for Using Letters of Intent
There are a variety of reasons why SCM may want to use letters of intent in advance of a contract. First, a non-binding letter of intent can memorialize the progress of negotiations, identify the people that will participate in each meeting, and establish a timeline for the parties so that they do not lose momentum.[109] The letter of intent can serve as a red flag for the parties if any deadlines are missed.[110] In this way, a letter of intent can serve as a helpful roadmap for a lengthy, complicated deal. It may also form the basis for the final contract.[111]
Second, binding and nonbinding letters of intent can be used by a supply chain manager to communicate to a supplier that his company is serious about the deal and to identify any deal-breakers before both parties spend significant time negotiating the formal contract.[112] Alternatively, the supply chain manager may want to communicate the preliminary outcome of the RFP and his company’s intention to award business to a supplier, albeit contingent on whether the parties can finalize the formal contract.[113] In certain cases, SCM may provide a letter of intent to a supplier which needs it in order to secure bank financing[114] or an operating permit at an airport.[115]
Third, binding letters of intent can be used to implement exclusivity provisions which prohibits either or both parties from negotiating with others.[116] This can be a helpful for SCM when a supplier has limited manufacturing capacity or state-of-the-art technology which SCM wants to secure for its company’s sole demand (defensively protecting its supply needs and offensively blocking its competitors).[117] Binding letters of intent can also protect one or both parties’ financial investments related to the deal by including “walk away fees” for failing to close the deal.[118] Binding letters of intent can include a confidentiality agreement so that SCM and the bidder can share sensitive information (alternatively, the parties could enter into a confidentiality agreement separate from the letter of intent).[119] Finally, if the parties have not yet reached an agreement on all material terms but are sufficiently confident that they want to commit themselves to completing the deal, the letter of intent could expressly establish a duty to negotiate in good faith (in jurisdictions which recognize such a duty).[120]
Finally, as a practical matter, SCM may be under a time pressure to award the business and is unable to complete the contract in time. In such circumstances, the letter of intent serves as a “crutch” or expedited means of documenting the deal while the formal contract is completed.[121]
C. Interview Findings
To better understand SCM and its use of letters of intent, interviews were conducted via telephone and email with SCM professionals in the airline industry.[122] While the interviews by no means rise to the standard of a scientific survey, the anecdotal evidence hints at the possibility that SCM in the airline industry may be exposed to some of the risks of the aforementioned legal pitfalls surrounding letters of intent, such as with its use of ambiguous “award letters.”
The scope of the interviews included six SCM professionals across four different airlines: Alaska Airlines, Allegiant Air, American Airlines, and Delta Air Lines.[123] These professionals negotiated contracts for a wide range of goods and services which included fueling, jet engine parts and maintenance, ground handling, cargo, catering, and aircraft deicing.[124]
Even though all of the interviewees worked in the same industry, the interviews revealed varying practices involving letters of intent. Five interviewees used letters of intent although in some cases the documents were referred to as an award letter or a term sheet.[125] One interviewee stated his team did not use letters of intent whatsoever.[126]
The interviewees that did use some form of letter of intent stated that the document was meant to be binding in some situations and nonbinding in other situations.[127] One interviewee stated that the letter of intent was meant to be binding on the supplier only, but nonbinding on the airline.[128] A court could find that a letter of intent that is only binding on one party is an option contract, and if it is unsupported by consideration,[129] then it is merely a nonbinding “offer to sell which may be withdrawn at any time prior to acceptance.”[130] Finally, most of the interviewees stated that when signed, the letters of intent were meant to be binding, however, one interviewee stated the signed letter of intent was meant to be nonbinding.[131] It is unclear why the parties would sign a letter of intent meant to be nonbinding, but doing so could eliminate the statute of frauds defense if one of the parties argued the letter of intent was binding.
