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Letters
of Intent:
In
the early stages of many transactions, the parties often choose to
memorialize the basic terms of their agreement by negotiating and
entering into a letter of intent. In general, the letter of intent
sets forth the purchase price and certain other key terms, all of
which form the basis for further negotiations between the parties.
The letter of intent is a preliminary document; it is intended to
be superseded by a definitive agreement. Nothing mandates a letter of intent, and parties
can simply proceed to the drafting of a definitive agreement without
ever signing a letter of intent. Nevertheless, buyers and sellers
often prefer to formalize the principal terms of a proposed deal early
in the process before engaging in lengthy and expensive negotiations
of the definitive agreement. Typically, a letter of intent contains both
binding and nonbinding provisions. It is possible, however, to make
the entire letter of intent binding, either explicitly or accidentally.
Careful drafting is critical to avoiding unintended results. The primary benefit of a letter
of intent is its potential
to save time and money. It injects a degree of certainty into the
early bargaining process. If the parties can agree on essential terms
quickly, confirming those terms in a letter of intent encourages the
parties to expend the resources necessary to close the deal, and the
time and expense of due diligence and final negotiations become more
palatable. Alternatively, attempting to draft and agree on a letter
of intent may make it clear to both parties that they are simply too
far apart to continue negotiations. In either case, both the prospective
buyer and the prospective seller are better off for having assessed
the terms of the proposed deal before negotiations reach a more advanced
stage. If the deal moves forward,
a letter of intent serves as a useful road map for negotiating the
definitive agreement. With the basic terms in place, the remaining
negotiations are more likely to be focused and straightforward. Moreover,
the parties typically develop a psychological or moral commitment
to the terms of the transaction, particularly when the parties issue
press releases or otherwise make the proposed transaction known to
the public, employees, shareholders or customers. Further, the letter
of intent may set forth the parties’ expectations regarding when they
will conduct due diligence and negotiations, so the process will benefit
from the certainty of schedules and deadlines. A letter of intent may also
be advantageous to a buyer who needs to secure outside financing.
Absent a written commitment to the deal, prospective lenders may not
be willing to evaluate or commit to financing the transaction. In
addition, the letter of intent evidences a commitment to the transaction
that may help attrct third-party investment dollars. Finally, a letter of intent
may speed regulatory approvals. Many larger transactions require filings
under the Hart-Scott-Rodino Antitrust Improvements
Act of 1976 (“HSR Act”), which cannot be made until after the buyer
and seller have entered into an agreement with respect to the acquisition.
A fully executed letter of intent can serve as the basis for making
the filing under the HSR Act. For these and other reasons,
executing a letter of intent is common practice in many transactions.
Disadvantages Despite the frequent use of letters of intent,
there are significant disadvantages and potential pitfalls associated
with the practice. While none of these should absolutely discourage
the use of letters of intent, diligent practitioners will want to
evaluate carefully both the upside and the downside before deciding
that a letter of intent is indispensable to any particular deal. The greatest disadvantage of a letter of intent
is that, depending on the circumstances, a court may later find that
provisions the parties intended to be nonbinding are actually binding.
As a result, the parties could be stuck with a deal that has not been
thoroughly negotiated and from which material terms are missing. The
remaining unnegotiated terms must be worked out between unhappy parties,
or be filled in at the court’s discretion. While a letter of intent may ultimately prove
beneficial, the process of drafting and negotiating it has costs.
Negotiating a letter of intent frontloads the expense in anticipation
of a smoother path to an ultimate deal (or quicker insight that no
deal is to be had). As a result, such letters tend to make
more sense in larger and more complex transactions. Parties to smaller
or more straightforward deals may prefer to proceed directly to a
definitive agreement absent other compelling reasons for a letter
of intent. In addition, parties should be wary of the potential
effects of negotiating too many details too early in the deal. Drafting
a letter of intent may push the parties to consider fine points and
difficult issues better left until after the broad outlines of the
deal are established. The danger, of course, is that negotiations
will bog down before they gain real momentum. Moreover, parties who execute a letter of intent
often negotiate ultimate terms in the definitive agreement that differ
significantly from those in the letter of intent. This may not pose
a problem in circumstances where the parties proceed with the understanding
that the letter of intent represents tentatively agreed-upon terms.
However, if discord arises, it is possible that the parties will point
to competing written agreements. Negotiating
a Letter of Intent In the merger or acquisition context, the control
of information often defines the parties’ respective bargaining positions.
