The Letter of Intent: Non-Binding, With Binding Parts

A letter of intent records that two parties intend to proceed with a transaction on a described shape. Most of it is a statement of intention. A small set of clauses binds from signature: confidentiality, exclusivity, costs and governing law. The binding clauses constrain behaviour immediately, and the non-binding ones are what everybody discusses. The trap sits in that inversion.

Start with something almost everyone has signed. A hall is booked for a wedding. The couple sit with the manager, agree the date, agree roughly what the food will cost per plate, agree that the decoration will be discussed later, and then sign a booking form and hand over a token amount. The honest question is what exactly was agreed to in that moment. Not the menu. Everybody spent forty minutes on the menu. The menu will change three times. The date came off the market for everybody else, and money changed hands that will not come back in full if the booking is abandoned. The part of the form that changed the world was the part nobody read.

A letter of intentA signed document recording that two sides intend to do a transaction on a described shape. Most of what it contains does not commit either of them to complete. is that booking form, written for a purchase of a company instead of a hall. Two sides have talked. Both sides have reached a shape they recognise. Neither has finished checking what the other has said, so neither is ready to be committed. So they write down the shape, they sign it, and they attach a small number of clauses that do bind. Without those the next stage cannot safely happen at all.

Almost everything a reader will be told about a letter of intent concerns the parts that do not bind, and almost everything that changes behaviour the following morning sits in the parts that do. The gap between what is discussed and what binds is where the expensive mistakes live. A letter of intent can be read from end to end, every commercial line in it understood and agreed with, and the only clause that will govern what the parties can and cannot do for the next several weeks still missed entirely.

Harivansh Packaging Limited, an invented listed maker of rigid and flexible packaging, is buying the whole of Sundarban Polymers Private Limited, an unlisted maker of flexible packaging films. Devyani Kulkarni is the chief financial officer of Harivansh Packaging Limited and Ashwin Rege leads its transaction team.

Where does this document sit, and what has already happened?

Reading the instrument requires knowing when it arrives. A transaction of this kind moves through seven named milestones in a fixed order: approach and confidentiality, indicative offer and term sheet, confirmatory diligenceThe checking a buyer does after a shape is agreed, aimed at confirming what it has already been told rather than at discovering the business for the first time., documentation, signing, the conditions period, completion.

The letter of intent sits at the second of those, in the same slot as the indicative offer and the term sheet, and this matters more than it sounds. The document sits before the checking, not after it. No lawyer has yet drafted an agreement. The two sides have agreed what they are trying to do and have not yet agreed how any of it will be written down.

Hold on to that position. Every strange feature of the document follows from it. Why is so much of it vague? Because the detail has not been checked yet. Why does it not commit anybody to complete? Because a buyer that has not done its confirmatory work cannot honestly commit, and a seller that lets it would be handing over a promise the buyer would break. Why does any of it bind at all? Because the checking that comes next is expensive, intrusive and one-sided, and neither party will start it without some protection.

Nobody knows very much when the letter of intent is written, and that is why it promises so little and constrains so much. Everything drafted after it, the definitive agreement and its whole apparatus of limits and protections, belongs to the documentation stage that follows. Agreement comes first and drafting comes second, and this instrument is the moment the agreement becomes visible in writing.

What has each side actually committed to?

The answer fits in one line, and then the line comes apart. Both sides have committed to how they will behave while they try, and neither has committed to the thing itself. Nobody has promised to buy. Nobody has promised to sell. Both sides have promised conduct: to work towards this, not to talk to others, not to repeat what is learned, and for each side to carry its own costs.

A letter of intent is a commitment of behaviour, not a commitment of outcome, and confusing those two is the single most expensive misreading the document allows. A buyer who believes the seller is now committed to sell will spend accordingly. A seller who believes the price in the letter is the price it will receive will stop preparing for the alternative. Both are wrong. Both will find out at the worst possible moment, the moment the other side changes its mind.

The household version again. Two households in the same lane agree that one will buy the other's shop. The two households write it out on a single sheet: this shop, this price, completion after the accounts have been looked at, and neither party to discuss it with anyone. Both sign. Now, has the shop been bought? Plainly not. Has anything changed? Enormously. The seller has stopped mentioning the shop to the other interested party down the road. The buyer has started paying somebody to look at the books. Money and position are moving on the strength of a document that binds nobody to complete.

The shape of the thing is now visible. A letter of intent produces real consequences from an unreal promise, and the consequences arrive through two doors: the clauses that genuinely bind, and the behaviour that a signed document causes even where it does not bind. The first door is a drafting question, answerable from the document itself. The second is a question about people and, in part, a question of law, settled by a lawyer on the particular facts.

