Anatomy of a Letter of Intent
A letter of intent (LOI) is a documented handshake between a potential buyer and a potential seller that sets forth the principal points of the agreement. In this way, an LOI mitigates the risk that prolonged negotiations may not result in a closing. In addition, with transactions requiring financing, the buyer’s lender may require a signed LOI before issuing a commitment to finance the acquisition. An LOI may even enable accelerated compliance with regulatory requirements such as those under the Hart-Scott-Rodino Antitrust Improvements Act.
But to be most effective, it’s critical that an LOI clearly delineate the binding provisions from the nonbinding ones. Briefly: The binding provisions regulate the negotiation process; the nonbinding provisions outline the transaction and its structure. Note that even though they’re nonbinding, there is a “moral commitment” by both sides to abide by the nonbinding provisions.
Binding provisions may include buyer access to the target company’s facilities, books and records, and require the target’s cooperation in the due diligence process. They may also contain a “no-shop” or “exclusive-dealing” provision that prohibits the acquisition candidate from directly or indirectly soliciting or entertaining offers from, or negotiating with, third parties in a transaction similar to the one the LOI outlines. Another common binding provision is that the seller must operate the company in the ordinary course of business. A mutual, comprehensive confidentiality provision protecting both parties and encouraging forthright dealings is also customary.
Each party typically bears its own costs and expenses and helps the other prepare and file for any necessary consents or approvals from lenders, landlords or third parties. It’s advisable to include a statement that the binding provisions constitute the entire agreement between the parties, superseding all prior oral or written agreements, and that the LOI may be modified only in writing, signed by both parties.
The binding provisions may also specify jurisdiction and venue for any disputes involving the LOI. It may be wise to include a provision relating to the LOI’s termination, perhaps incorporating a breakup fee. But note that the breakup fee normally isn’t the only remedy in the event of a breach by the seller
The nonbinding provisions may be broadly scoped, including a description of the transaction type, a good-faith estimate of the closing date and a summary of the target executives’ employment agreements. They may also incorporate an adjustment to the purchase price based on changes in the consolidated stockholder’s equity following a specified date. In addition, they would address the preparation and approval of definitive documentation that would contain customary and comprehensive representations, warranties, indemnities, terms and conditions. Last, they could set forth escrow provisions for holding back a portion of the purchase price for specified contingencies.
One caveat: The LOI drafter must ensure that the nonbinding provisions cannot morph into binding provisions. The most powerful weapon against this danger is clear and concise draftsmanship. However, the courts have given significant weight to communications and other actions between the parties. For example, a statement such as “We have a deal,” followed by handshakes all around, may persuade a court that the parties intended to be bound.
Nothing guarantees that a deal will close successfully – or at all. But a carefully crafted LOI certainly paves the way to a smoother transaction. In essence, they’re written agreements with the target made before the purchaser incurs full-blown negotiation and due diligence costs. Please call us for assistance with LOIs or any other aspects of an acquisition or merger.