In a multipart series, we're examining important points to consider when negotiating commercial real estate purchase and sale contracts from the perspectives of buyers and sellers. Our prior posts addressed negotiating contract terms regarding payment of the purchase price and deposit, the due diligence period, title and survey matters, representations and warranties, and covenants and closing costs. In this final post in the series, we are focusing on negotiating the letter of intent (LOI), which is a critical step in negotiating a real estate purchase and sale contract (the contract). The LOI establishes the business terms and economics of the deal, sets expectations regarding deal structure, influences negotiating power later in the transaction, and prevents disputes from arising after the LOI has been signed and the parties have each expended significant time and resources. A thoughtfully negotiated LOI can serve as a roadmap for the contract and provide the foundation for an efficient transaction.
Establishing Economics of the Deal
The LOI locks in the fundamental economic terms, including purchase price, deposit structure due diligence period, closing timeline, and allocation of transaction costs. Even if the LOI is non-binding, negotiating these terms up front is crucial because it becomes difficult for a party to materially change the core economic terms once they have been agreed to in the LOI. Doing so would undermine trust and slow the deal.
Setting Expectations Regarding Deal Structure
By negotiating structural elements of the deal in the LOI, the parties can avoid misaligned expectations later in the process. Structural elements include the nature of the transaction, identification of the parties, scope of the property being conveyed, how title matters will be addressed, the length of the buyer's due diligence period, whether deposits become non-refundable after due diligence, and the anticipated closing timeline. Once these terms are agreed to in the LOI, the contract is generally drafted to implement those terms rather than renegotiate them. Negotiating these structural components helps ensure that the parties are aligned before the contract drafting process begins, so as to avoid protracted and contentious contract negotiations.
Influence on Negotiating Leverage
The terms the parties agree to in the LOI can significantly impact each party's negotiating leverage during contract negotiations. For example, if the LOI specifies a short due diligence period, the buyer may have less leverage to request an extension during contract negotiations. Similarly, if the LOI states that the deposit will become non-refundable after a certain point, the seller will be in a stronger position to resist requests for a refundable deposit in the contract. Conversely, a buyer who negotiates favorable terms in the LOI, such as a lengthy due diligence period or seller financing, can use those terms as a baseline in the contract and push back against any attempts by the seller to reduce those benefits. The LOI sets the stage for the contract negotiation leverage going forward.
Preventing Disputes
A well-drafted LOI can help prevent disputes by clearly establishing the parties' mutual understanding on key terms before they invest significant time and resources. When essential deal points are addressed in the LOI, both parties have a clear reference point if disagreements arise during contract negotiations. The LOI can also identify potential deal-breakers early in the process, allowing the parties to resolve them or walk away before incurring substantial transaction costs. Additionally, even though most LOI provisions are non-binding, by including specific terms regarding exclusivity, confidentiality, and the allocation of costs in the event the deal does not close, the parties can reduce the likelihood of disputes if the transaction fails to proceed. By taking the time to negotiate a comprehensive LOI, the parties can establish a framework of mutual expectations that minimizes misunderstandings and facilitates a smoother path to closing.
What's Next? The Tenant's Lease Playbook: A Commercial Tenant's Guide to Key Lease Provisions
In our next series, we will examine essential lease clauses that commercial tenants should seek to include in their leases to protect their business interests.
If you have any questions about drafting and negotiating commercial real estate purchase and sale contracts or handling any aspects of transactional real estate matters, such as commercial leasing, acquisitions and dispositions, title matters, diligence, and financing, contact Allison S. Mercantini and Zlata Fayer.