One more thing is visible while the household is still in view. The buyer's spending started the moment the document was signed, and nothing in it returned that money if the transaction failed. The loss is not a defect in the drafting. A checking stage costs money, and somebody was always going to pay it. The letter simply makes visible the fact that the buyer has agreed to pay it in exchange for a period in which it can check.

How is it different from a term sheet, honestly?

A great deal of writing on this subject goes wrong at exactly this point. Very often there is no difference at all. The same instrument travels under several names: letter of intent, heads of agreementAnother name for the same kind of pre-agreement document, recording the main points two sides have agreed before any full contract is drafted. Also written as heads of terms., heads of terms, memorandum of understanding, term sheet. Two transaction teams can produce documents with different titles, identical substance and identical legal effect.

Form does differ, usually. A letter of intent reads as a letter. A letter is addressed to somebody, opens with a paragraph explaining why it is being written, and runs in sentences. A term sheet reads as a list. A term sheet has headings down the left and terms down the right, and a reader can find the price in four seconds. One is written to be sent to a person and the other is written to be scanned by a transaction team.

Practice observes no such distinction: the title at the top of the document decides nothing, and the only question worth asking about any such document is which of its clauses are expressed to bind. Where somebody asserts that a letter of intent is weaker than a term sheet, or that a memorandum of understanding is the softest of the three, the answer is to ask where in the document that softness lives. There is no answer in the name. There may be an answer in clause nine.

Generalisations still circulate, and some of them describe genuine tendencies rather than rules. A document that reads as a letter often runs shorter and carries fewer commercial details. A document that reads as a list often carries more of them. The format invites completeness. Neither tendency says anything about what binds. A letter of three printed sheets can carry a fierce exclusivity clause and a term sheet of fifteen sheets can carry none.

Where is the binding island, and how is it found?

The document can be pictured as a sheet of water with a small island in the middle of it. Everything that is water is intention: the price, the structure, the timetable, the ambition to complete by a certain point. None of it obliges anybody to do anything. The island is a handful of clauses that bind from the moment of signature, whatever the heading at the front says.

Four clauses usually make up the island, and it is worth knowing what each of them actually does.

The reading discipline is the practical skill the whole subject turns on. Do not infer the island from the four names above, and do not infer it from the title of the document. Find the binding provisions clauseThe clause inside a mostly non-binding document naming the provisions it intends to be legally binding, and the provisions it does not.: the clause that says, in terms, which provisions of this document are intended to be binding and which are not. Read that clause first, before the price, before the structure, before anything. The binding provisions clause is the map of the island.

A document whose binding provisions clause is missing, or vague, or contradicted somewhere else in the same document, is not a document either side should be relying on, and the answer to that situation is a lawyer rather than an assumption. What such a document means is a matter for advice rather than assumption, and stopping to obtain that advice is the correct professional response.

Two smaller reading habits go with it. First, check whether the recitalsThe opening paragraphs of a document that describe the background and who the parties are, before the operative clauses begin. at the front say anything that conflicts with the binding provisions clause. Opening paragraphs written by a business person and clauses written by a lawyer do not always agree. Second, check whether the binding clauses have their own survival period, meaning how long they last if the transaction never happens. A confidentiality obligation that ends the day talks end is worth considerably less than one that continues, and that difference sits in a subclause almost nobody reads aloud.

What does non-binding not protect against?

The word non-bindingExpressed in a document as not creating an obligation that either side could be made to perform. The word describes the drafting intention; whether a court agrees is a separate question. does exactly one thing reliably, and it is worth stating that one thing precisely before listing what it leaves untouched. A signature alone cannot force either side to complete the transaction. The buyer can walk. The seller can walk. Nobody has to explain themselves.

The protection is real, and it is the reason the instrument exists at all. A buyer that has not finished checking cannot responsibly promise to buy, and this word is how it says so on paper without ending the conversation.

Now the first thing it does not do. Non-binding does not stop either side spending money, and on a transaction of this kind the buyer's spending starts the week the letter is signed and is never returned by anything in the document. Advisers begin work. The buyer's own people stop doing their ordinary jobs and start reading a data room. Travel happens. On the seller's side, management time drains into answering questions instead of running the business. The cost never appears on any invoice and is often the larger of the two. If the transaction dies at week ten, all of that has been spent and the costs clause has already told each side that it carries its own.

The second thing it does not do calls for care. A signed document is followed by conduct: promises made in meetings, assurances given in email, work done in reliance on what somebody said, money spent because somebody encouraged it. Whether conduct of that kind creates an obligation of its own, despite the document saying nothing binds, is a question of law. The answer depends on how the clause was drafted, on what was actually said and done, and on the law governing the document.

The question belongs to a lawyer looking at the particular facts. Whether a particular set of facts created an obligation is determined by the law governing the document and by a lawyer applying it. The company law route in India sits with the Ministry of Corporate Affairs at mca.gov.in, and a reader with a live document should be speaking to their own advisers. Knowing that the question exists is what matters. The commonest version of the mistake is a person who believes the words non-binding at the top of a document settle everything that follows.

