Letter of Intent (LOI) in Crude Oil Deals – The Legal Traps and Pitfalls of LOI for Crude Buyers

Nowadays, to hear many of the oil sellers and operators, particularly their brokers and agents, who are involved in the international open market crude selling, describe it, this document – called the “Letter of Intent” or LOI, for short – is not only an essential document for doing crude oil business, but one which every credible person or company engaged in crude buying should always use in initiating a purchase. To many of these operators, not only should crude oil buyers use the LOI to initiate their buying orders, but initiating the purchase order in that manner, they say, has always been the usual way by which credible buyers initiate their purchasing projects, as doing it that way indicates, they claim, that a buyer is “serious” and genuinely committed to making a purchase.

THE SELLERS’ RATIONALE FOR DEMANDING THE LOI

This position expressed by one representative of a seller, a Swedish-based broker, in a recent exchange with this writer’s office regarding the seller’s offer wherein the prospective buyer’s mandate resisted the broker’s insistence that the prospective buyer must first sign an LOI, pretty much sums up the traditional rationale offered by sellers and/or their agents for having an LOI:

“Buyer who is serious, ready and able to purchase [crude oil], will sign [an] LOI and all the necessary documents that protect the rights of the Brokers and proceed. There is nothing to lose in signing those documents. This is how it is usually done and this is how it should be.”

In sum, the rationale underlying the Seller’s demand for LOI, can essentially be summed up as follows:

1) That giving an LOI to a seller by a prospective buyer, is an indication that the buyer is “serious” and willing to purchase;

2) That use of the LOI is the usual way of initiating a purchasing proposal by a buyer, and is the right and proper way to go; and

3) That there is nothing for anyone in the deal to lose by a prospective buyer signing an LOI.

HOW VALID, OR OTHERWISE, ARE THESE USUAL RATIONALE BY SELLERS OR THEIR AGENTS?

Ironically, while oil sellers and their agents frequently demand that prospective “serious” buyers involved in crude oil transactions should first offer an LOI, the buyers, on the other hand, are not generally enamored of that idea. Especially when, in effect, what is being asked of them is to provide the LOI upfront to a little-known Internet-generated seller about whom they lack any familiarity with or whose bona fides as sellers they know next to nothing about – other than, perhaps, that they (the buyers) had had some initial communication with the “seller” via an Internet contact. In deed, to this writer’s knowledge, crude buyers, particularly the more established and prominent ones, would very rarely offer an LOI upfront to any sellers to initiate a purchase. And when, especially, the supposed “seller” that’s involved is one that is a virtual unknown to the buyer, or one that is merely an Internet-generated seller about whose bona fides and credentials the buyer knows practically next to nothing, one can be almost absolutely certain that the chances of a crude buyer of substance signing over an LOI to such a seller, is practically next to zero.

Contrary to the sellers’ and their super sales-conscious agents’ familiar claim that “There is nothing to lose in signing those documents,” quite the complete opposite is true – namely, a great deal, in fact, could potentially be lost particularly by the buyer by signing an LOI to a supposed seller. Why? In a word, this is because the LOI is actually fraught with many incalculable legal flaws, traps and pitfalls, much of which could often be prohibitively costly for the buyer, according to legal authorities and contract law experts. (See below for more on this)

In fact, some experts have called the LOI a document whose use is primarily advocated or promoted only by amateurs and marginal dealers or “joker-broker” types in the crude trade business, especially the overzealous sellers’ agents and brokers in a desperate hurry to land some buyers. Mr. Ziad K. Abdelnour, President & CEO of Blackhawk Partners, Inc, a New York-based advisory firm to traders and suppliers of metals, minerals and crude oil commodities, calls the LOI document something that is primarily “used out on the Internet by inexperienced traders,” and by “inexperienced ‘intermediary seller’ who is claiming to be the supplier.”

The point is that the often-heard notion and claims by some sellers or their overzealous agents and brokers that the use of the LOI to initiate a purchasing proposal by a buyer “is how it is usually done and this is how it should be,” may be applicable and prudent only in the minds, the imagination, and hopes or dreams of those sellers, especially the more marginal ones and their brokers and agents who operate on the fringes largely on the Internet. It is NOT a view that is shared by the broad spectrum of credible buyers, more especially when the “sellers” involved are largely unknown and obscure operators.

