Letters of intent versus memoranda of understanding

Letters of intent and memoranda of understanding are tools frequently used to outline the terms of an intended future agreement. There are differences between them. A letter of intent, sometimes referred to as a term sheet or discussion sheet, is often a less formal document that is signed only by the party suggesting the terms. Letters of intent typically only involve two parties. On the other hand, memoranda of understanding often involve multiple parties. These documents typically represent understandings achieved by the parties; understandings that will be included in the final contract or agreement.

Letters of intent and memoranda of understanding are used to put into writing the most essential terms of a deal. They are typically used in commercial transactions, but occasionally will appear in more sophisticated residential deals. Both documents are intended to establish that the parties agree on the “essential” terms of a proposed deal – after all, if you don’t agree on things like price, financing and commencement dates, you want to know that right away neither document is intended to be binding; but, as with any tool, if misused, either can have unintended consequences.

For example, a recent decision from the PA Superior Court has caused some raised eyebrows across the Commonwealth. The facts are straightforward. A document titled “purchase offer” identified the parties, the land, the location and the purchase price of the real estate the buyer intended to acquire. It also identified who was paying the real estate brokers’ commissions and who was paying closing costs and stated that the buyer was buying property “as-is.” This “purchase offer” also stated that if the sellers “accept this offer, both buyers & sellers will enter into a sales agreement.” Both buyer and seller signed and dated the “purchase offer”, but sellers found a new buyer who was willing to pay more money for more land. The sellers concluded that because all they had was an agreement to agree in the future, there was no binding contract, and they were free to sell to whomever they chose.

Not so fast!

The Superior Court held that the essential terms for an agreement to sell real estate are the parties, the property and the purchase price. The statute of frauds is satisfied when there is a writing that includes the above information and is signed by the party to be bound – in this instance, the seller who was attempting to elude sale. In this case, the Superior Court decided that all of the essential terms of the agreement had been agreed upon and set forth in the “purchase offer.” Moreover, both buyer and seller signed the “purchase offer.” Finally, there is no indication that the agreement of sale that was ultimately presented by the buyer to the sellers contained any material terms different from what was included in the “purchase offer.” Thus, the Court was able to conclude that all essential terms had been agreed upon and set forth in the “purchase offer.”

Was this a letter of intent? A memorandum of understanding? There are several cases that hold letters and memoranda are not binding agreements. However, the specific language and the amount of detail included in the document will determine whether the “letter of intent” is sufficient to form a contract or is merely a green light to enter into further negotiations. In Pennsylvania, if the parties have agreed upon the terms of a contract, the failure to “formalize” the agreement in a writing (or in a different writing) will not defeat enforceability.

This case illuminates a number of the reasons why real estate licensees need to exercise caution when drafting letters of intent and other documents as part of a real estate transaction. This Court found that this letter was a (potentially) enforceable agreement of sale.

What you say or do can come back to haunt you. Simply stating that a letter is not “binding” may be inadequate if all the essential terms of a contract are present and all parties sign the documents. Know your tools. Know your limitations. And know when it’s best to involve a lawyer.

Mr. Thomas Lee, Esq. contributed to this article.