Letters of intent in lease negotiations: what they are, when are they binding, and how to get them right

Commercial lease negotiations rarely move straight from the first conversation to a signed lease. Somewhere in between, the parties usually want something in writing that records where they have landed, before either side commits the time and cost of a full legal drafting exercise. This document is typically called a letter of intent.

What is a letter of intent?

A letter of intent (“LOI”), sometimes called heads of terms, a memorandum of understanding, or a term sheet, is a short written record of the key commercial terms the parties have provisionally agreed for a prospective lease. In substance, it performs the same function in a leasing context that a memorandum of understanding performs in other commercial dealings: it captures the deal in outline before the parties invest in a fully drafted, legally exhaustive agreement.

An LOI typically sets out matters such as the identity of the parties, the premises, the proposed rental and escalation, the lease period, and any conditions that still need to be satisfied before the parties are prepared to commit — for example, board or shareholder approval, confirmation of development or municipal approvals, or securing of finance. It is usually prepared and exchanged before due diligence, detailed drafting, or (in the case of a development) construction has been finalised.

Importantly, an LOI is not itself a lease. It does not, on its own, grant occupation or create a tenancy. Its function is preparatory: it narrows the scope of what still needs to be negotiated and gives both sides a basis on which to proceed with confidence — but the extent to which it creates legal obligations is a separate question, and one that causes more disputes than almost any other document in commercial property practice.

When does a letter of intent become legally binding?

This is the question that matters most, and the honest answer is: it depends entirely on what the document actually says and how the parties conduct themselves, not on what it is called.

South African courts approach this by asking, objectively, what the parties intended, having regard to the language used, the context, and the purpose of the document (the same interpretive approach the courts apply to contracts generally). Calling a document a “letter of intent” rather than a “lease” carries no magic. A document headed “letter of intent” that nonetheless records full agreement on all the essential terms of the lease — premises, rental, duration, and the parties' intention to be bound — can be found to constitute a binding lease in its own right, particularly if the parties then act as though they are bound (for example, by allowing the tenant into occupation or accepting rental payments).

Conversely, a document that leaves essential terms open, or that is expressly stated to be “subject to contract,” “subject to the conclusion and signature of a formal lease agreement,” or otherwise non-binding, will generally not be enforceable as a lease, provided the language is clear and the parties' subsequent conduct doesn't contradict it.

As a general principle, an agreement to negotiate further terms in future, without a mechanism for resolving what happens if agreement isn't reached, is not something our courts will enforce as a binding contract.

In practice, three things tend to determine the outcome of a dispute over whether an LOI binds:

• The words used. Clear, express language that the document is (or is not) intended to create binding legal obligations, and which specific clauses are intended to survive even if the deal falls through, carries significant weight.
• Completeness of essential terms. The more the document reads like a complete deal (parties, premises, rental, term, and clear mutual intention to be bound now), the more likely a court is to treat it as binding, whatever it is called.
• Conduct after signature. If the parties behave as though a deal is done — for example granting access, commencing fit-out, paying or accepting rental — that conduct can be used to show that a binding agreement existed, regardless of the document's stated intention.

The safest course, from a drafting perspective, is never to leave this to inference. A well-drafted LOI should say, expressly, whether it is binding, non-binding, or binding only in specified respects.

The commercial purpose of a letter of intent

Despite the legal uncertainty an LOI can create if poorly drafted, it serves a genuine and valuable commercial function when used correctly:

• Speed and cost efficiency. It lets the parties record commercial agreement quickly, without incurring the cost of a full legal drafting exercise before they know whether the deal will proceed.
• Internal approval processes. It gives a tenant's board, a landlord's investment committee, or a funder something concrete to consider and approve before either side commits further resources.
• Sequencing complex transactions. In development leases in particular, an LOI allows commercial terms to be locked in while conditions such as development finance, municipal approvals, or franchise/licence agreements are still being finalised — conditions that will ultimately be recorded as suspensive conditions in the lease itself.
• Managing exclusivity. It can secure a period during which the landlord agrees not to negotiate with other prospective tenants (or vice versa), protecting the party that is about to invest time and cost in due diligence or design work.
• A drafting roadmap. It gives the attorneys instructions — the commercial terms the parties have agreed, which the lease must then reflect and elaborate on.

