This is the second blog in a series on the legal and strategic aspects of mergers and acquisitions (M&A). In the previous blog, the focus was on what buyers and sellers actually aim to achieve with the transaction. Once they have found each other, a next step often follows: the drafting of a letter of intent, also referred to as an LOI or intent agreement. This document marks the moment at which the parties set out their intentions in writing. But what are the legal consequences of this? And what should buyers and sellers pay attention to?
A letter of intent is a document typically prepared in the early stages of a business acquisition. It serves as a kind of intermediary step: the parties are not yet in a position to conclude a definitive purchase agreement, but they do wish to record the current status of negotiations and set out the framework for further discussions. Although the document is preparatory in nature, it may, under certain circumstances, have more far-reaching legal consequences than the parties initially intended. It is therefore worthwhile to carefully consider what is being legally recorded in this document.
In practice, this question most often gives rise to disputes. Courts interpret a letter of intent on the basis of the so-called Haviltex standard. This means that not only the wording of the document is relevant, but also what the parties could reasonably have expected from one another in the circumstances.
Three outcomes are possible. A letter of intent may be regarded as a non-binding document, namely where the parties’ intentions clearly indicate that it is not meant to be binding. In some cases, however, the document may be qualified as the final agreement itself: if a letter of intent contains sufficiently specific arrangements—such as on price—the court may conclude that it constitutes an agreement from which legal rights and obligations arise. In M&A practice, this risk is limited but not excluded. The most common scenario is a hybrid form: the letter of intent is not binding as a whole, but does contain binding provisions relating to the negotiation process itself, such as exclusivity or confidentiality, while the substantive terms of the final agreement remain open.
A well-drafted letter of intent typically contains a number of standard building blocks. The most important are outlined below.
Exclusivity clause
An exclusivity clause requires the seller not to negotiate with other potential buyers for a specified period. Such a clause is enforceable, but it is advisable to explicitly define its duration. If no term is agreed, a court may determine what constitutes a reasonable period.
Confidentiality clause
A confidentiality clause ensures that the content of the negotiations and any information disclosed therein remains confidential. This is particularly important in light of the due diligence process, during which the buyer gains extensive insight into the target company. The more precisely this clause is drafted, the greater its value in the event of a dispute.
Non-binding clause or condition precedent
Parties may also explicitly emphasise the preparatory nature of the letter of intent by including a non-binding clause. A commonly used variant is a condition precedent: the parties agree that a binding agreement will only come into existence once the final transaction agreement has been signed. Until that moment, the letter of intent does not, in principle, bind them.
Finally, parties may agree on the allocation of costs, such as those relating to due diligence or external advisers. A so-called break-up fee may also be included: a payment owed by the party that decides to withdraw from the transaction. Such arrangements provide financial certainty for both parties and help prevent unnecessary delay or lack of commitment in the process.
A letter of intent is not automatically non-binding. It sets the framework for negotiations and may, depending on its wording and the circumstances, give rise to binding obligations. Careful drafting is therefore essential. Clearly distinguish between binding and non-binding provisions, define the duration of any exclusivity period, precisely describe what information is confidential, and anticipate issues of governing law and jurisdiction in cross-border transactions. Addressing these questions upfront significantly reduces the risk of disputes at a later stage.
In the next blog in this series, I will take a closer look at the due diligence process: what is examined, who bears which risks, and which legal considerations play a role in this context.
Read the other blogs here:
Would you like to know more about the letter of intent or the acquisition process? Please feel free to contact Tim de Vries.
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