During the initial stages, the seller may remain circumspect, revealing
only enough information about its business to maintain the buyer’s
interest without ceding its bargaining edge. The buyer, on the other
hand, wants as much information about the seller as soon as possible.
This bargaining friction is at its maximum before the parties have
committed to a letter of intent, and in large part dictates what the
negotiating parties will want to include in that preliminary agreement. The Seller’s
Interests.
Generally, the seller will be more motivated than the buyer to make
the letter of intent as specific and explicit as possible. The seller’s
leverage is likely to be greatest before it signs a letter of intent,
because the buyer has not yet had the opportunity to gather detailed
information about the seller, and because the seller may solicit and
entertain, or purport to entertain, multiple suitors. Thus, the seller
is more likely to obtain favorable terms during this period and will
want to go as far as possible toward formalizing and solidifying the
material terms, such as deal structure, price, and form of consideration. Beyond this overarching desire for specificity
in the letter of intent, the seller will want to secure the buyer’s
promise to keep in confidence certain information about the seller.
Because any breach of confidentiality can be very damaging to the
seller’s interests, including its employee morale and its various
business relationships, the seller will want the confidentiality provision
within the letter of intent to be binding. If the confidentiality
covenant is favorable to the seller, the buyer will be bound not to
disclose any information about the seller that the seller chooses
to designate as confidential. The provision should carve out any publicly
known information and any uses of information that are necessary for
obtaining consents or approvals necessary to close the deal. Sellers may also want to consider obtaining
a promise that the buyer will not compete with the seller nor solicit
the seller’s key employees, customers, or suppliers during negotiations
and for a period of time following the conclusion of unsuccessful
negotiations. Again, because the buyer will gain access to information
regarding the seller’s business relationships during the negotiations,
the seller will want to prevent the buyer from using this information
to affect adversely its business operations. The Buyer’s Interests. While the seller has a strong interest in preserving
confidentiality, the buyer has an equally strong counter-interest
in obtaining access to information from and about the seller. Even
though the two interests substantially compete with one another, they
are not mutually exclusive. The buyer will simply want to be sure
that one of the provisions within the letter of intent grants it free
access to the target company’s otherwise proprietary information for
the full term of the negotiations. The buyer will also want unlimited
access to the seller’s personnel, contracts, books and other data.
Since the buyer will not gain this access until after the parties
execute a letter of intent, the buyer will want to keep the key terms
of the deal as general as possible, putting off the more problematic
issues until it possesses greater knowledge. Further, the buyer will want, at the earliest
possible stage, to eliminate other suitors and elevate its own bargaining
position. To that end, the buyer will want to include a “no-shop”
commitment and other standstill provisions in the letter of intent.
A no-shop provision establishes a period of exclusive dealing and
typically has two components: a prohibition against soliciting or
negotiating offers from any third party, and a mandate to notify the
buyer if the seller receives any offers or inquiries. A break-up fee
might also be considered, which would require the seller to pay the
buyer an agreed-upon amount in the event the seller completes the
business transaction with another buyer within a specified time period.
Break-up fees are heavily negotiated, and most sellers will resist
such a proposal. The combination of a no-shop provision and the
ability of the buyer to have full access to information regarding
the seller leads most commentators and practitioners
to conclude that letters of intent generally are more favorable to
the buyer than to the seller. Binding or Nonbinding? The question of whether a letter
of intent is binding is by far the thorniest—and the most litigated—issue
associated with the topic of preliminary agreements. Professor Allan
Farnsworth has flatly said that “[i]t would
be difficult to find a less predictable area of contract law.”1 The difficulty may not be immediately
apparent. Corbin, in his treatise on contract law, declared it well-settled
that no contract exists “where the parties consider the details of
a proposed agreement, perhaps settling them one by one, with the understanding
during this process that the agreement is to be embodied in a formal
written document and that neither party is bound until they execute
this document.”2 The problem may arise, however,
when trying to determine the parties’ understanding during this process.
