Business Transactions: Letter of Intent and Litigation

In many business transactions, it is commonplace to execute a Letter of Intent (“LOI”) prior to executing a detailed and more complicated purchase agreement or lease. If you are a business owner discussing or considering signing a letter of intent, it is likely prudent to discuss your legal rights with an attorney. Executing a letter of intent can impact your legal rights in ways you may not know. 

A recent case from Milwaukee, IFS Filing Systems LLC (“IFS”) v. 11225 Heather LLC (“Heather”), highlights a few ways a LOI can have a legal impact on a party’s legal rights, including litigating Tortious Interference of Contract claims (1). If you are involved with a letter of intent, or want to know more about Tortious Interference of Contract claims and whether this cause of action may apply to your situation, please consider reaching out to me to discuss.

What is a Letter of Intent?

The letter of intent often operates to restrict the seller from marketing the thing being transferred to anyone else for a reasonable period. It often requires both parties to act in good faith to finalize a formal deal at a specific time in the future. It may evidence agreement on the specific property right being transferred, such as assets of a business or a lease. The letter may show agreement on a price or price range. It also often requires the parties to keep confidential any information and communications between them. Importantly, the letter of intent evidences the intent to enter a contractual relationship in the future, which may have legal consequences. It is often prudent for both parties to try to nail down many potentially contentious issues in the letter of intentin hopes that negotiating the final agreement may be easier. 

The LOI will also often have a statement that only the ‘confidentiality’ and ‘dealing with others’ provisions are binding. So, if the LOI is so nonbinding… what other legal effect may it have? 

What is Tortious Interference With a Contract?

Under Wisconsin law, establishing a claim for tortious interference with a present or prospective contractual relationship requires proof of the following five elements: 

(1) the plaintiff had a contract or prospective contractual relationship with a third party; 

(2) the defendant interfered with the relationship; 

(3) the interference was intentional; 

(4) a causal connection exists between the interference and the damages; and 

(5) the defendant was not justified or privileged to interfere.

Addressing the first element, it can sometimes be difficult to determine whether two parties had a potential contractual relationship, but a LOI likely helps a plaintiff prove this first element.

Letter of Intent and Impact on Litigation

IFS v. Heather arose from an attempted sale of a leased commercial property by Heather, which was leased to IFS (3). The value of a commercial property is often correlated with the terms and conditions, and financial health, of its tenant. Heather tried to sell the property to a couple prospective buyers and obtained multiple LOIs. Heather requested financial records from IFS during due diligence, which was its right under the lease between it and IFS (“Lease”) (3). It alleged that those prospective sales failed because IFS refused to provide financial statements as required under the Lease. Heather moved to evict IFS and alleged additional damages under the theory of Tortious Interference of Contract and Breach of Contract (the Lease). 

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Evidence presented at trial demonstrated the requests for tenant financial records were made because the prospective buyers requested them. The trial court specifically found that IFS’s refusal to provide those records led to the prospective buyers cancelling the offers. The Court found IFS’s failure to produce financials blocked Heather’s ability to sell the property.

Importantly, the Court found that the letters of intent evidenced Heather had a “prospective contractual relationship with a third party” as required in the first element of a Tortious Interference of Contract claim. The letters assisted in proving the prospective deals failed because IFS failed to provide the financial records. First, Heather and the prospective buyer would indicate an intent to sell; Second, Heather would request certified financials from IFS; Third, IFS would refuse to execute and provide them within a reasonable period; and Fourth, the prospective buyer would not proceed with the sale. 

The letters of intent also appeared very important in proving damages. Damages flowing from breach of contract or torts are often not automatic and must be proven. The LOIs accepted by the trial court evidenced prospective sales of $4.55 Million, $4.7 Million, and $5 Million. The court used the $5M letter of intent to calculate $1.25M in damages.

The letters of intent also appear to have assisted in proving breach of the Lease and right to eviction. IFS argued that breaching the Financial Statement clause was not a “material” breach and could not be used to evict. Some less-important lease terms and ‘light breach’ thereof are sometimes not considered ‘material’ enough to be remedied with eviction. However, the letters of intent demonstrated the valuable prospective sales hinged on the tenant providing financial statements as required by the Lease.

