A Closer Look at "Accidental Contracts"

Author: Tom Muller

While the intention of the parties in the deal may be straightforward, unfortunately the law is often not. Most real estate deals begin with a letter of intent (or term sheet) spelling out the principal terms of the deal. Often, because these are viewed as informal, the parties to the transaction don't bother having them reviewed by lawyers until after they are signed, which can be a big mistake.

It's not particularly unusual to see such a term sheet calling for, say, a 20-day due diligence period. Apparently, this is supposed to be impressive to the seller, showing that the buyer is a can-do player. However, unless the title work and survey have already been completed, it is highly unlikely they can be done, let alone reviewed, within that 20-day period, nor can the necessary Phase I environmental review be done and reviewed within 20 days. A sophisticated seller will understand that this supposedly motivated buyer actually doesn't know what he's doing.

Similarly, if a buyer requires financing or a seller needs to obtain estoppel certificates from tenants, an impressively aggressive closing date may well be pure fiction, later leading to disappointment or even default.

And while the intention of the parties in the deal may be straightforward, unfortunately the law is often not. In particular, tax law may dictate a transaction structure quite different from the terms of the letter of intent. The tax code provides many ways for real estate owners to defer or even avoid recognition of gain, and it's best to include tax advisors as early as possible before the parties' expectations get set.

An even bigger problem is that a letter of intent may very well be an enforceable contract, which requires only a writing, signed by the parties, containing the primary terms of the deal, such as the property and the price.

Several cases in the past decade have held enforceable very simple and informal letters of intent, because they meet the legal requirements for a contract.

But what about the other 30 or 40 pages of a typical real estate purchase agreement, loan document, or lease? Courts will imply "customary terms" into the letter of intent to supply all of those missing pieces. That is, the judge will supply most of the terms of your inadvertent agreement based on an understanding of "customary terms," which will be based upon conflicting expert testimony obfuscated by litigators.

To avoid this, lawyers routinely insert language into term sheets attempting to make it abundantly clear that the parties do not intend the term sheet to be a legally enforceable document (usually excepting confidentiality and exclusivity provisions).

In some cases, though, courts have found poorly worded "not enforceable" language unconvincing, and have implied obligations to negotiate in good faith or use best efforts to reach a deal, so the wording of the "not enforceable" provision is very important.

Bottom line: For important practical, tax and legal reasons, it is critical to involve experienced real estate counsel from the very beginning of the discussions of your deal.