That is, when negotiations go awry, the courts may be tasked with
determining the intent of the parties after the fact—no easy job if
the parties’ words and actions contain any ambiguity. To complicate
matters further, courts of various jurisdictions take different approaches
in determining the intent of the parties. Minnesota courts, for example,
take the strict-interpretation approach and construe any ambiguity
in the language of the letter of intent against the party trying to
bind the other party. Other courts look beyond the four corners of
the letter of intent and consider other factors. Those courts may
look at oral statements and other actions, and turn a letter of intent
that is nonbinding on its face into a binding agreement. Lessons from the Case Law. Courts typically examine several
factors in attempting to determine whether the parties intended to
be bound:
The first of these factors—the actual language
in the letter of intent—is the most important. Especially in Minnesota,
the courts look primarily at the language of the letter of intent
to determine the intent of the parties. Minnesota courts generally
start with the premise that a letter of intent constitutes an agreement
to agree and thus is not a binding contract.4 If the parties clearly
express that the letter of intent is legally binding, or explicitly
identify which portions of the letter of intent are legally binding,
such expressions control. If the parties do not manifest such an explicit
expression on paper, Minnesota courts are unlikely to enforce such
an agreement. Further, a letter of intent that merely represents a
summary of the parties’ negotiations and shows nothing more than an
intention to negotiate in the future is unenforceable in Minnesota.5
Such agreement does not constitute the parties’ complete and final
agreement.6 To create a binding contract, the parties should
use keywords, such as “legally binding” and “enforceable,” in the
letter of intent. The parties may specify early on in the document
that the entire agreement is “legally binding and enforceable,” or
indicate separately which parts of the agreement are binding. A mere
label “letter of intent” alone will not be determinative.7 The Minnesota
Supreme Court declined to enforce a letter of intent containing the
language, “the parties shall enter into a definitive purchase agreement
… .”8 Similarly, the Minnesota Court of Appeals
held that the language, “the parties agree to proceed forward with
a formal agreement” did not bind the parties.9 Interpreting these
Minnesota cases, the 8th Circuit also concluded that language that
speaks of future actions and agreements indicates the parties’ intent
not to be bound.10 Conversely, to assure that a letter of intent
is not enforced, the lawyers drafting a nonbinding a letter of intent
should clearly label the letter of intent as “nonbinding.” Further,
based on a Minnesota Court of Appeals decision, the drafter should
include disclaimers, such as “[t]his letter of intent shall not be
a binding legal agreement,” and “neither party shall have any liability
to the other until the execution of the definitive agreement.”11 A word of caution is in order, however, when
drafting a partially binding letter of intent. In one Minnesota case,
the Court of Appeals invalidated the entire agreement, although the
agreement contained a binding covenant. The provision stated that
the parties “agreed to terminate negotiations with other prospective
purchasers and work toward finalizing the definitive purchase agreement.”12
The court pointed out that, despite the good-faith covenant, there
were two overwhelming facts that indicated otherwise. The letter was
titled “nonbinding offer” and the letter also contained a broad statement
to the effect that the entire document shall not be a binding legal
agreement. Given the obvious title and the applicability of the broad
language to the entire contract, the court decided to quash the covenant.13
Subsequently, the 8th Circuit followed this precedent and concluded
that where the parties have agreed that a letter of intent, in its
entirety, is not binding, it will not enforce an individual provision
of the letter of intent as a freestanding “contract” promise.14 Therefore, to create a partially binding letter
of intent, a general statement declaring the agreement as nonbinding
should be qualified with additional language, such as “except as specified.”
The ensuing provisions should then be separately noted and labeled
as “legally binding and enforceable.”15 The combination of the two
should alert the reader and the court that the letter of intent, though
generally not binding, contains provisions that are binding. Finally, for a letter of intent to be binding
and enforceable in Minnesota, the parties must also include the essential
terms in the agreement.16 Without the essential terms, such an agreement
does not provide a basis for determining the existence of breach or
giving an appropriate remedy.17 The mere inclusion of essential terms
alone, however, will not bind the parties, unless the intent of the
parties to be bound is also explicit in the agreement. In Lindgren
v. Clearwater Nat’l Corp., despite the inclusion of precise terms—such
as sale terms, the property’s legal description, the purchase price,
the terms of the mortgage and a closing date—the Minnesota Supreme
Court nonetheless held that the agreement was unenforceable as a contract.
The Court found that a letter of intent was not binding as a matter
of law unless the parties clearly manifested intent to be bound. One should bear in mind, however, that depending
on the jurisdiction courts may nonetheless find agreement to negotiate
in the future binding. In other jurisdictions, if the parties include
a covenant to negotiate in good faith, they may be bound by it notwithstanding
the nonbinding nature of the rest of the letter of intent.18 Moreover,
when the parties themselves have not been explicit as to whether or
not its provisions are binding, the courts are split on the question
of whether buyer and seller are bound by the letter of intent.19 Even language that apparently contemplates a
definitive agreement to be reached in the future may not prevent a
letter of intent from binding the parties.20 If
courts find that the parties, by their actions, demonstrated an intention
to be bound, an ambiguously worded letter of intent may be held binding.
