Meaning
A Letter of Intent (or “LOI”) is a pre-contractual document that lays down broad contours of the actual contract between two parties. As the name suggests, it consolidates the “intention” of the parties and specifies the key terms of the contract upfront, thereby aiming to avoid disputes at a later stage. The two parties collaborate and put down an outline or summary of the terms, and ingredients of the transaction before the finer details are resolved. A LoI generally marks the starting point for the two parties that are negotiating a business deal.
Objective
A LoI is drafted with a view to identify the fundamental aspects, intention and role of the parties involved within the contract. It gives a basic structure to the intended action and demonstrates the commitment of the parties to the transaction. In some way, it acts as a safety net for the parties before they set foot into the contract. The idea is to identify, address and possibly resolve any obvious or potential commercial issues arising, beforehand. Additionally, along with setting the stage for a possible final agreement, the letter of intent typically enables the parties to begin their formal due diligence.
The legality of a Letter of Intent
In Indian law, it is a well-established legal proposition, that an agreement to “enter into an agreement” is not legally enforceable, nor does it confer any right on the parties. The essence of a LoI represents precisely this. As a result, it does not legally bind the parties or tie them with a legal obligation of any nature. This non-binding nature of the document is subject to revocation by either of the parties or even non-fulfilment of any condition thereby.
The Judiciary has been crystal clear with its stance regarding the legal validity of a letter of intent. For instance, in Rajasthan Co-op Dairy Federation Ltd v.. Maha Laxmi Mingrate Marketing Service Pvt. Ltd. 1996, AIR 1997 SC 66, Supreme Court observed:
“The Letter of Intent merely expresses an intention to enter into a contract…….. There was no binding legal relationship between the appellant and the respondent 1 at this stage and the appellant was entitled to look at the totality of circumstances in deciding whether to enter into a binding contract with respondent 1 or not.”
The case of Dresser Rand S.A. v. Bindal Agro Chem Ltd. and K.G. Khosla Compressors Ltd. AIR 2006 SC 871 also sets a similar premise, in the specific facts whereof, one of the disputing parties had invited global tenders for the supply of various equipment and materials, and the other party (the bidder) had sent a letter offering to supply the same. As a result, letters of intent were issued in favour of the bidder. However, the bidder was informed that the tenderer would instead purchase the tendered equipment and materials from a third party, thus giving rise to a dispute between the tenderer and the bidder. One of the key issues considered by the Hon’ble Supreme Court of India while adjudicating the dispute was whether the letter of intent was a legally binding contract and was observed as under:
“…it is clear that the letter of intent is only a prelude to the purchase order and not itself the purchase order… …Clause (M) made it clear that the Letters of Intent were being issued subject to necessary approvals being given by the Authorities of the Indian Government. These provisions clearly indicate that the Letters of Intent were only a step leading to purchase orders and were not, by themselves, purchase orders……It is now well-settled that a Letter of Intent merely indicates a party’s intention to enter into a contract with the other party in future. A Letter of Intent is not intended to bind either party ultimately to enter into any contract. “
This was reiterated in M/s. Karamchand Thapar & Bros (C.S.) Ltd., v. M/s. M.P. Power Trading Co. Ltd 2012 ELR (APTEL) 1185 and a similar dicta was also propounded in Speech and Software Technologies (India) Pvt. Ltd. v. Respondent: Neos Interactive Ltd. (2009) 1 SCC 475.
In Nikhil Adhesives Limited thro’ DharmeshbhaiDhirajbhaiPandya v. Kandla Port Trust 2011 GLH (2) 283, a case involving a dispute between a tender issuing authority and a bidder, the High Court of Gujarat has resonated the above understanding and called the letter of intent a “mere expression of intent”. Along with this, in alignment with the specifics of the matter, the Court also identified that without the fulfilment of certain conditions, the letter of intent could not be legally binding.
Basis in Literature
Many authors have been understood to hold a similar perspective. For instance, T. S.Venkatesa Iyer in his book ‘The Law of Contracts & Tenders’, has stated that, just by giving a letter of intent, a party cannot be said to have intended to agree, or do anything in order to give rise to a binding contract. In Cheshire, Fifoot and Furmston’s Law of Contract, it is stated that a letter of intent is a very commonly employed commercial device by which one party indicates to another that it is very likely to place a contract with them.
However, it is pertinent to note that such a non-binding letter of intent can often take a hybrid form where the parties agree to be bound by certain identified provisions, such as confidentiality; exclusivity; costs/expenses; governing law/jurisdiction etc. In a nutshell, the judicial determination of LoI remains subject to the circumstances of each case and the provisions of the respective letters. Many aspects play a role in ascertaining the legality of the letter, few being the language in which the letter has been drafted, the intention of the parties involved, and the nature of the matter or the transaction.
Recent Development in Understanding
In South Eastern Coalfields Ltd. & Ors. v. M/S. S. Kumar’s Associates Akm (Jv), Civil Appeal No. 4358 of 2016, the facts of which involved a Letter of Intent being issued by the appellant company to the respondent firm while awarding the contract for a total work of Rs.387.40 lakhs. The respondent accepted the contract; however, the work could not commence due to mechanical reasons beyond the control of the respondent firm. After a series of events and subsequent notices issued, the appellant issued a termination letter and asked the respondent to not only forfeit the bid amount but also the differential contract value between the respondent and the new contractor. The respondent firm filed a writ petition before the High Court seeking quashing of the termination letter and the recovery order issued to them. The Court held that there was no valid contract inter se the parties, as it was subject to completion of certain formalities by the respondent, like furnishing the performance security, which were never initiated; and consequently, the appellant was within their rights to cancel the award of work and forfeit the bid security. Thus, only the forfeiture of bid security was upheld, while the endeavor of the appellants to recover the additional amount to another contractor, was not recoverable. The appellant, thus, filed a Special Leave Petition, which was granted. A Division Bench of Sanjay Kishan Kaul and Hemant Gupta, JJ. reiterated and upheld the judgement given by the High Court and were of the view that,
“The judicial views before us leave little doubt over the proposition that an LoI merely indicates a party’s intention to enter into a contract with the other party in future. No binding relationship between the parties at this stage emerges and the totality of the circumstances have to be considered in each case. It is no doubt possible to construe a letter of intent as a binding contract if such an intention is evident from its terms. But then the intention to do so must be clear and unambiguous as it takes a deviation from how normally a letter of intent has to be understood.”
This has further consolidated that a LoI, being a foundational document for the parties, must be sufficeintly coherent, transparent and apparent in its essence. A business transaction is a multi-fold process with umpteen procedures, and it is vital to understand that ambiguity should not play any role in it. Sanjay Kishan Kaul and Hemant Gupta, JJ. have created a precedent that will ensure a smooth system in matters of such nature. In addition, the same shall act as a driving force for the parties in a transaction to intently examine and draft the LoI, effectively avoiding any conflict, while ensuring clarity and unambiguity in the execution of it, from the first step.
Conclusion
A LoI embodies the crux of transaction: a practical and upfront document to assess the pros and cons thereof and helps in arriving at a broad commercial understanding agreeable to all. Therefore, in cases where a LoI is being entered into and is intended to be non-binding, utmost care should be exercised in ensuring no contractual binding on either party, in any form.