In a perfect world, whenever people enter into a business relationship they will outline all of the terms of that relationship at the outset. This usually involves lawyers drafting joint venture, partnership, or company agreements that address every contingency that may occur during the endeavor.
In the real world, people run into an opportunity when they least expect it and time is of the essence. There is no time to sit down and think through each and every minute detail in the business relationship. No time to ponder every contingency that may occur. You have a limited amount of time to decide whether or not to take advantage of a business opportunity. You discuss the general parameters of the relationship and agree to reduce the details to writing at some future date. Only that date never comes or there is disagreement between the partners that prevents you from ever putting an agreement in writing.
This can create a whole host of problems:
- Is there a binding oral agreement in place at that time?
- What are the terms of that agreement?
- What if there is a misunderstanding between the partners?
- What if one partner fails to live up to key promises but demands to continue in the venture?
- What if one partner’s participation is contingent on some event that may occur weeks or months down the road? What if that partner has a change of heart during that time?
- Is that partner responsible for contributing to the group’s obligations?
- Can one partner bind the other partner for a liability to a third party?
- What are the other partners’ rights or obligations?
Enter the letter agreement.
While a letter agreement can serve many purposes, in the context above a letter agreement acts as an “agreement to agree.” The letter may contain both binding and non-binding terms depending on the needs of the parties.
The letter agreement does not attempt to address every detail of the relationship between the partners. Rather, the letter agreement lays out the key terms of that relationship and mitigates the biggest risks. The letter agreement lays out the rules under which the parties will operate until they reduce a final agreement to writing.
- The letter agreement will explicitly state the parties’ intention to come to a formal overriding agreement in the future.
- Letter agreements generally do not require the parties to reach a final agreement, however there may be a good faith clause in the agreement.
- There may or may not be a set of conditions that relieve any of the parties of their responsibilities under the letter agreement.
- The letter agreement may address confidentiality and trade secret issues.
- The letter agreement does not attempt to cover every possible outcome.
- The letter agreement may address what happens if the parties fail to reach a formal agreement in the future.
The important thing is that a letter agreement puts the key terms in writing for the partners to operate under so they can move quickly to evaluate or secure an opportunity. Most importantly, if there are problems or divisions that develop you are protected against the most significant risks.
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