What does exclusivity do to the seller?

Of the four clauses on the island, three are close to symmetrical and one is not. Confidentiality binds both. Costs binds both. Governing law binds both. Exclusivity binds the seller and, in nearly every case, the seller alone. For a stated period the seller will not talk to anybody else about a sale, will not respond to approaches, and will not run any process alongside this one.

Exclusivity reads better as a change in the seller's position than as a clause. Before it was signed, the seller could truthfully tell a buyer that others were interested and that nothing was owed to it. Afterwards, the seller cannot say it, cannot make it true, and both sides know it.

One buyer negotiating against nobody is in a completely different position from one buyer among several, and the exclusivity clause is what moves the seller from the second situation to the first. Nothing else in the letter of intent does anything comparable. The price line does not bind. The structure does not bind. The clause that quietly determines how the price line will eventually be renegotiated is the one that removes the seller's alternatives from the room.

The street version makes it obvious. A shopkeeper has three people asking about buying his shop. He tells one of them that for the next while he will not speak to the other two and that the inspection can go ahead. He has not lowered his price. He has not promised to sell. He has simply arranged matters so that the person inspecting knows that, for now, there is nobody else to lose the shop to. Every negotiating conversation from that point on happens in a room with fewer people in it, and the person left in the room knows exactly how many people left.

Exclusivity is not a trick. Say fairly what it is for. Exclusivity is the price of the checking stage. A buyer about to spend real money on confirmatory diligence is entitled to ask that it is not funding somebody else's auction, and a seller who refuses every form of exclusivity will find that serious buyers do not begin serious work. The clause is not the problem. The clause without an end date is the problem, and those are two different sentences that get treated as one.

What does each side actually buy by signing?

Both sides get something real. A letter of intent is not a document where one party wins and the other is naive, and describing it that way would make it impossible to explain why sellers sign these things at all.

The buyer buys a period in which its spending is not funding somebody else's auction. The period is the purchase, stated plainly. Confirmatory diligence is expensive and the expense is entirely at risk. A buyer that spends heavily while three other parties are quietly doing the same work is paying to improve a seller's negotiating position, and knows it. Exclusivity converts that spending from a contribution to a contest into an investment in a transaction it has a serious chance of completing.

The seller buys two things. The first is evidence of seriousness, worth more than it sounds. A buyer willing to sign, willing to name a price and willing to commit to a costs position has moved out of the crowd of people who ask interesting questions and never do anything. The second is a written shape it can hold the buyer to, not in law, but in the only currency available at this stage: consistency. If the buyer comes back at week nine with a materially different price and cannot point to something it discovered, it has to explain the change to a person who has the letter on the desk in front of them. The obligation to explain is not enforcement, only friction. Friction has value.

Both purchases are real, and both are paid for in optionalityThe value of keeping a choice open. Giving up optionality means giving up the ability to do something else later. Nothing need have been promised. rather than in money. The buyer gives up the option to keep several targets warm at once, because a signed letter concentrates its people and its budget on one. The seller gives up the option to run a competing conversation. The seller's option is the more valuable of the two, and it is why the clause is negotiated so hard by anyone who has done this before.

Devyani Kulkarni, as chief financial officer of Harivansh Packaging Limited, reads this trade the way a finance person reads any option: what am I giving up, for how long, and what do I get to learn during that time? Ashwin Rege, running the transaction team, reads it as a scheduling problem: how much work must fit inside the period, and what happens to the process if the work runs long. Both are correct readings of the same clause, and neither of them is about the price.

What does the letter say on this transaction?

Put it on the invented purchase and it becomes concrete. Harivansh Packaging Limited and the sellers of Sundarban Polymers Private Limited sign an instrument recording the shape they have reached. The instrument records an enterprise value of Rs 1,320 crore, being 10.0 times Sundarban Polymers' earnings before interest, tax, depreciation and amortisation (EBITDA) of Rs 132 crore. The purchase is of the whole of the shares, on a cash-free and debt-free basis, with net debt deducted at completion. The buyer will complete confirmatory diligence, the definitive agreement will follow, and the parties intend to move to signing without delay.

Now run the bridge. A reader who stops at the headline will walk away with the wrong number in their head. Enterprise value of Rs 1,320 crore less Sundarban Polymers' net debt of Rs 180 crore gives an equity value of Rs 1,140 crore, and Rs 1,140 crore is what the sellers actually receive. The Rs 1,320 crore is never the amount paid to the sellers. The letter of intent is usually the first document to show that distinction, and the first to have it misread.