The most common reason cited for using letters of intent was a lack of time to complete the contract – although some interviewees noted a strong preference to use contracts and avoid letters of intent, interviewees would use letters of intent when faced with tight timelines and pressing supply needs.[132] Interviewees also cited challenges in grappling with often-complex deals and ambiguity for which letters of intent were helpful in documenting the progress of negotiations.[133] One interviewee stated that in his particular commodity area, simple term sheets are used in place of contracts because the attorneys of both sides were unable to agree on contract terms other than fixing a specific price (this interviewee also noted that while airlines will generally avoid doing business without strong contract terms, when SCM is faced with a single supplier at an airport, suppliers may adopt a “take it or leave it” approach to contract negotiations).[134]
Finally, interviewees provided a few sample letters of intent. One of the letters of intent contained language that was expressly binding.[135] However, two different airlines provided “award letter” examples which did not contain language that was expressly binding or nonbinding – in fact, the language was ambiguous and contradictory regarding the binding nature of the document.[136] Both award letters appear to contain all material terms regarding pricing, services and locations, and the start and end dates.[137] In the first example, the document awarded business to the supplier and mentioned imminent startup preparations but also noted agreements which need to be signed:
It gives me great pleasure in advising you that [airline] has decided to award the [services] . . . [Airline] launch team will be contacting you soon in order to facilitate the startup operation . . . I would like to once again congratulate [supplier] for the award of business. I am attaching following draft agreements and documents for necessary review and signatures.[138]
In the second example, the document awarded business on the basis of the contract boilerplate included in the RFP, though the language also appeared to be an offer to which the supplier could “accept” by signing.
[Airline] is awarding a three-year contract for [services] . . . [Airline] is processing a formal contract to set forth our agreement in full. The contract will be substantially in the form included in the Request for Proposal to which you responded, if applicable. Please sign and return this document . . . as soon as possible (no later than three business days), acknowledging your acceptance of this award.[139]
In both examples, the language is unclear as to whether the letter is conditioned on executing the formal contract. Under a literal approach to letter of intent analysis, a court that interprets the language as merely mentioning a formal contract but not subject to that contract could hold the letter binding because it falls under Corbin’s third category.[140] Or, if the court reads the letter as subject to the execution of the formal contract, it could find the letter nonbinding because it falls under Corbin’s second category.[141] Alternatively, under a comprehensive approach, a court might decide that the context of negotiations and customary practice weighed in favor of finding that both award letters were nonbinding notifications of the progress of negotiations (in other words, SCM completed its bid evaluation in the RFP process and wanted to notify the leading supplier that it was now time to negotiate a formal contract).
It is possible that these ambiguous award letters may never lead to legal problems, especially if SCM executes the formal contracts contemplated in the award letters. SCM is at risk, however, if it decides not to execute the formal contract and instead rescinds the award, because the supplier may have a claim that the award letter was binding. In fact, ambiguous award letters have been the subject of litigation in the airline industry before – see Quake Const., Inc. v. American Airlines, Inc.[142]
III. RECOMMENDATIONS FOR SUPPLY CHAIN
As previously discussed, letters of intent can be useful for SCM. However, they also come with risks. Letters of intent require careful drafting and scrutiny by legal counsel, much like formal contracts, and SCM should not draft a letter of intent on its own.[143] The most important issue for legal counsel to discuss with SCM is the intentions of the parties.[144] Once this is clearly understood, legal counsel can draft the document to reflect these intentions as well as caution SCM on the relevant risks and pitfalls.