THE REASONS WHY BUYERS & EXPERTS SHUN & DISAPPROVE OF THE USE OF LOI

They include the following:

1. LOI is used as manipulation tool at the hands of unscrupulous sellers & agents.

Often times, obscure or scam-oriented persons who claim to be crude Sellers, or represent themselves as sellers’ agents, mandates or brokers largely by an Internet contact or communication, employ the LOI merely as a tool to quickly “corner and box in” a prospective buyer to a purchase deal, before the prospective buyer may demand that they provide their business profile or show him something tangible to demonstrate that they are truly legitimate sellers. Such sellers would persistently demand that the prospective buyers hurry and issue them an LOI right upfront purportedly as proof that they are “serious” about making the purchase – that is, before the buyer may probably start raising some probing questions about them or their credentials as legitimate sellers.

Many a time, especially in a case involving a supposed seller who is either a fake seller or does not actually have the supposed crude in hand yet, or, an unscrupulous aspiring seller’s agent or broker who actually has not acquired a crude supplier (seller) yet, buyers may issue an LOI only to find out that there is no seller on the other end. This happens a lot in situations where you have an hungry agent or facilitator who is still struggling to get a real supplier, and by extracting this LOI from an unsuspecting buyer, this facilitator can commit the buyer only for him then to start hustling to find a seller or supplier.

2. LOI is a Legally Worthless Document That Means Virtually Nothing

As a practical matter, in legal terms, the Letter of Intent is a worthless and meaningless document. The LOI is a badly flawed legal document. This is because the document is, as one experienced contract law expert put it, “an agreement to agree which is non-binding and non-enforceable as a contract.”

Ziad K. Abdelnour, President & CEO Blackhawk Partners, Inc, the New York-based advisory firm on such matters, puts it this way: “Giving a Letter of Intent only means ‘Yes I’m intent to buy the goods but I can change my mind anytime.’ A letter of Intent is not a binding contract. [Hence] The Letter of Intent is a total waste of time on a worthless piece of paper.”

So, if a letter or document that nominally or presumably conveys the signer’s “intent” or intention to buy, is essentially meaningless and worthless in legal terms, and is not binding on the signer or anyone, and CANNOT be enforced on him, then why would a respectable crude buyer, in the first place, want to waste its precious time and resources (or that of its expensive lawyers) to engage in such a fruitless exercise for the benefit of a seller? Especially for an unknown or obscure seller?

3. LOI is fraught with many legal booby traps & pitfalls especially for the buyer.

But probably the most damning reason why credible crude buyers would have little or no use for LOI in their buying dealings, is that using the LOI is fraught with many incalculable legal traps and pitfalls much of which could atimes be very costly for, and to the detriment of, the buyer, according to legal authorities and contract law experts.

A fundamental flaw of the LOI, lies in what Vasilios J. Kalogredis, a Wayne, Pennsylvania attorney, calls “the uncertainty and potential risk of any such undertaking.” Kalogredisis, a business contract law expert, explains it this way:

“Letters of intent are often touted as a ‘non-legally binding’ way to get the parties to set forth in writing what the undertaking is among them relative to a transaction. Too often, parties will sign such a document, feeling that they have little or nothing to lose by doing so… [True, that’s] one of the attractive elements of the letter of intent [its purported non-binding nature]. However, courts have found letters of intent to create binding obligations, even if the letter itself does not explicitly state that it is binding… certain provisions within the document may indeed [still] have legal effect.”

Kalogredis calls that basic fact that a document generally viewed by many as a casual and non-binding document, could atimes still become binding under certain unpredictable circumstances, “one of the traps in a letter of intent,” and adds:

“My advice [to parties contemplating having an LOI] is to proceed with caution before signing any such document. As a general rule (and there are exceptions), I urge the parties to go right to the final documents and “dot all of the I’s and cross all of the T’s,” rather than go through this interim step of a letter of intent, which has many potential traps.”

Another contract law attorney, Ivan Hoffman of California, makes essentially the same point:

“Parties to a transaction sometimes intentionally create a letter of intent as an expression of what they intend to agree upon should certain circumstances arise… [whatever happens], the document will not be binding and thus not enforceable until those circumstances arise. Thus, the letter of intent is essentially a legally worthless document. It is not clear to me the reason any party would ever bother to create such a document and yet I have seen it used on many occasions. If parties to a transaction intend to bind each other, then they should create a binding contract, not a letter of intent. If the parties to a transaction do not intend to bind each other, then why bother creating a document that is not binding?

However, sometimes one of the parties prepares a document believing it to be a valid and enforceable agreement only to find, after expensive litigation, that it was not a binding agreement at all but merely a non-binding, non-enforceable agreement to agree, letter of intent.”

