Letter of Intent
Regardless of whether you are the seller or the buyer of a business, a letter of intent can help protect you through the M&A process in a number of ways. First, it will identify early in the negotiation process issues that can be “deal breakers” before substantial expenses are incurred with due diligence and drafting the definitive agreement. Second, it can help facilitate the negotiation process; resolving the principal terms of a transaction at an early stage can enhance deal stability and make negotiation of definitive agreement more focused and straightforward. Third, an LOI can also establish the time frame for the proposed deal and memorialize the parties’ agreements regarding payment and allocation of expenses for the transaction.
In entering into a letter of intent, a buyer’s principal interest is to commit seller to not negotiate with others for a specified time. Buyer will also want the letter of intent to include provisions that facilitate buyer’s due diligence investigation of seller and ensure seller cooperation with investigation. Other than above two provisions, buyer is best served by having the remaining provisions of LOI be nonspecific. This is because, general language allows buyer to defer negotiation of more difficult issues unit it has gained more knowledge about the target and buyer will also likely have substantially improved negotiation position by this time.
As a general proposition, seller’s bargaining leverage is greatest immediately before it signs an LOI and declines continuously thereafter. It follows that it’s in seller’s best interest that the LOI be as specific as possible with respect to material terms of the transaction such as: purchase price, structure, representations and warranties, indemnification, employment agreements, non-competition covenants, earn-outs, and other special arrangements. Seller should have the LOI include a strong confidentiality provision (about the proposed transaction and its business), which will be enforceable. Seller also may want to prevent buyer from soliciting or hiring any of its employees for a period of time if transaction is not consummated.
Binding vs. Non-binding
The letter of intent is typically not a binding contract, but it should establish that certain of its provisions such as confidentiality and exclusivity are to be binding. Parties often fail to do this and as a result there have been numerous reported cases of litigation involving LOI’s. To reduce the risk of litigation, the single most important provision of the LOI is to disclaim contractual effect as to all but specifically preserved terms, a key one being the disclaimer itself.
Example: “Other than the covenants contained in paragraphs ___ of this LOI, this LOI is not binding upon either the Purchaser or the Seller, and is subject to the negotiation and execution of a definitive acquisition agreement between the parties. The covenants in paragraphs ____ are binding upon the Purchaser and the Seller whether or not the Parties reach a definitive agreement with respect to the acquisition of the business.”
If parties intend to be bound prior to execution of a definitive agreement, court will give effect to that intent even though parties contemplate replacing the LOI with a definitive. Parties will be bound even if there are certain unresolved matters; depending on significance of those matters, a court will either supply commercially reasonable terms or impose a contractually duty to negotiate the terms in good faith. Factors that courts will look to in determining whether the parties intended to be bound include:
- Actual words of the document. (Most important)
- The context of negotiations.
- The partial performance of the obligations of either of the parties.
- Whether there are any material issues left to negotiate or whether the terms as stated in the LOI are sufficiently definitive to be enforceable (price, structure of transactions, assets or properties involved).
- Whether the subject matter of the discussions concerns complex business matters that customarily involve definitive written agreements.
In short, there is no such thing as a typical LOI applicable to all, or even most transactions. If you are considering the purchase or sale of a business, it is in your best interest to speak with an attorney before you even begin the negotiations process. This is the one sure way to ensure the sales process is handled legally and in your best interest. For further information or to schedule an appointment with an experienced and reputable business attorney at Hakim Law Group please contact us at 310.993.2203 or visit www.HakimLawGroup.com.