What Is a Letter of Intent in a Commercial Lease?

A commercial lease is a long legal document that takes time and legal fees to produce. Neither side wants to start that work until they know they agree on the essentials. The letter of intent is how they find out.

It is usually a few pages, written in plain business language and negotiated between the brokers on behalf of their clients. It lists the rent, the term, the space and the other principal terms. Once both sides sign, or simply confirm they are in agreement, the landlord's attorney uses it as the outline for drafting the lease.

You may see the same document called a term sheet, a proposal, heads of terms or a letter of understanding. A request for proposal and the landlord's response are earlier steps in the same conversation. The LOI is the version on which both sides have settled.

Most LOIs are written to be non-binding. They say, in substance, that neither party is obligated to lease or to rent the space until a full lease has been signed by both, and that either may walk away before then.

There are common exceptions. An LOI often identifies a few provisions that are intended to bind the parties even though the rest does not.

• Confidentiality: an agreement to keep the terms and any shared financial information private.
• Exclusivity: sometimes the landlord agrees to stop marketing the space to others for a defined period while the lease is negotiated.
• Costs: each side bears its own expenses if the deal does not close.
• Brokers: identification of the brokers involved and who pays them.

Whether a particular letter is binding depends on how it is written and on the law of the state involved. Careless wording, or conduct that suggests the parties treated the letter as a done deal, can create arguments neither side intended. Have your attorney review an LOI before you sign it, even though it is short and even though it says it is non-binding. This guide is general information, not legal advice.

Non-binding cuts both ways. Until the lease is signed, the landlord can also change its mind or lease to someone else, unless the letter grants you exclusivity. Do not give notice at your current space on the strength of an LOI alone.

A thorough letter of intent covers both the economics and the rights that matter to the tenant. The list below is what we would expect to see addressed for an office lease.

• The parties, including the exact legal entity that will sign as tenant and any guarantor.
• The premises: building, floor, suite and rentable area.
• The term, commencement date and when rent starts.
• Base rent and the schedule of increases.
• Any free rent period and what it applies to.
• The lease structure: which operating expenses and taxes are included, the base year if there is one, and any caps on increases.
• The tenant improvement allowance or the landlord's work, and who manages construction.
• The security deposit or letter of credit, and any schedule for reducing it.
• Renewal options and how renewal rent is determined.
• Expansion rights, rights of first offer or refusal, and any termination or contraction option.
• Sublease and assignment rights, including transfers to affiliates or in a sale of the company.
• Permitted use, hours of access and building services such as after-hours heating and cooling.
• Parking, signage and any rooftop or riser rights.
• Restoration obligations at the end of the term.
• Electricity, and any special power, cooling or connectivity needs.

Not every deal needs every item at length. A technology company with equipment needs, uncertain growth or a possible acquisition ahead should make sure the items that touch those concerns are written down at this stage.

Because the letter is short and non-binding, first-time tenants tend to treat it as a formality and plan to sort out the details in the lease. Experienced tenants do the opposite, for four reasons.

• It sets the anchor. Once both sides have agreed to a term in writing, reopening it is seen as retrading the deal. A landlord will resist, and will often ask for something in return.
• Leverage peaks here. Before the LOI is settled, the landlord is still competing with other buildings for your tenancy. Afterward, alternatives fade, your team begins planning around one space, and the landlord knows it.
• Silence favors the landlord. The first lease draft comes from the landlord's attorney. Any point the letter did not address will be drafted the landlord's way, and you will be negotiating to change it from a weaker position.
• It controls legal cost. Lease negotiations run long when the attorneys are left to settle business points that were never agreed. A complete letter lets them concentrate on the legal language.

The practical consequence is that rights such as a termination option, a cap on expense increases or permission to transfer the lease in an acquisition should be raised in the letter of intent. Introducing them for the first time in lease comments is far less likely to succeed.

1. Your broker sends a request for proposal to the landlords of the buildings on your shortlist, setting out your requirement and the terms you want addressed.
2. Each landlord responds with a proposal.
3. Your broker compares the responses on a common financial basis and reviews them with you.
4. Counterproposals go back to the leading candidates, usually to more than one building at once.
5. Terms narrow over several rounds until one building's offer is the clear choice.
6. The agreed terms are consolidated in a final letter of intent, which your attorney reviews before you sign.
7. The landlord's attorney drafts the lease from the letter, and legal negotiation begins.

Keeping at least two buildings in play until the letter is settled is the most effective thing a tenant can do at this stage. It also helps to involve your attorney before signing, not after, so that legal concerns with business consequences are caught while the terms are still open.

• ✓Does the letter say clearly which provisions are binding and which are not?
• ✓Is the tenant named as the correct legal entity?
• ✓Are all the economic terms stated, including increases, free rent, expenses and the allowance?
• ✓Are our flexibility rights included: renewal, expansion, termination, sublease and assignment?
• ✓Are our technical needs recorded: power, cooling, access hours, connectivity?
• ✓Is there an exclusivity period, and is it long enough to finish the lease?
• ✓Has our attorney reviewed it?

Negotiating the letter of intent is a central part of what a tenant representative does. At TAG, we treat it as the point where the deal is made, and we aim to hand the attorneys a document complete enough that the lease holds few surprises.