Letter of Intent or Lease….One In The Same?

A case decided this year in the 9th Circuit highlights how important it is to properly draft a letter of intent (“LOI”). In First National Mortgage Co. v. Federal Realty Investment Trust, the 9th Circuit upheld a district court decision to award the proposed landlord $15.9 million dollars in damages based on an anticipatory breach of the LOI, despite there not being a signed lease in place. 631 F.3d 1058 (9th Cir. 2011). First National involved a LOI that was called a “Final Proposal” which stated its terms were “hereby accepted by the parties, subject only to approval of the terms and conditions of a formal agreement”. The LOI was signed by both First National Mortgage Company (“First National”), as the proposed landlord, and First Realty Investment Trust (“First Realty”), as the proposed tenant. The LOI provided for rent at $100,000 per month and gave a “put” option which would allow the landlord to require the tenant to purchase the property at any point during ten years. After the LOI was signed, the parties tried to negotiate a lease, but ultimately could not come to terms. First National filed suit in federal court against First Realty for anticipatory breach of the LOI. The District Court awarded First National $15.9 million dollars in damages for lost rent and for the loss of its “put” option under the LOI.

Federal Realty appealed to the 9th Circuit arguing that the LOI was not binding and was a proposal, further evidenced by its title as a “Final Proposal”. The court held that it was in fact binding and distinguished the language that it was “hereby accepted by the parties, subject only to approval of the terms and conditions of a formal agreement” from Rennick v. O.P.T.I.O.N., in which the LOI in Rennick expressly provided that it was “of no binding effect”. 77 F.3d 309 (9th Cir. 1996). The court further found that calling the LOI a “proposal” did not change the outcome of the case citing that the California Supreme Court has recognized that it is important for the parties to be certain that their interim agreements will be recognized. Gavina v. Smith, 25 Cal. 2d 501, 504 (1944).

Federal Realty also argued that the LOI fell within the Statute of Frauds, thus it was not binding because it omitted an essential term in the form of the duration of the Lease. The Statute of Frauds requires that certain contracts, including those that cannot be performed in one year, must be in writing and include certain essential terms, in order to be enforceable. The court explained that just because the term of the lease is an essential term does not mean it has to be express in the contract. In fact, extrinsic evidence can be used to explain essential terms that were understood by the parties. In this case the court found it could imply a 10 year term of duration based on the LOI citing a “put” option within 10 years.

First National Mortgage Co. v. Federal Realty Investment Trust underscores that it is critical for parties to properly draft letter of intents to ensure that they are a means of negotiation, rather than a contract subject to a breach and recovery of damages. In addition, parties cannot rely on the fact that a LOI might not specifically list all of the essential terms as a way to avoid enforcement, if the term can be implied based on the nature of the contract and the surrounding circumstances. The LOI should be clear that it is of “no binding effect”, otherwise one party could be left paying the other substantial damages due to an alleged breach even if the operative contract is never executed.

The issues discussed in this update are not intended to be legal advice and no attorney-client relationship is established with the recipient. Readers should consult with legal counsel before relying on any of the information contained herein. Reuben & Junius, LLP is a full service real estate law firm. We specialize in land use, development and entitlement law. We also provide a wide range of transactional services, including leasing, acquisitions and sales, formation of limited liability companies and other entities, lending/workout assistance, subdivision and condominium work.

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