First, legal counsel should determine whether a letter of intent is necessary or advisable. As a general rule, it is preferable for the parties to go straight to a final and complete formal contract, thereby avoiding the pitfalls associated with a letter of intent altogether.[145] If SCM has sufficient time to complete the formal contract, a letter of intent may be unnecessary. If SCM is struggling with a supplier that is difficult or appears uninterested in negotiating a formal contract, it may be better to do business with an alternate supplier if possible,[146] because “letters of intent are a way of suppliers passing risk back to purchasers.”[147]
If SCM simply wants to memorialize the progress of negotiations, legal counsel can provide guidance on drafting an expressly nonbinding memorandum. The document should clearly state that it is nonbinding upon the parties and that neither party shall be bound until both parties execute a separate, definitive agreement. The document should also contain language which eliminates ambiguity or reliance upon it so that it serves as strong evidence against an oral contract or promissory estoppel claim.[148] An example of such a clause is provided below:
This document is only a list of proposed points that may or may not become part of an eventual contract. It is not based on any agreement between the parties. It is not intended to impose any obligation whatsoever on either party, including without limitation an obligation to bargain in good faith or in any way other than at arms’ length. The parties do not intend to be bound by any agreement until both agree to and sign a formal written contract, and neither party may reasonably rely on any promises inconsistent with this paragraph. This paragraph supersedes all other conflicting language.[149]
Additionally, the document should not be signed by either party because, for certain transactions subject to the statute of frauds, an unsigned document can show clear intent of the parties to remain unbound.[150] The letter should also be simple and should not attempt to capture all of the material terms necessary to complete the contract, because the absence of material terms can show that the parties did not intend to be bound.[151] Lastly, the document should not be referred to as an agreement or a contract.[152]
On the other hand, if SCM wants the letter of intent to be binding, then legal counsel must draft the letter of intent with expressly binding language. The letter of intent should also include all material terms. If the letter of intent requires many detailed provisions, legal counsel may find that there is no time advantage to documenting the deal in a letter of intent instead of in a formal contract.[153] Or, if done in haste, legal counsel could risk overlooking the need to negotiate important contingencies, such as an airline’s ability to terminate a long-term aircraft lease if an aircraft manufacturer stopped supporting the aircraft type.[154] In other cases, however, a letter of intent could be used to bind the parties on smaller, piecemeal agreements as the parties work towards a larger deal (for example, confidentiality or exclusivity), thereby saving time on putting these priority agreements in place and facilitating the larger deal. Another possibility is that SCM negotiated most but not all of the terms, however, the parties are committed to finalizing a formal contract. If so, legal counsel may draft the letter of intent to be binding in part (on the settled terms) and set forth a duty on the parties to negotiate the open terms in good faith. To avoid confusion, the binding terms should be grouped together in one distinct section, and the open terms which the parties agree to negotiate in good faith should be grouped together in a separate, distinct section.[155]
Finally, legal counsel should educate SCM on the risks of making statements in conversations or emails which may inadvertently bind SCM like “we have a deal.” SCM should be coached to use language like “subject to our letter of intent” or “subject to the execution of the contract” when communicating with the other party.[156] With legal oversight and education for SCM professionals, the risks of letters of intent can be reduced.
CITATIONS
[1] Gregory G. Ballard, Jessica Lively, Should You Sue over A Term Sheet? When Negotiations Break Down Between Term Sheet and Contract, You Might Need to Litigate. but If You Do, Proceed with Caution, Prac. Litigator, July 2007, at 43.
[2] Peter Siviglia, Contractual Foreplay: Letters of Intent vs. Term Sheets, N.Y. St. B.J., May 2015, at 49.
[3] Texaco, Inc. v. Pennzoil, Co., 729 S.W.2d 768, 786 (Tex. App. 1987) (affirming judgment against Texaco for tortious interference with Pennzoil and Getty Oil’s agreement to be bound by the terms of a memorandum, even though the parties contemplated a formal contract which they had not yet signed).
[4] Nick J. Vizy, Special Study for Corporate Counsel on Using Letters of Intent in Business Transactions, § 1:5, Westlaw (database updated Aug. 2015).
[5] Restatement (Second) of Contracts § 1, 2 (1981).
[6] Id. at § 3, 17 (1981).
[7] Id. at § 4, 18, 27 (1981). Even if the parties express an intention to prepare and adopt a formal written contract, a manifestation of mutual assent can be sufficient to establish a contract before the formal written contract is executed. Alternatively, circumstances may show that the parties were engaged in preliminary negotiations; their expressions memorialized the progress of negotiation rather than made binding promises, and did not rise to an enforceable contract.
