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Answering Common Questions in Negotiating Letters of Intent

Spring 2007Cole Schotz Docket

Letters of Intent, also known as “LOI’s”, are the framework for commercial ventures, as they outline the material terms of a proposed transaction before formal documentation.   Non-binding letters of intent contain the most basic elements of a deal, giving each party the ability to “kick-out” at any time, without any liability.  They are appropriate when the parties have not reached agreement on all the elements of a deal, or when one of the parties is not fully committed to the transaction and may still be “shopping” the deal. 

In contrast, fully binding letters of intent obligate the parties to consummate the proposed transaction, or at a minimum, use good faith efforts to finalize a formal contract.  They often contain more detailed representations and warranties, alternate deal scenarios, and default language.  Because of the potential consequences of a default, it is very important to evaluate all potential risks when negotiating a fully binding letter of intent.  Fully binding letters of intent are particularly beneficial when one of the parties believes it has secured a favorable deal and will not risk the other party shopping the deal.  Partially binding letters of intent fall somewhere in the middle, containing those material elements of the transaction which have been negotiated, as well as the deal specific terms the parties have agreed-upon to date.  It is imperative that partially binding letters of intent contain an express “survival provision” to identify those terms which the parties intend to survive following termination of the letter of intent.

The basic elements of a letter of intent include: the parties, general description of the transaction, purchase price, closing date and conditions to closing, due diligence, confidentiality and public disclosure, limitation of liability, termination rights and exclusivity.  The introduction should contain an accurate description of the parties and each party should ensure that the person executing the letter of intent has the legal capacity to enter into the agreement. The introduction should also include a detailed description of the proposed transaction, the consummation of which should be subject to the terms and conditions of  more definitive agreements.  This is generally viewed as “an agreement to agree” and is not binding on the parties.

Most transactions are subject to conditions precedent including: due diligence, financing, and consents from shareholders, boards or lenders.  The due diligence period is frequently the one variable that keeps consummation of a deal in limbo.  It is important to clearly define the scope and timetable within which due diligence must be completed and the terms of access to information.  From the acquirer’s perspective, the right to terminate at the expiration of due diligence should be broad enough to permit the acquirer to terminate in its sole discretion, for any reason or no reason, regardless of the results of the due diligence inspection.

The remaining portions of a letter of intent may include binding provisions relating to confidentiality, public disclosure, limitation of liability, termination and exclusivity.  It is common to agree that documents exchanged during due diligence and negotiations will remain confidential and such confidentiality will survive the termination of the letter of intent.  In addition, premature public disclosure of the transaction may jeopardize closing and the parties should consider the terms of public disclosure following finalization of definitive agreements, particularly in high-profile transactions.   Limitation of liability is generally negotiated, as each party will seek to limit its exposure in the event the letter of intent is breached or otherwise terminated.  The letter of intent must contain a termination provision which allows either party to unilaterally terminate the letter of intent at any time.  Finally, exclusivity provides the acquiring party with protection that the seller or landlord will not negotiate with others while formal documents are being negotiated.  A deposit is typically required from the acquiring party to obtain exclusivity protection.  From the seller or landlord’s perspective, there should be a specified time when exclusivity expires to protect the seller or landlord in the event the parties are unable to reach a formal agreement in a reasonable time period.

Breaching a letter of intent may subject a party to monetary and/or equitable  damages.  Damages will depend upon the nature of the breach and whether the letter of intent was binding upon the offending party.  Because letters of intent are frequently vague, and viewed merely as an “agreement to agree”, it is essential to make certain that the parties plainly state those provisions they intend to be able to enforce following termination.  If properly prepared, a letter of intent can serve as more than simply an expression of the parties’ intent to negotiate and consummate a transaction, but it is imperative to know and understand each parties’ objectives before negotiating any form of  letter of intent, particularly one which contains provisions which survive termination.

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