A letter of intent is more than an intention

A letter of intent is not a non-binding intention: certain parts are immediately legally binding, and anyone who breaks off negotiations at the wrong moment risks having to pay damages. Whether you can still withdraw depends on what you have agreed upon and what expectations you have raised with the other party. In this article, you will read exactly what a letter of intent is, which parts are binding and which are not, when breaking off becomes risky, and how to draft a good letter of intent.

Letter of intent in brief

• What it is: a document in which parties record their intention to enter into an agreement, while the final deal has not yet been finalized.
• Other names: letter of intent (LOI), agreement of intent.
• Partially binding: practical agreements such as confidentiality, exclusivity, and cost allocation apply immediately; the main agreement (the deal itself) usually does not yet.
• Main risk: breaking off negotiations at the wrong moment, resulting in you having to reimburse incurred costs or, in exceptional cases, damages.

What is a letter of intent?

A letter of intent – ​​also known as an intention agreement – ​​is a document in which parties record their intention to enter into an agreement with each other, while the final deal has not yet been finalized. You use such a statement, for example, when you first want to conduct due diligence, need to arrange financing, or when there is still uncertainty regarding the matter to which the contract relates.

The thinking is often: if it turns out not to be as rosy as hoped, I will simply withdraw. However, it is not that simple. Unlike New Year's resolutions between Christmas and New Year's, the agreements in a letter of intent can indeed be enforceable.

When do you use a letter of intent?

A letter of intent is particularly useful for larger or more complex projects where you cannot sign in one go. Consider:

• a business acquisition where a due diligence investigation takes place first;
• a collaboration or joint venture that still needs to be worked out;
• the purchase or lease of real estate subject to financing;
• negotiations in which you share confidential information and wish to agree on exclusivity.

In all these cases, you want to guide the negotiations without committing yourself fully just yet. A good letter of intent helps you with this – provided you draft it carefully.

Is a letter of intent legally binding?

Partly, yes. A letter of intent typically contains two types of agreements, with a very different character:

• Directly binding agreements. These are practical agreements that take effect immediately, even if the final deal falls through. Examples include a confidentiality clause, agreements regarding who bears the costs of preliminary research, exclusivity during negotiations, and the division of advisory fees. These agreements are not open to discussion and must simply be adhered to.
• The intention to reach a deal. Whether this part is binding is much less black and white. Whether an enforceable agreement arises depends on what the parties could reasonably expect from each other.

Important: the name of the document is not decisive. Just because you call something a “letter of intent” does not mean that a binding agreement cannot be formed. Judges look at the content and the conduct of the parties, not the label.

The reasonable expectations of the parties

The reasonable expectations of the parties are central to the question of whether an agreement is actually concluded. Based on the provisions included, as well as the statements and conduct in the pre-contractual phase, it is assessed how far the letter of intent extends:

• Did the parties only intend to conduct a preliminary investigation, or to actually reach a deal?
• Should the other party have relied on the fact that an agreement would actually be reached?

The answer to those questions determines whether the letter of intent is binding or non-binding. The further the negotiations have progressed and the more trust you have built, the less free you are to back out.

Risk: breaking off negotiations

The greatest risk lies in abruptly breaking off negotiations. Under Dutch law, parties negotiating with each other must act in accordance with standards of reasonableness and fairness. In principle, you may break off negotiations, but there is a limit.

The Supreme Court applies a strict and restrained standard in this regard: breaking off negotiations may be unacceptable if the other party was justifiably entitled to rely on an agreement being reached, or if doing so is unacceptable in view of the other circumstances of the case. Anyone who breaks off negotiations at such a moment may be held liable. Depending on the situation, this may mean:

• that you must reimburse the costs incurred by the other party;
• that in exceptional cases you even have to compensate for lost profits;
• or, very exceptionally, that you may be forced to continue negotiating.

Whether termination is permitted depends heavily on the specific circumstances. Moreover, case law on this point is nuanced and continues to evolve. Therefore, in the event of an impending conflict, always seek personal advice rather than relying on general rules of thumb.

Practical example

Suppose an entrepreneur negotiates for months regarding the acquisition of a competitor. The parties sign a letter of intent, due diligence is initiated, and the buyer has a draft contract drawn up. Just before signing, the seller backs out because someone else offers just slightly more. Because the buyer was justifiably entitled to rely on the deal going through based on all the actions taken, the seller runs the risk of having to reimburse the incurred advisory and research costs. A carefully drafted letter of intent could have mitigated this risk.