[8] Restatement, supra note 5 at § 110, 131.
[9] Vizy, supra note 4 at § 1:8. Under the parol evidence rule, courts generally do not allow the admission of evidence of prior negotiations or agreements that modify or contradict the terms of a written contract intended to be final and complete (usually achieved with a merger clause).
[10] Quake Const., Inc. v. American Airlines, Inc., 141 Ill. 2d 281, 286-309 (1990). If the letter of intent has ambiguous or contradictory terms, courts may look beyond the letter of intent and allow the admission of parol evidence in order to ascertain the parties’ intent.
[11] Restatement, supra note 5 at § 90. Under promissory estoppel, a promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee, and does, is binding if injustice can be avoided only by enforcement of the promise. See also Quake, 141 Ill. 2d at 310-11.
[12] Mansfield Square, Ltd. v. Big Lots, Inc., 2008-Ohio-6422.
[13] Thomas C. Homburger, James R. Schueller, Letters of Intent – A Trap for the Unwary, 37 Real Property, Probate and Trust Journal, 509, 513 (2002).
[14] Vizy, supra note 4 at § 1:25.
[15] Teachers Ins. and Annuity Ass’n of America v. Tribune Co., 670 F. Supp. 491, 498 (S.D. N.Y. 1987).
[16] Id.
[17] Id.
[18] Burbach Broad. Co. of Delaware v. Elkins Radio Corp., 278 F.3d 401, 407-08 (4th Cir. 2002).
[19] Id.
[20] Teachers, 670 F. Supp. at 498.
[21] Burbach, 278 F.3d at 407-08.
[22] Id.
[23] Homburger, supra note 13 at 513.
[24] Violeta Solonova Foreman, Non-Binding Preliminary Agreements: The Duty to Negotiate in Good Faith and the Award of Expectation Damages, 72 U. Toronto Fac. L. Rev. 12, 20 (2014).
[25] Id.
[26] Id.
[27] Homburger, supra note 13 at 513.
[28] Vizy, supra note 4 at § 1:6.
[29] Id.
[30] Homburger, supra note 13 at 518-25.
[31] Homburger, supra note 13 at 519.
[32] Cochran v. Norkunas, 919 A.2d 700, 710 (2007).
[33] Homburger, supra note 13 at 519.
[34] Vizy, supra note 4 at § 1:25.
[35] Teachers, 670 F. Supp. at 499.
[36] Vizy, supra note 4 at § 1:13, 15.
[37] Rennick v. O.P.T.I.O.N. Care, Inc., 77 F.3d 309, 311 (9th Cir. 1996).
[38] Vizy, supra note 4 at § 1:13.
[39] Cochran, 919 A.2d at 707-08 (2007).
[40] Id.
[41] Id.
[42] Id.
[43] Id.
[44] Falls Garden Condominium Ass’n, Inc. v. Falls Homeowners Ass’n, Inc., 215 Md. App. 115, 79 A.3d 950 (2013), cert. granted, 437 Md. 422, 86 A.3d 1274 (2014).
[45] Cochran, 919 A.2d at 707-08 (2007).
[46] Vizy, supra note 4 at § 1:24.
[47] Hunneman Real Estate Corp. v. Norwood Realty, Inc., 54 Mass. App. Ct. 416, 765 N.E.2d 800 (2002).
[48] Falls Garden, 79 A.3d at 1191.
[49] Interway, Inc. v. Alagna, 407 N.E.2d 615, 616-17 (1st Dist. 1980).
[50] Id.
[51] Empro Mfg. Co., Inc. v. Ball-Co Mfg., Inc., 870 F.2d 423, 425 (7th Cir. 1989).
[52] Vizy, supra note 4 at § 1:27.
[53] Id. at § 1:14.