4. LOI as a Source or Promoter of Undue Litigation

Aside from the legal problem of the ambiguity and uncertainty inherent in LOI, there is yet another major problem inherent in the document, from a legal standpoint. Namely, precisely because the LOI is basically ambiguous and non-definitive by nature, the document often easily lends itself to different interpretations and understandings at the hands of different parties (or even the courts), and thus lends itself, in turn, to being a fertile source for undue litigation and legal contests for those involved with the use of that document in their transactions.

Lawyers at the Coollawyer.com, explain the legal “paradox” inherent in the LOI, wherein the signing of an LOI, is often prone, not to bringing about less litigation, but more litigation, and put it this way:

“Letters of Intent, legally, are the worst of all worlds. Writing a letter of intent is not to be taken lightly. In law, you either have a contract or you don’t. LOI’s are the legal equivalent of “almost pregnant.” Letters of Intent emphatically state that. They state that they are not formal agreements, and then often proceed to set forth agreed terms of the proposed transaction. Given this paradox, if the deal goes sour, one party can argue [in court] that those agreed-upon points were, in fact, agreed upon – or, in fact, a binding contract. And, in some cases, furthermore, that the party relied on the LOI and has monetary damages based on such reliance.”

The lawyers add that: “This is the legal problem with a Letter of Intent – you can’t legally state you agree to something and then state that you don’t in the same document.”

Famous Case of a Letter of Intent Gone Bad: Court Case of GETTY OIL vs. PENNZOIL

A famous example often cited by legal scholars, was a case involving the Getty Oil and Pennzoil in very early 1984. The parties had signed a “Memorandum of Agreement” – viewed by the parties at the time as a Letter of Intent – for a complex investment and stock transaction, whereby Pennzoil would purchase Getty Oil stock, and set forth general terms of the investment that had been reached in conversations, and also stipulated that the Memorandum was subject to the approval of the Board of Getty Oil. The Board of Getty Oil sooner approved the transaction and both parties announced on January 4, 1984 in a press release, an “agreement in principle” to the terms of the Memorandum. The final agreements for the merging of Texaco and Getty Oil were signed by the parties on January 6 – 8.

However, during the same period, on January 6, another oil company, Texaco, came into the picture as it publicly announced that Texaco and Getty Oil would merge. Pennzoil protested the proposed merger, and Getty Oil filed a law suit for the court to issue a declaratory judgment that it was not bound by any contract it had with Pennzoil.

The long and short of the story, is that the court, after scrutinizing not only the Memorandum, but also the wordings of the press releases and other documents that Getty Oil and Pennzoil had issued over the course of their dealings, found Getty Oil to be “in breach” of the Memorandum of Agreement – the document the parties had viewed as a letter of intent. Thus, a document (the letter of intent) that the parties had started out viewing as non-binding and unenforceable, had changed from being that, to being a final agreement! Pennzoil, on the other hand, ended up with $10.6 billion (later settled for $3 billion) from Texaco for interfering in its deal with Getty Oil.

Moral of the story? If you’re ever contemplating using a Letter of Intent in a business transaction, you had better watched out, it may not be as simple a matter as you might think. You better be very cautious, for it could result in unforeseen and unpredictable consequences!

SUMMARY

Put very simply, as a legal or even business document, it’s hard to image any document that could be as beset with so many near-crippling legal flaws, traps and pitfalls for its signer, as the LOI. Consequently, it comes as no surprise that in the REAL world of international buying and selling of crude oil, while the crude sellers and their army of sales-obsessed aggressive brokers and agents may generally be infatuated with the idea of having the LOI document widely and routinely used by prospective crude buyers to initiate their purchasing offers, nothing, on the other hand, could be more disliked, more unacceptable or unwanted by most crude buyers, particularly the more credible and substantive lot. What is more, on top of everything else of decisively negative nature about this document, the LOI is a document adjudged by virtually every legal expert in the field as a document that is legally meaningless, worthless, unenforceable and non-binding both on the signatory parties or on anyone, but yet has the potential to bring forth immense and unanticipated legal complications and problems for the signer(s).

To conclude, there’s perhaps no more apt way to conclude this piece, than to quote this very fitting statement by contract law attorney, Ivan Hoffman, of California: “[Given that] the letter of intent is essentially a legally worthless document [but yet one that could potentially cause many serious legal problems for the signer]. It is not clear to me the reason any party would ever bother to create such a document and yet I have seen it used on many occasions.”

FOR A FOLLOW UP

YOU WANT TO FOLLOW UP ON FINDING CRUDE OUR SELLERS THAT DO NOT DEMAND LOI? OR, AS A CRUDE SELLER, TO FIND OUT HOW YOU CAN STRUCTURE YOUR DEAL FOR A NON-LOI OFFER? Please see the instructional information in the author’s resource box below

Source by Benjamin Anosike, PhD

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