Letters of Intent and Covenants to Negotiate in Good Faith

Letters of intent (“LOI”) play an important role in the negotiation of many private transactions. An LOI documents an agreement in principle on key terms of a deal. It can evidence parties’ serious intent and provide the framework for a definitive agreement, but is usually “non-binding” – it does not legally require the parties to finalize the deal on any certain terms or even at all.

Does a “non-binding” designation preclude an LOI from imposing any duties or conferring any rights on the parties? No, not necessarily. May the parties be required to at least negotiate in good faith? Yes, but only if the contract is governed by state law that imposes such a duty on every contract or the parties expressly provide for such binding obligation.

Unlike many states, Indiana does not impose a generalized duty of good faith and fair dealing on every contract.[2] If an otherwise non-binding LOI does not include an express, binding covenant to bargain in good faith, no duty of good faith will be imposed. If parties to an LOI wish to impose an obligation to negotiate a definitive agreement in good faith, then the LOI should include a carefully drafted covenant to this effect.

In a case decided earlier this year, the Delaware Supreme Court reinforced the importance and force of covenants to negotiate in good faith in the context of LOIs governed by Delaware law.[3] In Siga Technologies, Inc. v. PharmAthene, Inc., the Delaware Supreme Court held that “an express contractual obligation to negotiate in good faith is binding on the contracting parties.”[4] Under Delaware law, both “binding” and expressly “non-binding” provisions of an LOI may be enforceable if the trial judge were to determine what the parties “would have agreed to” had they negotiated in good faith.[5]

This recent case underscores the utility of an express, binding covenant to negotiate in good faith in an otherwise non-binding LOI. This is especially important in the auction context, where sellers often bid high initially, only to backslide when the negotiations get pointed. A binding covenant to negotiate in good faith may be used to protect against unserious bidders or fickle sellers.

Conversely, the Siga Technologies case is an instructive warning for parties wishing to avoid any liability under an LOI. To help ensure that a “non-binding” LOI is truly non-binding, parties should 1) avoid Delaware choice of law provisions; 2) expressly disclaim any obligation to negotiate in good faith, to be bound by any term of the LOI, or to reach a definitive agreement at all; 3) expressly limit available remedies.

For more information about the issues discussed in this article, please contact Brian Bouggy at 317.669.0140 or bbouggy@dblaw.us.

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