How do you limit reasonable expectations?

Fortunately, you can limit expectations – and thereby your commitment. However, this requires you to draft the letter of intent carefully. Consider:

1. Suspensive conditions. Specify which conditions must be met before a definitive agreement is formed (for example, a positive due diligence or securing financing).
2. Reservations. Make it clear that a deal is only concluded upon signing of a written agreement (“subject to contract”) or after approval by, for example, the board of directors or shareholders.
3. Break-off clause. Determine under what conditions parties may withdraw from negotiations and what the consequences thereof are.

Do bear in mind, however, that subsequent statements or conduct can still throw a spanner in the works. Therefore, you must consistently maintain your reservations during the negotiations as well. That is precisely why clear suspensive conditions should not be missing from a good letter of intent.

What should be included in a good letter of intent?

A letter of intent is therefore less non-binding than is often thought. To avoid becoming bound too early, it is important that the document is drafted with care. Strict suspensive conditions must prevent the agreement from being unjustly enforced, while other agreements must be clearly binding – for example, the division of research costs.

A good letter of intent includes, among other things:

• a description of the intended objective and the schedule of the negotiations;
• a confidentiality clause regarding the exchanged information;
• agreements regarding exclusivity and cost allocation;
• suspensive conditions and reservations;
• a forum or jurisdiction clause and, where appropriate, a penalty clause.

Letter of intent, preliminary agreement, or contract: what is the difference?

In practice, these concepts easily become confused. The distinction determines how strongly you are bound:

• Letter of intent. Sets down the intention to reach a deal and regulates the negotiation phase. Some parts are immediately binding; the main agreement usually is not yet.
• Preliminary agreement. In this, the parties already commit to entering into a later agreement. The binding effect is therefore stronger than with a “bare” letter of intent.
• Final agreement. The final contract in which all rights and obligations are fully elaborated and laid down.

The type of document you need depends on how far you want to commit and how much room you want to leave to withdraw. Unsure which stage you are in? Then have your document reviewed before you sign. In the case of a business acquisition, broader corporate law a role.

Frequently asked questions about the letter of intent

Is a letter of intent the same as a contract?

No. A letter of intent establishes that the parties intend to enter into an agreement and contains arrangements for the negotiation phase. Some elements, such as confidentiality and cost allocation, are immediately binding; the final deal only becomes binding once the agreed conditions have been met.

Can I still withdraw after a letter of intent?

Often yes, but not always without obligation. The further the negotiations have progressed and the more trust you have built, the greater the chance that you will have to reimburse incurred costs or, in exceptional cases, damages. Clear reservations in the statement increase your room to withdraw.

What is the difference between a statement of intent and a letter of intent?

In practice, the terms are used interchangeably; a letter of intent is simply the English name. “Content Agreement” and “LOI” also refer to the same type of document.

Does a letter of intent have to be in writing?

In principle, a letter of intent is not subject to any specific form, but in practice, it is always recorded in writing. This prevents disputes regarding exactly what has been agreed upon and allows you to properly substantiate reservations and conditions precedent.

Can I use a free example or template?

A standard template provides at best a rough structure but rarely covers your specific situation. The value of a letter of intent lies precisely in the custom-formulated suspensive conditions, reservations, and agreements regarding exclusivity and costs. An incorrectly completed template can bind you more strongly than you think; therefore, always have a draft reviewed before signing.

How much does it cost to have a letter of intent drawn up?

That depends on the complexity of the process and the agreements you wish to record. A simple letter of intent is quicker to tailor than a document for an extensive business acquisition involving suspensive conditions and exclusivity. Ask for a clear price indication in advance so that you are not faced with any surprises.

Have your letter of intent drafted or reviewed

Would you rather not take any risks? A letter of intent seems simple, but the legal consequences are not. Our legal experts draft your letter of intent or review an existing draft so that you know exactly what you are committing to. Do you need broader advice regarding your contracts or an impending dispute? Then view our page on contract law or contact us directly via rechtshulp.

Do you want certainty before you sign? Schedule a no-obligation intake meeting with one of our legal experts.