This is true even when the letter of intent does not resolve all of
the issues that require resolution for the transaction to be completed.21 Drafting
Considerations Because the actual language in the letter of
intent is crucial, it is vital for the parties to seek legal counsel
in drafting its provisions. Some parties may resist involving lawyers
at all because they fear driving up the cost of the transaction or
because they do not want to overcomplicate the process. Other parties
prefer to work out the essential aspects of the deal and then invite
their respective attorneys to review and comment on a draft of the
letter of intent. In no case should the parties assume that simply
captioning a written document with “agreement in principle” or “letter
of intent” will reliably bind or prevent it from becoming binding.
Many ships have broken on the shoals of such optimism. Beyond making certain that attorneys are a part
of the negotiation of letters of intent, parties who want nonbinding
letters of intent should know that certain strategies will help to
ensure that courts will not reach a contrary conclusion:
Given the numerous benefits associated with
negotiating and entering into a letter of intent and the fact that
most parties prefer to have the basic business terms memorialized
early in the negotiations, it is unlikely that the practice of using
letters of intent will change. Consequently, it is imperative that
the parties and their legal counsel draft all provisions carefully
and purposefully in order to avoid unintended consequences. Notes 2 1-2 Arthur L. Corbin et al., Corbin on Contracts §2.9 (2007 ed.). 3 To be enforceable, a letter of intent must contain
the essential terms of the transaction—price, structure, and the assets
or properties involved. See
Restatement (Second) of Contracts §27, cmt.
c (1981); Winston v.
Mediafare Ent. Corp.,
777 F.2d 78 (2d Cir. 1985).
4 Hansen v. Phillips Beverage Co., 487 N.W.2d 925, 927 (Minn. App. 1992). 5 Id. 6 Mohrenweiser v. Blomer,
573 N.W.2d 704, 706 (Minn. App. 1998). 7 Metro Office Parks Co. v. Control Data Corp., 295 Minn. 348, 355 (Minn.
1973). 8 Lindgren v. Clearwater Nat’l Corp., 517 N.W.2d 574 (Minn. 1994). 9 Mohrenweiser, 573 N.W.2d at 707. 10 Richie Co. v. Lyndon Ins. Group, Inc., 316 F.3d 758, 762 (8th Cir.
2003). 11 See Hansen,
487 N.W.2d at 926. 12 Id. at 927. 13 Id. 14 Richie,
316 F.3d at 761. 15 See Huber and
Sons, Inc. v. Service Corp. Int., 2003 U.S. Dist. LEXIS 4094,
at *6 (D. Minn. 03/13/03). 16 J & W Enterprises
v. TM Marketing, Inc., 1997 Minn. App. LEXIS 678, at *3 (Minn.
App. 06/24/97). 17 Richie,
316 F.3d at 761. 18 See Fickes v. SunExport,
Inc., 762 F.Supp.
998 (D. Mass. 1991); see also
A/S Apothekernes Laboratorium v. I.M.C.
Chemical Group, Inc., 678 F.Supp. 193 (N.D. Ill. 1988); Feldman
v. Allegheny Int’l, Inc., 850 F.2d 1217 (7th Cir. 1988).
19 For a discussion of this split in courts nationwide,
see Farnsworth, supra note 11, at 288–90 and
accompanying notes. 20 The leading case is Texaco, Inc. v. Pennzoil Co., 729 S.W.2d 768 (Tex. App. 1987). See also Field v. Golden Triangle Broadcasting,
Inc., 305 A.2d 689, 693 (Pa. 1973), cert. denied, 414 U.S. 1158 (1974); Restatement (Second) of Contracts
§27 (1981). 21 The court may supply terms that are left unresolved
according to what is commercially reasonable, or it may require the
parties to negotiate those matters in good faith. See
Itek Corp. v. Chicago Aerial Indus., Inc.,
248 A.2d 625 (Del. 1968). Mark
Williamson is a principal
at Gray Plant Mooty and cochair
of the firm’s Mergers & Acquisition practice team. He practices
in the areas of general business, corporate and securities law and
has extensive experience representing public and private companies
in corporate transactions including mergers, acquisitions and divestitures,
public and private offerings, tender offers, and corporate financings.
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