[54] Falls Garden, 79 A.3d at 1191.
[55] Falls Garden, 79 A.3d at 1192.
[56] 20 Atlantic Ave. Corp. v. Allied Waste Industries, Inc., 482 F. Supp. 2d 60, 62 (D. Mass. 2007).
[57] Kelly v. Rio Grande Computerland Group, 128 S.W.3d 759, 760-2 (Tex. App. El Paso 2004).
[58] Vizy, supra note 4 at § 1:13, 25.
[59] Teachers, 670 F. Supp. at 499.
[60] Vizy, supra note 4 at § 1:25.
[61] NAP, Inc. v. FRAJAC, 104 F.3d 350, 1996 WL 537914, at *2 (2d Cir. 1996).
[62] Vizy, supra note 4 at § 1:20.
[63] Id.
[64] Id.
[65] Id. at § 1:35.
[66] Id. at § 1:31.
[67] T.O. Stanley Boot Co. v. Bank of El Paso, 847 S.W.2d 218, 221 (Tex. 1992).
[68] Restatement, supra note 5 at § 241. In comments: “[Materiality] is necessarily imprecise and flexible . . . It is to be applied in the light of the facts of each case in such a way as to further the purpose of securing for each party his expectation of an exchange of performances.”
[69] Stanley Boot, 847 S.W.2d at 221.
[70] Cobble Hill Nursing Home, Inc. v. Henry & Warren Corp., 548 N.E.2d 203, 206 (1989).
[71] Milex Products, Inc. v. Alra Laboratories, Inc., 603 N.E.2d 1226, 1227-30 (2d Dist. 1992).
[72] Milex, 603 N.E.2d at 1227-30.
[73] Id.
[74] Id.
[75] Vizy, supra note 4 at § 1:36.
[76] Flight Systems, Inc. v. Electronic Data Systems Corp., 112 F.3d 124, 130 (3d Cir. 1997).
[77] Vizy, supra note 4 at § 1:37.
[78] Midwest Mfg. Holding, L.L.C. v. Donnelly Corp., 975 F. Supp. 1061, 1062-4 (N.D. Ill. 1997).
[79] Id.
[80] Vizy, supra note 4 at § 1:35.
[81] Venture Associates Corp. v. Zenith Data Systems Corp., 96 F.3d 275 (7th Cir. 1996).
[82] Richie Co., LLP. v. Lyndon Ins. Group, Inc., 316 F.3d 758, 759 (8th Cir. 2003).
[83] Id.
[84] In re Demmert Bldg. Co., Inc., 2008 WL 516679.
[85] Turner Broadcasting System, Inc. v. McDavid, 303 Ga. App. 593, 595-6 (2010).
[86] Id.
[87] Id.
[88] St. Joseph Hosp., Augusta, Georgia, Inc. v. Health Management Associates, Inc., 2011 WL 1225577, at *7-8 (S.D. Ga. 2011).
[89] Id.
[90] Id.
[91] St. Joseph Hosp., 2011 WL 1225577, at *7-8.
[92] St. Joseph Hosp., 2011 WL 1225577, at *7-8.
[93] Id.
[94] Flameout Design & Fabrication, Inc. v. Pennzoil Caspian Corp., 994 S.W.2d 830 (Tex. App. Houston 1st Dist. 1999) (holding that the letter of intent for the sale of goods was not a binding contract because its lack of a signing was insufficient to satisfy the statute of frauds under the UCC).
[95] Restatement, supra note 5 at § 110, 131.
[96] Id.
[97] Benton B. Bodamer and Kevin J. Sullivan. CYA on that LOI: Avoiding Liability Under Preliminary Agreements (July 21, 2016), http://www.metrocorpcounsel.com/articles/17975/cya-loi-avoiding-liability-under-preliminary-agreements.
[98] Rossmoor Corp. v. Tri-Cty. Concrete Products, Inc., 375 So. 2d 896 (Fla. Dist. Ct. App. 1979).
