Potential Pitfalls With Letters of Intent
By: Renee Eshelman, partner, Haight Brown & Bonesteel LLP, San Francisco
What should landlords do when they discover that “nonbinding” really isn’t?
GONE ARE THE DAYS of handshake and scribbled-napkin deals. Today, most commercial real estate transactions are memorialized with a letter of intent (LOI) to outline the main agreed-upon deal points for a proposed transaction. Although signed by each party, LOIs are typically stated to be “nonbinding” and therefore not legally enforceable, merely an agreement to agree.
The nonbinding nature of LOIs can be both a blessing and a curse. Busy landlords considering a new lease might review the main points of the deal that affect their bottom line — lease term, rental rate, tenant improvements, etc. — and, finding that everything seems correct, might consider themselves finished. Why not skim over or altogether avoid reviewing the rest? The details can be worked out in the lease; there seems to be no need to put themselves to sleep reviewing the fine points now. Why spend the time and expense of legal review? What harm can these provisions really do? The answer: quite a bit!
In the worst case scenario, a landlord may find that he or she has signed a nonbinding LOI in which a specific provision is actually stated to be “binding” and is legally enforceable. A landlord may have inadvertently agreed to take his or her property off the market for a certain period of time or agreed to certain restrictive confidentiality language. In the best case scenario, the other party may accuse the landlord of reneging on terms that he or she expressly agreed to in the LOI, starting off the negotiations on the wrong foot.
The following “cheat sheet” can help landlords avoid some of the more common problems found in LOI provisions.
Assignments and Subleasing
Tenants often include broad LOI language about their ability to assign or sublease their premises. The intricacies of these provisions are best handled in the lease document. However, if agreeing in the LOI to certain assignment or subleasing rights is unavoidable, the landlord should ensure that at a minimum the following safeguards are included: 1) the original tenant(s) and any guarantor(s) remain liable under the lease; 2) the landlord must be notified in writing of the assignment or sublease before the transfer; and 3) the transferee must assume in writing all of the tenant’s obligations under the lease, to the extent applicable for a sublease. The landlord may also want to insist that no assignment will be permitted unless the assignee, at the time of the transfer, has a net worth equal to or greater than that of the tenant as of the date of execution of the lease.
A savvy tenant may include in an LOI certain broad representations by the landlord; for example, a representation that no hazardous materials are on the premises or that the premises will comply with applicable laws, codes and ordinances throughout the lease term. A landlord should always try to avoid making any representations in an LOI. Although the applicable representation may sound correct, it will likely require refinement and specification by an attorney. And the tenant typically will want the representation to be included in the lease “word for word.” If LOI representations are unavoidable, they should always be limited to the landlord’s “actual” knowledge (without duty of inquiry) and should be limited to being true as of the date of execution of the LOI.
Maintenance and Repair Obligations
These LOI provisions are often vague and can lead to different points of view and disagreements during lease negotiations. The LOI should always specify what portion of the premises and project each party is responsible for maintaining and whether each item includes maintenance, repair and/or replacement. With regard to the landlord’s obligations, it should specify what, if any, obligations will be at the landlord’s cost and what obligations the landlord intends to pass through to the tenant through common area costs.
The Americans with Disabilities Act and similar state statutes can result in costly compliance requirements for both landlords and tenants. A tenant will often want to ensure that the premises will be ADA compliant as of the lease’s commencement date. Some general exceptions that should always be noted in an LOI are that the landlord is not responsible for any compliance that is required in connection with the tenant’s specific use of the premises or any improvements that are constructed or paid for by the tenant. That compliance should always be the responsibility of the tenant. After the commencement date, any ADA compliance with regard to the premises should be the sole responsibility of the tenant.
Common Area Cost Caps
Any time a landlord and tenant agree to a cap on common area costs, it should be specifically stated which costs are subject to the cap. Landlords are typically willing to cap only the costs that they consider to be generally within their ability to control. At a minimum, taxes, insurance and utilities are not generally considered to be controllable. The LOI should also specify if the cap is cumulative and compounding.
Indemnities are agreements to assume another party’s costs and liabilities. Immense liability is connected with indemnities, and a landlord should never be asked to commit to an indemnity in an LOI. If an indemnity provision appears in an LOI, strike it. If it is absolutely unavoidable, a landlord should have his or her attorney review the document before signing it.
Landlords who find themselves confronted with an unfamiliar provision when negotiating an LOI should not worry. Landlords can avoid such provisions until they have had an opportunity to consult with their attorney. Ideally, landlords should start the negotiations with a “form” LOI that has been reviewed by their attorney. The landlord can then carefully scrutinize any changes to the LOI. If forced to use another form, or if an unfamiliar provision is added, the landlord should add a note along the lines of “to be negotiated in the [lease document].” And, of course, you should always sit down with a strong cup of coffee and carefully read the fine print.