A Signed Letter of Intent Isn't a Binding Lease
A signed letter of intent (LOI) is often the preliminary step to a commercial lease. The LOI typically requires the sides to keep the deal confidential while outlining the crucial terms of the lease they both ultimately intend to sign. However, while it may feel like a commitment, the LOI is less than ironclad. Parties may still change their mind either on the lease terms or whether they want to sign a lease at all. So, treating an LOI as a binding contract may cause landlords to make business decisions that prove unwise if the tenant decides to walk away, such as turning away a promising prospect.
Owner Ditches Prospective Tenant at the Altar
A fast-growing West Coast sports clothing retailer recently learned this lesson the hard way. The company decided that the new five-story building being constructed on posh Newbury Street would be the perfect location for its Boston store. The company co-president and landlord signed a six-page LOI outlining the basic terms of the prospective lease. They then finalized the lease terms. The retailer signed the final lease and popped the champagne corks—but the landlord pulled out at the last minute.
The retailer insisted that the LOI was a binding contract and asked the court to enforce it. The Massachusetts court disagreed and dismissed the case. “Parties to a preliminary agreement containing all the necessary terms of a contract may be bound even if the preliminary agreement contemplates the execution of a subsequent, more formal or detailed agreement,” the court acknowledged. However, this isn’t the case where the LOI clearly expresses the parties’ intent not to be bound by the preliminary agreement. The LOI in this case included such language. It appeared in bold face just above the signature lines:
Other than the Confidentiality provision stated above, this Letter of Intent does not constitute a binding enforceable agreement between the parties. Rather, it is only an outline of the basic business terms on which Landlord and Tenant are willing to continue their negotiations for the lease of the Premises. Landlord and Tenant each acknowledge that the parties have not set forth in this Letter of Intent, and have not yet agreed upon, all of the essential terms of the transaction, including warranties and representations, conditions precedent and indemnities. Except for the parties' obligations under the “Confidentiality” section above, binding, legal obligations of Landlord and Tenant will only arise upon the execution of a definitive lease agreement containing all essential terms for the transaction.
It’s not that unusual for negotiations to break off at the last moment, the court concluded. “The law recognizes the right of parties to a proposed business transaction ‘to hug before they marry’” [Alo, LLC v. L3 149 Newbury St., LLC, 30 LCR 746, 2022 Mass. LCR LEXIS 115].
HOW TO CREATE A LEGALLY SOUND LOI
If you’re going to enter into an LOI “hug” with your own prospective tenants, at least ensure that it’s as tight an embrace as possible. Language expressing the intent not to commit, as in the LOI in the Newbury St. case, will obviously have the opposite effect.
Recognizing that the LOI isn’t an “I do” is only the first step. You can also do yourself a world of good by ensuring that it spells out the lease terms clearly and specifically so as to minimize a tenant’s potential wiggle room. Although the LOI doesn’t have to cover every single lease term, attorneys say that there are five key things that it should address:
1. The Leased Premises
Nailing down the precise premises to be leased may not be as easy as it sounds, warns a New York City leasing attorney, because not all space may be “rentable” or “usable.” As a result, not defining the leased premises in the LOI can lead to disputes if the prospective tenant can’t use some or all of the space the landlord wants to lease.
It’s also important to depict exactly where in the building or center the space is situated. For example, an LOI on an office lease should identify the floor and suite number. It should also include a copy of the floor plan as an attachment.
2. The Rental Rate
In addition to listing a rent amount, the LOI should specify whether it’s a “net” or “gross” number. It’s common to state rent not as a dollar-per-square-foot figure, but as a monthly or annual flat number, the New York attorney notes. But it may be more advisable to charge a dollar-per-square-foot, rather than a flat amount, particularly if the space itself isn’t clear and/or subject to change, such as when a tenant leases an entire floor that won’t be precisely measured until after the buildout.
3. Scope of, Responsibility for Construction Work
If a tenant is planning to do its own buildout, the LOI should specify whether an allowance will be provided. For large or complex buildouts, the LOI should also spell out which costs are included. The attorney says she’s seen a number of battles at the lease stage over whether the intent was for the landlord to pay for soft costs or hard costs. Even fees for the same category of cost may be split between the landlord and tenant.
For example, some landlords pay for certain engineering costs but not others. When a landlord has an interior designer on staff, the question of whether the tenant is expected to pay for those services out of its allowance should be raised.
At the same time, attorneys also caution not to feel pressured to come up with figures. For example, it’s okay to agree to give the tenant a $100,000 buildout allowance while also indicating that the exact scope of work will be determined later.
4. The Security Deposit
It may be impossible or unwise to decide on the exact amount of a security deposit or other tenant payout if you haven’t yet reviewed its financial statements. Just be sure that you note that in the LOI. “If you leave the security deposit out, you run the risk that the tenant will infer that a deposit isn’t required,” the attorney warns. What you should do instead, she advises, is state that the security deposit will be determined later “subject to Landlord’s review of tenant’s financial statements.”
5. The Unique Arrangements
The LOI should set out any unusual or specialized provisions, including those dealing with assignment and subletting, as well as options to terminate early, purchase, expand space, or other tenant options. Thus, for example, a franchise tenant may be required by its franchisor to have the right to assign its lease to the franchisor without your consent. You’ll want to include that in the LOI. Likewise, the LOI should make it clear if you expect a tenant to give you all or part of its profits from an assignment or sublet. The LOI should also spell out methods of making determinations about any of these unusual items, for example, by specifying that a tenant option to purchase the property will be at “the appraised value at the time of the sale” or other formula of calculation.