Key terms that should be included

A well-constructed LOI for a lease should, at minimum, address:

1. The parties: full identifying details, including registration numbers where applicable.
2. The premises: a clear description, ideally with reference to a plan, and the gross lettable area (or basis on which it will be determined).
3. Permitted use: the purpose for which the premises may be used and, if relevant, trading hours.
4. Lease period: the initial term and any renewal period(s), including whether renewal is automatic, subject to notice, or subject to fresh negotiation.
5. Rental: the basic rental, the escalation mechanism (typically a fixed annual percentage), and, where applicable, turnover rental — including the threshold and rate, and how “net turnover” will be defined and verified.
6. Deposit or security: whether a deposit, bank guarantee, suretyship, or other security is required, and in what amount.
7. Tenant installation allowance or landlord's works, where the landlord is contributing to fit-out or is responsible for base building or shell works.
8. Commencement mechanics: how and when beneficial occupation and the commencement date will be determined, particularly relevant where the premises form part of a development still under construction.
9. Suspensive conditions: conditions still to be met before the lease becomes unconditional (board resolutions, development finance, licensing or franchise approvals, municipal consents), with clear dates and consequences if they aren't met or waived.
10. Exclusivity/standstill period: if the landlord or tenant is to be restricted from negotiating with third parties, for how long.
11. Confidentiality: whether the terms of the LOI (and the fact of negotiations) are to remain confidential.
12. Costs: who bears legal costs, and whether this changes depending on whether the deal proceeds.
13. Binding effect clause: an express statement of which provisions (if any) are intended to be immediately binding, and which are subject to the conclusion of a formal lease.
14. Expiry: a date by which the LOI lapses if a formal lease hasn't been signed, so the document doesn't linger indefinitely as a source of ambiguity.

Common pitfalls and practical considerations

• Ambiguity about binding effect is the single biggest risk. An LOI that is silent, or only vaguely “subject to contract,” invites exactly the kind of dispute the document was meant to avoid. Say expressly what binds and what doesn't.
• “Subject to contract” is not a guarantee. If the parties' conduct is inconsistent with that qualification — for instance, if the tenant is let into occupation, starts fit-out, or pays rental before the formal lease is signed — a court may still find a binding lease came into existence, “subject to contract” notwithstanding.
• Undefined turnover rental mechanics. Where turnover rental is contemplated, an LOI that records only a headline rate without addressing how turnover will be defined, reported, and verified stores up a dispute for later; this is exactly the kind of detail that needs to migrate from commercial shorthand into precise drafting.
• Loose or missing suspensive conditions and dates. Conditions without clear deadlines and clear consequences (lapse versus a right to extend or waive) leave both parties in limbo and can trap a landlord into a de facto commitment before financing or approvals are secured.
• Informal channels create real risk. Terms agreed over email or, increasingly, over WhatsApp, can carry the same interpretive weight as a formal document. Parties (and their advisors) should be careful about what they commit to in informal correspondence during a live negotiation.
• Losing exclusivity through delay. If an LOI doesn't set a clear expiry or long-stop date, a party can find itself bound to (or waiting on) a stalled negotiation indefinitely, while the commercial opportunity moves on elsewhere.
• One-sided risk allocation in development scenarios. Where the premises don't yet exist in built form, an LOI (and the lease that follows) should protect the landlord against development risk — financing, approvals, and construction delay — with appropriate long-stop and lapse provisions, rather than assuming these will simply work themselves out once the lease is signed.
• Treating the LOI as a substitute for legal review. An LOI is not a lease, but its terms often become the anchor for the eventual lease negotiation. Terms agreed loosely at LOI stage — particularly around rental mechanics, renewal, and suspensive conditions — are far harder to walk back once the other side has relied on them. Early legal input at LOI stage, not just at lease-drafting stage, is time well spent.

A letter of intent is a useful and, in the right circumstances, an efficient tool for moving a lease negotiation forward — but its value depends entirely on precision. The document should say, in plain terms, what it is intended to achieve, which of its provisions (if any) are binding, and what happens if the parties don't ultimately conclude a formal lease.

Get that right, and an LOI does exactly what it's meant to do: create commercial certainty without creating unintended legal risk.