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Proper Use of Letters of Intent

You are the owner of a successful business and you have just completed negotiating the basic components of an important transaction with another business. Perhaps the transaction involves the acquisition of a competitor's business, a supply or distribution agreement, or a joint venture. Each party recognizes that completion of the deal will require formal legal documentation, and that certain important matters may have been overlooked or may still need to be resolved. As the old saying goes, " the devil is in the details." Nevertheless, before investing substantial resources in legal, accounting and any other services required to consummate the transaction, the parties wish to confirm in writing their mutual understanding of the basic deal.

This objective is often achieved through the use of a letter of intent. Parties entering into a letter of intent should be aware that letters of intent can have significant legal ramifications, and before signing a letter of intent an attorney experienced in business transactions should be consulted. Here are a few issues to be mindful of when drafting or reviewing letters of intent.

Properly Identify the Parties

Be sure to identify the proper parties to the transaction. If you are going to organize a subsidiary or affiliate to undertake the transaction, the letter of intent should so specify. The parties should be identified by their legal name and not just by their common name or initials.

Divide Provisions into Areas of Binding and Non-Binding

Although many people believe letters of intent should be non-binding, a properly drafted letter of intent will be divided into legally binding provisions and non-binding provisions. Careful drafting is required to properly distinguish the binding provisions from the non-binding provisions.

The non-binding provisions are used to describe the parties' mutual understanding of the proposed transaction. These provisions "spell out the deal" and are useful to an attorney when he or she prepares the formal legal documentation for the deal, often referred to as the definitive agreement(s). The preface to the non-binding provisions should have language indicating that the parties wish to confirm their mutual understanding of the transaction that they will enter into if they are successful in negotiating and signing a definitive agreement. Emphasize that the description of the deal as the parties understand it does not create any legally binding obligation on the part of the parties to enter into a definitive agreement.

Avoid the use of language such as "the parties will negotiate in good faith to enter into a definitive agreement" because language of this nature can create legal obligations to consummate a deal on terms similar to those articulated in the letter of intent. Prior to signing a definitive agreement, a party should be able to walk away from the deal for any reason or for no reason at all.

In the non-binding provisions describing the deal, use the word "would" rather than the words "will" or "shall" in order to emphasize the non-binding nature of these provisions. For example, in describing the price in an acquisition, a letter of intent should say "The price for the Assets would be $2.7 million."

Contingencies Should be Specified

Contingencies to the parties' obligations to consummate the transaction should be specified. For example, in an acquisition, the buyer will often insist on a bank financing contingency clause, as well as a clause stating that the buyer must be satisfied with the results of its due diligence investigation of the seller's business. A letter of intent will often contain deadlines for satisfying such contingencies. The binding provisions of a letter of intent usually focus on the rights and obligations of the parties in the negotiation process leading to the definitive agreement. These provisions often include the following:

  • A mutual confidentiality agreement in which the parties agree not to divulge to third parties or use for inappropriate purposes any information which they discover about the other during the negotiations.
  • Provisions concerning the extent of any due diligence investigations or other sharing of information required to consummate the deal.
  • The binding provisions of letters of intent often include "no shop" provisions in which one or both parties agree not to deal with any third parties during the term of the letter of intent. For example, in an acquisition, the seller of a business would be precluded from using the purchase price set forth in the letter of intent as a means to leverage another party into paying more for the business.
  • There is often a non-disclosure provision obligating the parties not to disclose the existence of the proposed transaction to any employees, agents or third parties.
  • The letter of intent should contain termination provisions so that the parties will know when their respective obligations under the letter of intent will expire. Some provisions such as the confidentiality provision, will survive the expiration of the letter of intent and continue to bind the parties.

The foregoing items are intended to give the reader a flavor for the types of considerations which go into properly drafting a letter of intent. Needless to say, each letter of intent must be tailored to the specific transaction at hand, based upon the nature of the transaction and the specific needs of the parties.

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