Understanding The Letter of Intent (LOI) in South African Commercial Real Estate

The Letter of Intent – What's the Big Deal?

In South Africa's dynamic commercial real estate landscape, the Letter of Intent (LOI) plays a crucial role. Whether you're a buyer and seller, or a tenant and landlord, this document outlines the preliminary agreements before diving into the nitty-gritty of the final sale or lease. Think of it as the "getting to know each other" phase in a business transaction. However, it’s essential to understand the legal nuances involved to avoid pitfalls down the road.

Important Disclaimer: This guide offers insights into LOIs but is not a substitute for legal advice. Always consult with your legal advisor before engaging in any transaction.

The Three Versions of an LOI

An LOI can take on three forms:

1. Non-binding Term Sheet: A simple outline of discussions.
2. Binding Agreement to Negotiate in Good Faith: A commitment to negotiate sincerely.
3. Binding Contract: A firm agreement for a future transaction.

The challenge is ensuring that your LOI is precisely what you intend it to be. South African courts have seen their fair share of LOI-related lawsuits due to vague language or misunderstandings. Remember, the courts’ job is to decipher the true intent behind the LOI, which can be tricky if not clearly defined.

Wording is Everything – Crafting a Non-Binding LOI

In the world of commercial real estate, a carelessly drafted LOI meant to be non-binding can inadvertently become a legally binding contract. Here’s how to prevent that:

• Start with a Clear Disclaimer: At the top of the document, include a disclaimer such as: "This document is not a sale agreement but merely a record of discussion points that may lead to a future agreement. Neither party is bound by this document. This paragraph supersedes all others in this document."
• Choose Your Words Wisely: Avoid terms like "contract" or "agreement." Opt for "term sheet" or "proposal" instead.
• Use Conditional Language: Phrases like "potential deal" or "proposed transaction" help maintain the document's non-binding nature.
• Include a Non-Binding Clause: Add a clause at the end reaffirming that the LOI is non-binding.
• Seek Legal Approval: Incorporate a clause stating that the proposed transaction is subject to approval by legal counsel or a board of directors.
• Act Consistently: If you act inconsistently with the non-binding nature of the LOI, a court may view your actions as binding. For example, suppose you verbally promise something outside the LOI and the other party relies on that promise to their detriment. In that case, South African courts might invoke the principle of "promissory estoppel" to enforce the agreement.
• Avoid Signing: Under the Statute of Frauds, contracts for the sale of real property or leases over one year must be signed to be legally binding. However, actions can still override this if they contradict the LOI's non-binding intent.

Crafting an LOI to Negotiate in Good Faith

In many commercial real estate transactions, the LOI serves as a legally binding commitment to negotiate in good faith. It’s not about committing to the sale or lease but ensuring both parties negotiate honestly.

Example Scenario: Imagine you're considering acquiring an office building in Rosebank. You sign an LOI with the seller, who then takes the property off the market while you perform due diligence. In exchange, you make a deposit. If you decide not to proceed after your investigation, you get your deposit back, and the building goes back on the market. If you proceed with the purchase, the deposit goes toward the final price.

Guidelines for Creating a Good Faith LOI:

• Use Clear Language: Include phrases like "to Negotiate in Good Faith" in the title.
• Include a Clear Opening Clause: "This document does not constitute a sale agreement nor obligate either party beyond negotiating in good faith. This clause supersedes all others."

Common Points in LOIs

Whether you’re working towards a purchase or lease, here are key discussion points to consider:

For Purchase and Sale:

• Property details (address, ERF number, square meterage)
• Due diligence period length
• Required materials for due diligence
• Confidentiality terms
• Financing contingencies
• Deposit terms
• Broker fees and trust account details

For Lease Agreements:

• Property details (location, square meterage)
• Lease commencement date
• Lease term length and options
• Rent terms and reimbursable expenses
• Security deposit and tenant improvements

When Negotiations Go Pear-Shaped.

Sometimes, despite your best efforts, negotiations fail, and disputes over LOIs end up in court. South African courts will try to determine the parties' intentions through either the subjective approach (assessing all evidence, including oral agreements and emails) or the objective approach (focusing on the document's contents).

Final Thoughts on LOIs

For South African commercial property investors, a well-drafted LOI can be an invaluable tool for navigating the negotiation process, ensuring clarity, and preventing legal headaches. When done correctly, it guides both parties towards a Sale Agreement or lease, or allows them to walk away without legal repercussions. Done incorrectly, it can lead to prolonged court battles and unwanted costs.

Always work with experienced Commercial Property Professionals like the team from Corporate Real Estate Africa to give you peace of mind throughout your commercial real estate investment acquisition journey.

This article was written by:

Craig Cooper - Founder & Director of Corporate Real Estate Africa

Corporate Real Estate Africa (CREA) is a leading commercial real estate services firm based in Johannesburg, South Africa. With offices in Johannesburg, Pretoria, Cape Town, and Durban, CREA is positioned to serve its national portfolio of clients.

Visit our website at www.cre-africa.com