The Importance of the LOI before the Purchase Contract

Posted on Feb 5, 2021 by Jean Louise

The Letter of Intent, also known as an “LOI” or “Term Sheet”, is generally prepared by the buyer and submitted to the seller. In order to formalize the intent here, it is appropriate for both parties to review and sign the document, so everyone is on the same page as to how the purchase contract is going to be drafted and the terms of the deal. The LOI should include a brief legal description of the property or at least the property address. The description of the property should also include any unique assets the buyer wants to acquire in the transaction.

The purchase price of the transaction is typically one of the most critical clauses of the LOI and how the purchase price will be paid is another critical factor. The earnest money or deposit, which is typically part of the purchase price, can be delivered in different stages during the transaction and typically the Buyer will deliver 1% of the purchase price or less.  The buyer also wants the earnest money to be refundable as long as possible during the transaction so the buyer can terminate the transaction if something is discovered during the property inspections or due diligence period which is not satisfactory to the buyer and/or his/her lender. The earnest money is typically non-refundable during different stages of the purchase contract such as at the expiration of the due diligence stage or the financing approval period by the buyer’s lender.  On the other hand, the Seller will want the deposit to be hard/non-refundable immediately or as soon as possible.

The buyer should provide a solid timeline of how long it will take to review due diligence materials, obtain financing approval and closing date. The timeline of seller deliverables and how long it will take the buyer to review those items is typically between 15-45 days as long as there are not any unusual items of concern. It is a good idea of the buyer to list or attach a list of seller deliverables for the due diligence period so these items can be settled upfront as to what needs to be provided and the buyer may actually be able to get started earlier on reviewing those items.  The buyer needs to feel confident how many days they need to review will be enough and at the same time keep the seller engaged.  During that same timeline of due diligence, the buyer should be seeking lender approval which can also be a condition of closing.  The closing date is typically determined as a number of days after the due diligence period (typically 15-30 days) and the buyer may also be wise to include any extensions for any uncertain delays.  The seller should request an additional deposit for those extensions.

A financing contingency/clause should be included in the LOI and provide specific details of the transaction.  This will allow the buyer to control loan terms and create an exit from the contract if appropriate loan terms cannot be obtained from a lender. A confidentiality clause should always be included for the benefit of both parties and the buyer and seller should consider a clause for local customs for payment of closing costs for the transaction. Broker information is also pertinent, so those costs should also are addressed. The buyer should always push to include an “exclusivity” clause so the Seller cannot deal with any other buyer’s during your purchase contract phase. Finally, the LOI should finish with a “Binding Effect” clause which binds the seller and buyer to the confidentiality clause and exclusivity clause and state the LOI is intended to create a purchase agreement on the stated terms within the LOI but the terms are not legally binding in the LOI terms and the terms are only legally binding once a purchase contract is finalized and executed by the Buyer and Seller.

It is also very important that the buyer and seller execute the LOI in order to have a solid ground to start drafting the purchase contract. The purchase contract can be initially drafted by either party but having an executed LOI, by both parties, provides the buyer, seller and their respective attorney’s confirmation as to the terms and structure of the purchase contract. The LOI also provides starting terms for the brokers of the seller and buyer in order to negotiate any terms. Negotiating terms through a well-drafted LOI is much easier and simpler than negotiating terms through the purchase contract.

Having a solid, well-drafted LOI allows the parties to progress with the purchase contract and negotiations very quickly. The buyer, seller and respective attorneys are able to expedite the purchase contract phase and allow the buyer and seller to begin providing due diligence materials and reviewing due diligence materials. It also allows the buyer to contact their lender earlier in the process in order to determine loan terms. An LOI with not enough information about key terms and clauses about the transaction can create a lot of negotiation between the attorney’s instead of the buyer and seller and delays the process unnecessarily. Not enough information in the LOI can also create a lot of ambiguity in the initial draft of the purchase contract.

I advise that all buyers, sellers, brokers and attorneys take charge of the transaction with the LOI and negotiate the terms of the transaction in detail in the LOI before entering into a purchase contract.  This is the recommended practice so you can avoid uncertain terms and clauses in the initial draft of the purchase contract and avoid unnecessary delays in the purchase contract drafting, redlining and review phase.

Patel Law Group is willing and able to help buyers, sellers and brokers with the review and drafting of the LOI so please let us know if you need any assistance or help.