Letters of Intent in Merger and Acquisition Negotiations

A letter of intent (“LOI") is typically a non-binding agreement that is used by parties to memorialize the general terms of an M&A transaction once the preliminary verbal agreement on such terms has been reached. Despite the fact that an LOI may not be a binding contract, it is a mistake to overlook it or downplay its importance in M&A negotiations. LOIs outline the basic framework for the transaction and creating a roadmap of further steps toward closing. LOIs also allows several important, time-sensitive processes, such as due diligence and financing arrangements, to proceed before the parties are fully committed to the deal. For these reasons it is important to take a letter of intent seriously.

Below is a summary of four pitfalls that parties may run into when it comes to LOIs.

 1. Not Using an LOI

The framework provided by a letter of intent is valuable in pursuing a successful deal and focusing resources where they are needed most. Sometimes negotiations over a letter of intent can highlight the differences of both parties’ expectations. If these expectations are too far apart and irreconcilable, then it is possible negotiations will shut down and the deal will fall through. This is not ideal, but it is better that LOI discussions reveal these differences early, when less has been invested in the deal.

 2. Assuming the LOI Terms Are Easy to Re-Negotiate

Parties in M&A transactions may make the mistake of taking LOI negotiations lightly due to an LOI’s non-binding nature. They may agree to the terms proposed by the other party to rush the process with the hope that they would be able to re-negotiate the terms later. Although it is true that from a legal perspective the economic terms of the LOI are not mandatory, it is unwise to think such changes would be easy to negotiate. Any time a party proposes terms in conflict with the LOI, the burden is on it to justify the change by pointing to important facts or figures, which support the proposed change. Otherwise, the other party can argue that the terms are being re-negotiated in bad faith, which can put the success of the transaction at risk. This is not to say that changing the LOI terms is always inappropriate. If a party can show that the change is logical due to the results of due diligence or other factors unknown at the time of the execution of the LOI, re-negotiating is appropriate and common.

 3. Delaying or Overcomplicating LOI

In the absence of an executed LOI, the parties often cannot move forward with certain next steps, such as search for financing, due diligence, or preliminary communications with regulatory agencies. Further, parties may consider the likelihood of a successful deal too remote to spend more time and resources until the LOI is signed. Making a decision as to when to sign the LOI involves balancing many factors. On the one hand, as explained above, one should not rush to sign an LOI before having a chance to consider and get professional advice as to the proposed general terms of the transaction. On the other hand, unjustified delay of an LOI’s execution or overcomplicated LOI negotiations can delay the closing or even ruin what could be a mutually-beneficial transaction. To that end, it is important to understand that the economical terms in the LOI do not need necessarily to be very specific. Nor is it necessary to include every little detail in the LOI. The detailed terms belong to the definitive binding agreement, which is finalized after the due diligence has been complete and the parties gather the knowledge of all relevant information. An attempt to overcomplicate the LOI with such details is more likely to hurt the transaction than to help.

 4. Failure to Distinguish Binding Provisions from Non-Binding Provisions

Although LOIs are generally non-binding, it is common for parties to include several binding provisions in the LOI. For example, it is common to include binding nondisclosure provisions, even if an independent nondisclosure agreement[hyperlink] is already in place. Further, parties may agree to a binding exclusivity clause, which would prevent either party from negotiating with other parties while the LOI remains in effect. Additionally, binding terms may include the law governing the LOI interpretation and jurisdiction for any disputes stemming from the LOI. However, a party may harm itself by signing an LOI that includes a binding commitment to close the transaction or other unnecessary binding provisions. If the LOI does not specify which provisions of the LOI are non-binding, there is a risk that a court may enforce such provision as binding. This can result in damages by a party choosing to back out of the deal, even for legitimate reasons. This type of legal pitfall can be avoided by taking the letter seriously and clearly identifying the binding or non-binding nature of each LOI provision.

It is essential to obtain professional advice and assistance before signing a letter of intent. Whether you are new to M&A or have been dealing with M&A for your entire career, be sure to rely on the knowledge and experience of your investment banker or business broker, accountant, financial advisor, attorney, and other M&A team members to make sure that your LOI is well-timed, well-negotiated, and well-written.

Should you wish to discuss any legal issues related to the sale or purchase of a business, please contact attorney Steven Migala at (847) 705-7555 or smigala@lavellelaw.com, or attorney Roman Perchyts at (224) 836-6192 or rperchyts@lavellelaw.com.

This article is provided for informational purposes only and does not constitute legal advice. You should not rely on the information contained in this article without first consulting a licensed attorney.