During business negotiations, Italian parties often sign or exchange documents by which they declare the intention to work on a future project and clarify their position, leaving open certain aspects to be added or evaluated at a later stage.
English terminology is often employed: letter of intent, memorandum of understanding, heads of agreement, letter of understanding, agreements in principle… In Italy, letters of intent are also called “puntuazioni “or “minute di contratto”.
What is a Letter of Intent
The letter of intent is a pre-contractual document by which the parties aim to organize negotiations and the formation of the subsequent contract. Specifically, the letter of intent, depending on its content, may have some or all of the following functions:
- Organizational/preparatory: the parties set the dates and terms of the negotiation;
- Memo of the negotiation: the parties record the broad elements discussed or to be discussed;
- Demonstration of interest: the parties sign the letter of intent in order to show genuine interest in the negotiation;
- “Moral suasion”: the parties sign a letter of intent in order to put pressure on the other party, bind it to the negotiation for a certain time with a view to concluding the agreement.
When to resort to a letter of intent?
In Italy, the letter of intent (LOI) is drafted in the course of negotiations, especially when the transaction is structured and complex and requires the acquisition of authorizations or the evaluation of various elements and conditions.
Specifically, the letter of intent is used in commercial negotiations in Italy with a view to concluding the following contracts:
- Collaboration and partnership contracts
- Commercial or industrial joint venture contracts
- Real estate purchase and lease contracts
- Sale and purchase of company shares
- Sale and purchase of companies and business units
- Technology transfer transactions, assignment and licensing of patents, software
- Complex supply contracts
LOI: Types and Application
Typically, the letters of intent are business documents in which the parties make various commitments, ranging from minimally to maximally binding.
Let us therefore dispel a false myth: totally non-binding letters of intent are quite rare, not least because of the obvious consideration that, otherwise, there would be no point in signing them! Equally rare are letters of intent that are non-binding for one party and totally binding for the other. Very few people would agree to sign such an unbalanced document.
Unfortunately for those who sign them, it is common to find letters of intent drafted with the intention of being “non-binding” and which are in fact binding contracts.
Often the most skilled negotiators such as managers, real estate or tax advisors do not perceive the critical boundary between non-binding and binding statements and commitments. Mistakes are quite common and may have huge financial consequences.
Here we try to provide a concrete explanation of what it really means to sign a letter of intent and provide some useful examples:
- Non-binding letter of intent: a letter of intent does not bind one to enter into a final contract but, if it is subject to Italian law, at least contains a commitment to negotiate in good faith (we will see below what this entails).
- Partially Binding letter of intent: it contains confidentiality and exclusivity obligations but does not bind the parties to conclude the contract.
- Letter of intent that contains all the essential elements of the contract on which the parties already agreed: in this case, the name letter of intent is misleading because it is a contract, whether it may be a preliminary or final contract.
How to write a letter of intent?
If a party is not ready to commit to the conclusion of the deal, it is not enough to head the document “Non-binding Letter of Intent.” What matters is the content of the letter, as well as the behavior of the parties during the negotiations and, finally, in an international context, also the law applicable to the letter.
Non-compliance and liability
The consequences of failure to comply with the LOI depend on whether or not it is binding.
Breach of a non binding letter of intent
In letters of intent subject to Italian law, one undertakes to negotiate in good faith (Art. 1337 of the Civil Code). The same is true in other civil law countries (e.g., France and Germany).
Good faith means essentially the following:
– Duty to inform each other of elements that if known would lead the other party to break off negotiations
– Duty of confidentiality about the existence of negotiations
– Duty not to use or disclose secrets learned during negotiations
Parties negotiating in good faith undertake also to cooperate for the successful outcome of the negotiations. Which means that the sudden and unjustified breaking off of negotiations may give rise to damages, if the negotiations “have reached such a stage as to generate in the other contracting party a legitimate expectation about the conclusion of the contract” (Italian Civil Cassation No. 11438/04; Cass. civ. No. 8723/04). The damage is quantified in the unnecessarily incurred expenses (costs incurred in conducting negotiations) in addition to the loss of other and more favorable deals (in this sense: Italian Cass. July 30, 2004, No. 14539 and Cass. Feb. 14, 2000, No. 1632). Essentially, under Italian law, a party which interrupts lengthy and detailed negotiations, should have a valid reason to do so and should justify its decision to the other party.
People coming from UK or other Common law countries may have a different perception of their duties when negotiating.
In the U.K. the notion of good faith is absent. In common law countries, more importance is given to the free determination of the parties (so-called “freedom to deal”), so interruption of negotiations does not entitle a party to compensable damages, unless the parties agreed otherwise in the letter of intent or a party can demonstrate to be victim of fraud or misrepresentation (for example, when one party maliciously misleads the other or discloses confidential information received by the other party during negotiations).
Breach of a Binding Letter of Intent.
Letters of intent are not very easy to draft and may cause significant litigation when not written by lawyers. In Italy, parties often rely on brokers, intermediaries, and economic advisors of various kinds in drafting this kind of documents.
If letters are not drafted correctly and negotiations break down, disputes of various kinds can arise. These disputes may be not limited to claim for damages.
Actually in Italy, agreements – in any form (even by exchange of emails) – when one or both parties commit to conclude a contract are valid and enforceable. Therefore, a party may decide to sue the breaching party before the Italian judge and to obtain from the Italian judge a decision which entails the effects of the agreement the other party did not want to enter into (art. 2932 Italian civil code). This means, in the case of a deal for the sale of a property, that the seller will be entitled to receive the price and the buyer the property.
Clarity is therefore most important!
Let’s look at a concrete case, frequent in real estate deals, which the Italian Supreme Court decided in 2015 (Cass. civ. judgment, sec. un., March 6, 2015, no. 4628). During negotiations for the purchase of a property, the parties signed a document with a commitment to enter into a preliminary agreement following the bank’s decision to cancel the mortgage. The bank canceled the mortgage but the prospective buyers withdrew from the deal. The sellers sued them, claiming that the letter of intent they had signed was already a preliminary contract which, under Italian law, obliged the buyers to the purchase of the real estate. The first and appeal judges excluded that a document named as “letter of intent” was binding.
The Supreme Court disagreed with them stating that the judges had to examine the content of the letter of intent signed by the parties and assess if it contained a serious commitment of the buyers to enter into a real estate purchase agreement, commitment which is enforceable under Italian law.
Letters of intent are commonly used in Italy in commercial and business negotiations.
The binding nature of these documents depends on: i) their content, ii) the behavior of the parties during the negotiations and, in an international context, iii) the applicable law. If letters of intent are not drafted correctly and negotiations break down, disputes of various kinds can arise. These disputes may be not limited to claim for damages.
Under Italian law, the commitment to conclude a specific contract is valid and enforceable, provided that the parties reached already an agreement on the essential elements of said contract. Therefore, if the letter of intent is binding, a party may also decide to sue the party which interrupted the negotiations, and obtain from the Italian judge a decision which entails the effects of the agreement the other party did not want to enter into (art. 2932 Italian civil code).
Thus, when the values involved are significant, it is prudent to have an attorney write or review the letters of intent and any pre-contractual documents to be agreed upon.
CONTACT US FOR CLARIFICATION OR FURTHER INFORMATION ON LETTERS OF INTENT.