The purpose of LOIs are to state clearly the principal terms that the parties have agreed to as part of the deal and to represent the intent of the parties to pursue the contemplated transaction.
Typically, LOIs are non-binding in terms of requiring the parties to close the deal. LOIs are entered into commonly at the beginning of the transaction prior to detailed due diligence and preparation of definitive purchase documents. The framework put into place with the LOI is then used to form the definitive purchase documents needed to close the deal.
There are a number of reasons to use LOIs in transactions. Learn about when it's appropriate to do so.
Reasons to Use LOIs
There are a number of reasons to use LOIs in transactions. LOIs can help:
- Identify early on (prior to expending transaction costs) what terms are mutually agreed upon and which key terms may be deal breakers;
- Focus negotiations on key terms;
- Increase commitment and deal stability;
- Outline binding obligations such as exclusivity for negotiations, payment of costs and confidentiality concerns;
- Obtain third party approvals; and
- Enhance mutual understanding of deal terms for parties that have varying degrees of sophistication.
Reasons Not to Use LOIs
There are a number of issues which may outweigh these benefits, namely:
- The cost of negotiation and preparation of the LOI may be unnecessary or undesirable if the deal is easily understandable;
- Negotiation of the LOI can slow deal momentum;
- Improperly drafted LOIs may create unintended binding obligations to negotiate and close the deal.
- LOIs may inadvertently create a duty to negotiate in good faith which could eliminate the ability of a party to walk away if there is a change of mind.
- The LOI may weaken the negotiating position if the party later seeks to change the terms.
Intentionally Binding Provisions
While LOIs are typically non-binding, there are commonly certain terms within the document that are binding on the parties. The binding provisions typically relate to the exclusivity of negotiations, confidentiality of information during due diligence and the allocation of costs and expenses incurred during transaction.
Unintended Binding Provisions
The more definitive the LOI, the more likely it is that a court would state that the terms are sufficiently definite to be enforceable.
To avoid unintended binding obligations, the parties must clearly state which sections are binding and which are non-binding. If material terms are left out, the parties lower the risk of creating an unintended binding obligation.
Duty to Negotiate in Good Faith
Even if the LOI is non-binding, parties may be obligated to negotiate in good faith. The language in the LOI is important to clarify this issue. Courts are split on when this duty is implied in LOIs. Accordingly, careful drafting is necessary to avoid unintentionally creating a duty of good faith negotiation when such may not be desired.
Key Terms Outlined in LOIs
The following are the key points that most LOIs will include:
- Basic description of transaction and structure
- Principal deal terms (i.e. purchase price and payment terms)
- Closing conditions
- Key dates for due diligence and closing
- Allocation of fees and expenses
- Statement on binding and non-binding provisions
- Scope of due diligence
- Exclusivity of negotiations
LOIs are common place in acquisition deals, but there are a number of important issues to consider when utilizing these important documents.
LOIs serve a distinct purpose and deserve attention by the parties so that the purpose is achieved without the risk of the unintended circumstances discussed above.
Julie I. Kline, Esq.
This document is intended to provide information of general interest and is not intended to offer any legal advice about specific situations or problems. Neither the author nor Strassburger McKenna Gutnick & Gefsky intend to create an attorney-client relationship by offering this information, and anyone’s review of the information shall not be deemed to create such a relationship. You should consult a lawyer if you have a legal matter requiring attention.
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