Letters of Intent: An M & A Best Practice?
By: Brett Marshall
A letter of intent often, but not always, follows the execution of a confidentiality or non-disclosure agreement and the initial round of negotiations between the parties contemplating an acquisition. The letter of intent describes the key economic and procedural terms that will form the foundation for further negotiation of the definitive agreement. These terms usually include the following:
- The letter of intent addresses the structure of the transaction (i.e. whether a stock or asset purchase) including the specific assets that will and will not be purchased and the liabilities that will and will not be assumed.
- Purchase Price. The letter of intent will set forth the purchase price, the manner and type of payment (i.e. cash, stock or a combination of both) and corresponding adjustments including working capital adjustments, holdbacks, baskets and caps.
- Due Diligence. When the letter of intent is signed, the transaction is still conditional, and the buyer and seller will provide for orderly production and inspection of information about the seller’s business, employees, records and facilities.
- Pre-Closing Conditions. These conditions will normally include approvals by both buyer and seller, regulatory approvals and financing.
- In addition to being addressed in a separate confidentiality agreement, the letter of intent will normally include provisions governing the disclosure and use of confidential information obtained by the parties to the transaction.
- Deal Protections. The letter of intent can include deal protections that protect the buyer from competing deals like no-shop provisions and break-up fees.
One of the key considerations when drafting a letter of intent is whether the letter, or certain parts of it, will be binding. The intent of the parties is important, but depending on your jurisdiction, intent may not be enough if unsupported by language in the letter of intent itself. Generally, courts consider several principles for determining whether a letter of intent is binding. If the parties do not intend to be bound prior to the execution of a definitive agreement, the parties will not be bound until the definitive agreement has been executed, even if all negotiations have been concluded. Likewise, if the intent of the parties is to be bound prior to the execution of a definitive agreement, the parties will be bound, even if the intent is to replace the letter with a definitive agreement.
The most important factor used by courts to determine the intent of the parties is the language used by the parties in the letter of intent. Therefore, a letter of intent should be clear and specific about which provisions are binding and which are not. Nonbinding provisions typically include the general terms of the transaction, purchase price and employment and non-competition covenants, while binding provisions typically include due diligence procedures, confidentiality, pre-closing conditions and deal protections.
Although letters of intent are used frequently, there is no consensus among practitioners as to their desirability. Some practitioners insist on reducing the basic structure of the transaction to writing before any further negotiations occur. Others prefer to forego the letter of intent altogether and move directly to the drafting and negotiation of the definitive agreement. While each approach is valid, there is a great deal of strategy at play in drafting letters of intent, and parties contemplating a purchase or sale transaction should consult with experienced counsel to determine whether a letter of intent makes sense given the unique circumstances of the deal and to draft a letter that is both consistent with the law and the parties’ desires and expectations.
Brett practices in our Corporate & Transactional Law practice group, helping clients with commercial real estate, mergers and acquisitions, health care, commercial lending, and general business matters.