[99] Interviews with supply chain managers of Allegiant Travel Co., Alaska Air Group Inc., American Airlines Group, Inc., and Delta Air Lines, Inc. (June 11 – July 25, 2016).
[100] Id.
[101] Interviews, supra note 99.
[102] Id.
[103] Id.
[104] Id.
[105] Id.
[106] Id.
[107] Id.
[108] Id.
[109] Vizy, supra note 4 at § 1:2.
[110] Vizy, supra note 4 at § 1:2.
[111] Id.
[112] Id.
[113] Id.
[114] Id.
[115] Interviews, supra note 99.
[116] Vizy, supra note 4 at § 1:2.
[117] Interviews, supra note 99.
[118] Vizy, supra note 4 at § 2:1-3.
[119] Id.
[120] Id. at § 1:2.
[121] Letter of Intent – The CPIS Position, and What the Buyer Needs to Know (July 3, 2016), https://www.cips.org/Documents/Resources/Glossary/Letter%20of%20intent.pdf.
[122] Interviews, supra note 99.
[123] Interviews, supra note 99.
[124] Id.
[125] Id.
[126] Id.
[127] Id.
[128] Id.
[129] Restatement, supra note 5 at § 87.
[130] Berryman v. Kmoch, 221 Kan. 304, 306 (1977).
[131] Interviews, supra note 99.
[132] Id.
[133] Id.
[134] Id.
[135] Id.
[136] Id.
[137] Interviews, supra note 99.
[138] Id.
[139] Id.
[140] Falls Garden, 79 A.3d at 1191.
[141] Interway, 407 N.E.2d at 616-17.
[142] Quake, 141 Ill. 2d at 286-309 (1990). American Airlines’ contractor, Jones Brothers Construction, used a letter of intent to “award” construction business at Chicago O’Hare International Airport to Quake Construction, with work to commence a mere four to eleven days later. Yet the letter of intent also granted Jones Brothers the right to terminate the letter of intent if Quake did not enter into a formal agreement. The court interpreted some provisions, such as the award (“this notice of award authorizes the work”) and the short period of time to commence work as evidentiary of a binding intent. However, it interpreted other provisions, such as the reference to a formal contract, as evidentiary of a non-binding intent. In the case of the cancellation clause, the court interpreted it as evidentiary of both a binding intent (it would have no purpose if the letter of intent was not binding) as well as a non-binding intent (it indicated the parties did not intend to be bound until they entered into a formal contract). Although the court concluded the letter of intent was not binding, it also held that Quake sufficiently alleged a cause of action under promissory estoppel because Quake expanded its office space, hired a project manager, secured subcontractors, and made preparations to perform the work in reasonable reliance on Jones Brothers’ promise of an award.
[143] CPIS, supra note 121.
[144] Vizy, supra note 4 at § 2:1.
[145] CPIS, supra note 121.
[146] Id.
[147] Id.
[148] Homburger, supra note 13 at 519.
[149] Homburger, supra note 13 at 519.
[150] Joseph M. Fazio & Brandy L. Mathie, The Devil Is the Detail: When Being More Thorough Can Get You into Trouble Drafting Letters of Intent, Mich. B.J., June 2013, at 26.
[151] Id.
[152] John N. Iurino, Sivan R. Korn, There’s No Deal Until There’s A Deal: Drafting (and Living with) Letters of Intent, Ariz. Att’y, November 2013, at 40.
[153] Homburger, supra note 13 at 519.
[154] Fairbrook Leasing, Inc. v. Mesaba Aviation, Inc., 519 F.3d 421, 427 (8th Cir. 2008). The term sheet between Fairbrook and Mesaba, which the court held was a binding Type II agreement, did not contain a termination provision for Mesaba to exit the lease when Saab stopped supporting the 340 series of aircraft.
[155] Vizy, supra note 4 at § 2:1 – 3.
[156] Iurino, supra note 152 at 40.