Binding Terms in Letters of Intent for Business Sales

May 14, 2018

by Andrew P. Grau, Esq.

When selling a business, a Letter of Intent (“LOI”) is often regarded as non-binding.  One may be inclined to sign the LOI without first obtaining a legal review, thinking that the document can always be broken later without consequence. However, the LOI may contain certain important terms that are binding, and that survive the LOI’s termination.  Furthermore, a poorly drafted LOI may create ambiguity as to whether it is in fact generally non-binding.

After the LOI is signed, the buyer begins incurring significant expenses such as comprehensive due diligence and preparation of the purchase documents. Before a buyer embarks on this expensive process, it wants to know that the seller will not negotiate with other potential buyers. To address this, the LOI may establish an exclusive negotiating relationship.  The seller agrees that it will not solicit other offers, or even engage in discussions with other parties, regarding the sale of its business. A time period for the exclusivity is established, and even if the deal falls through, the seller remains bound by the exclusivity restriction.

Common exclusivity time periods range from 60 to 120 days. The LOI may establish stipulated damages which apply if the seller breaches the exclusivity restriction.  In the absence of stipulated damages, an aggrieved buyer may sue the seller for its costs incurred pursuing the acquisition. The seller should be aware of any such restrictions before signing the LOI.

Confidentiality is frequently a high priority of the parties. A non-disclosure agreement should be signed before any information is shared. Usually such an agreement is in place before the LOI is drafted. If not, or if the parties desire additional confidentiality terms, the LOI should include them and make them binding. For example, the financial and other terms of the LOI shall be confidential and shall not be disclosed to anyone besides the professional advisors assisting the parties with the transaction.

Governing law and jurisdiction may be defined in the LOI. In that case, especially when the parties are located in different states, those terms should be binding so they apply to claims brought following the LOI’s termination.

Any binding terms in the LOI should be the exception, not the rule. The LOI should contain an unequivocal statement that generally it is non-binding, that the definitive terms of the transaction shall be set forth in a purchase agreement, and that the LOI is not the purchase agreement. Any terms intended to be binding should be listed and referenced as exceptions to the non-binding declaration. If the LOI does not contain a sufficient non-binding declaration, it creates ambiguity that opens the door to litigation if the deal falls through and one side believes the other did not negotiate in good faith.

Even if the LOI contains no binding terms, it still sets the stage for the transaction in important ways. It is crucial that it be well-drafted, and protect the party’s interest.  In order to do this, the party’s legal counsel for the transaction should be involved in the process as early as possible.

Questions Every Business Must Ask

Q. Has your business recently reviewed its legal structure to determine whether it is set up in the most advantageous manner for legal and tax purposes, considering recent developments and changes in the law?

Q. Do the owners of your business have a current, updated buy-sell agreement which controls how ownership interests in the business are to be transferred in the event of an owner’s death, disability or termination of employment?

Q. Have the owners of your business developed a succession plan to define how ownership and authority will transition upon the death or retirement of the present owners?

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