Bankruptcy Protection, Lease Enforcement, Attorney Fee Provisions, and Litigation Delays

Heather provided the first notice of default of Lease to IFS on March 3, 2014. Trial occurred on January 9, 2017. The appeal lasted until at least November 13, 2018. IFS appears to have filed for Chapter 7 bankruptcy protection in late 2018 or early 2019. Heather won a judgment of $2 Million in damages and attorneys fees; but, the bankruptcy filing suggests it may not recover the entire judgment. There does not appear to be any insurance coverage for this loss. I would not otherwise expect insurance to provide coverage. Heather was not able to execute the eviction until 2018. Heather may not have been able to sell the property while the eviction was pending. I often find clients in shock when I discuss the potential time frame for executing their claims. I doubt Heather believed eviction would take over 4.5 years from the date of the first notice to evict IFS.

Some comments in the appellate decision suggest IFS failed to provide requested financials well-before the first letter of intent, earlier than 2014. IFS purchased the original tenant and assumed the Lease sometime in 2013. It appears Heather requested IFS’s financial records at that time but IFS failed to provide them. Heather may have had an opportunity to proactively prevent this dispute by enforcing the Lease at that time and preventing IFS from assuming the Lease in the first place. The trial and appellate court did not make much of this fact, but it caused me to pause with concern. 

It is important for owners to price in and prepare for the potential impact of protracted litigation. Heather obtained a judgment for attorney’s fees of $184,262.58 because the Lease provided that the prevailing party would recover attorney’s fees. Those fees may not have included the related fees from four or five letters of intent that failed. It also obtained a judgment for $83,586.07 in unpaid rent, suggesting it did not paid rent during part or all the pending litigation. This appellate decision suggests it may have cost Heather at least $267,848.65 to evict IFS and prosecute this case. This staggering number was also the result of what appears to be a completely successful litigation by Heather – it won at a three-day trial and won on appeal. The appellate court decision does not evidence any issues Heather lost. 

I believe it is vital for businesses considering litigation to factor in the impact of bankruptcy protections early on. Owners often underestimate how often litigation becomes “bet the company” level of exposure. Many small business disputes become “bet the company”. I often try to estimate the probability that the ultimate outcome of the litigation could be bankruptcy for one or both parties. Litigation costs could also push the lawsuit winner into bankruptcy. Heather appears to have sunk over $267K in this eviction. Litigation may have been unavoidable in this case, but the substantial costs on both sides suggest litigation avoidance may have been in the best interests of both parties. However, litigation is sometimes unavoidable.

Letters of Intent Can Impact Litigation

For business owners involved with buying or selling a business or executing a business lease, I highly recommend contacting an attorney to discuss your legal rights. The letter of intent may appear rather basic and unimportant. You may believe the letter of intent is not actionable. This thinking is wrong.

Please consider the impact of a letter of intent on proving beach and damages in cases such as IFS v. Heather and consider reviewing with an attorney before you sign. Also, it can be beneficial for you to execute a letter of intent as it can give you legal defenses and potential claims if things go bad. Had Heather not executed letters of intent, it may have had more difficulty proving tortious interference with contract and obtaining a $1.25 Million judgment on that claim. Before you execute a letter of intent, please consider reaching out to me to discuss.

(1)  IFS Filing Sys. LLC v. 11225 Heather LLC, 385 Wis.2d 211, 923 N.W.2d 176 (Wis. App. 2018)

(2) Very close to Drezka Park Golf Course, near the 3rd tee box and the 5th green. If you have any tips or tricks for this or Brown Deer, please drop me a line at MEJ@MichaelJohnsonLegal.com.

(3) Section 15.1. of the lease, in relevant part, provides: Financial Statements. Tenant agrees to timely provide financial information as requested by Landlord, including, but not limited to , annual financial statements audited by independent certified public accountants (or if Tenant does not cause its financial statements to be audited in the normal course of business, then such financial statements shall be certified as true, correct and complete by the Tenant’s customary accountant) within 90 days after the end of each fiscal year and quarterly financial statements within 60 days after the end of each fiscal quarter and any other financial information reasonably requested by Landlord[.]…

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