And now the part that matters most: none of that binds. Not the Rs 1,320 crore. Not the 10.0 times. Not the cash-free and debt-free basis. Not the intention to move to signing. Confidentiality, exclusivity, costs and governing law bind, and if there were time to read only one sheet of this document, the sheet carrying those four clauses would be the one to read.

Put the exclusivity clause against the timetable

One question is worth raising against the timetable. Twenty two weeks ran from term sheet to completion on this transaction, of which nine were the conditions period after signing. Subtract, and thirteen weeks ran from term sheet to signing. The weeks belong to this transaction alone. No transaction takes a standard number of them.

Thirteen weeks is the span during which the checking, the drafting and the negotiating all had to happen. So ask: what does an exclusivity period shorter than thirteen weeks do? A shorter period expires before signing. The seller gets its alternatives back at exactly the moment the buyer is most committed, with its money spent and its people deep in the work. And what does one longer than thirteen weeks do? Signing had already happened and the parties were bound by something far stronger than a letter, so the extra weeks did no work at all.

The exclusivity period for this transaction is not on record, so the question stands against the thirteen weeks and goes unanswered. No standard period exists to put in its place. A number carried away from one transaction becomes a convention that was never one. The comparison itself is the lesson. An exclusivity period and the time the work actually takes are usually decided by different people at different moments, and are rarely checked against each other at all.

Close on the asymmetry. The asymmetry is the sentence to carry away. For however long exclusivity runs, Harivansh Packaging Limited is the only buyer at the table, and the sellers of Sundarban Polymers Private Limited are in a weaker position than the same sellers occupied at week zero. Nothing was taken from them. The sellers agreed to it, in a clause that took ninety seconds to discuss.

What goes wrong most often, and how early?

Three failures, and they are the same failure at three severities. Exclusivity granted too early. Exclusivity granted for too long. Exclusivity granted with a start date and no end.

Too early means before the buyer has said what work it intends to do. A seller who grants exclusivity without a stated scope of work has no way to tell whether the period is being used or merely occupied. Too long means a period set by reference to comfort rather than to the work: somebody asks for a generous run and nobody checks the request against a plan.

No end is the serious one, and it arrives in two forms. Sometimes there is genuinely no end date. Any careful reader catches that one. More often there is an end date with an automatic extensionA clause under which a period renews itself when it expires, usually while some stated condition still holds, without either side having to agree to the renewal.: the period renews itself for as long as the parties are still in discussions. The condition for extending is a condition the buyer controls, so what reads as reasonable is not. As long as the buyer keeps talking, the parties are still in discussions, and the clock resets.

As exclusivity runs, the seller's alternatives disappear from the room and a buyer willing to be slow gains from every week that passes, so the damage compounds. Those alternatives are not paused. Alternatives are people and businesses with their own plans, and after enough weeks of silence they buy something else, commit their capital elsewhere, or simply lose interest. When the seller emerges, it does not find the same three parties waiting. The seller finds a market it has been absent from, and it now has to explain the absence.

The rate at which a seller's position decays is not knowable. The shape below is drawn without a scale for that reason. Only the direction of the two lines can be said with confidence, and the two move in opposite directions at the same time. The whole of the argument is there.

How does a transaction team actually use this document?

Four readers, four different starting points, and none of them starts with the price.

A transaction team reads it as a work plan with a fence around it. Ashwin Rege, leading the team at Harivansh Packaging Limited, takes the exclusivity period and works backwards: what has to be finished before it expires, who does each piece, and what the process looks like if a workstream runs long. The period is not a comfort to him. The period is a constraint he has to schedule inside, and the first thing he does with a draft letter is check whether the work fits.

A chief financial officer reads it as a spending authorisation with no recovery attached. Devyani Kulkarni knows the costs clause means every rupee spent on advisers and diligence is spent whether or not the transaction completes, so the letter is the moment she puts a number on the cost of finding out and asks whether the shape is worth that much to check. She also reads the price line for what it fails to fix. A price expressed as a multiple of a figure that diligence has not confirmed is a price with a moving part in it.

A lender reads it as the shape it is being asked to fund. When a buyer approaches a bank about financing a purchase, the letter of intent is usually the document that goes with the request. The letter is the first written statement of what is being bought and roughly at what price. The lender knows nothing in it commits anybody, and reads it for structure rather than certainty: what is being acquired, on what basis, and how much of the money will have to come from borrowing.

A seller's adviser reads exactly one clause first, and it is not the price. The first clause read is the exclusivity clause, and specifically the sentence that says when the period ends. Everything else in the document can be renegotiated later. After signature the seller has nothing left to trade, so the exclusivity period is the one term that can never be improved.

The household version of that last point is worth keeping. A seller who agrees to stop talking to the other two interested parties should fix the date on which those conversations resume in the same conversation. Not later. Later, it becomes a favour asked of somebody who has no reason to grant one.