Letter of Intent: Avoid Common Pitfalls
On January 11, 2013
If you have been involved in a business transaction, then you have likely signed a letter of intent (sometimes referred to as a “memorandum of understanding” or “term sheet”). The purpose of a letter of intent is to outline the key terms of a deal before more detailed agreements are finalized. It is essentially “an agreement to agree.” A well crafted letter of intent will help set expectations for the proposed deal and provide safeguards in the event of deal collapse. On the other hand, a poorly crafted letter of intent can create problems. Most problems arise in connection with (i) which terms are binding, or (ii) which binding terms, if any, remain binding (i.e., survive) following termination of the letter of intent. Fortunately, with the advice of legal counsel, these issues can be avoided.
The terms of a letter of intent are generally non-binding and are designed to provide only a framework for detailed, binding documents, referred to as the “definitive agreements.” Generally, if definitive agreements are not signed, there is no deal and the parties are free to walk away. Despite this general rule, a number of terms are commonly binding. These terms usually include: (i) only signed, definitive agreements will create further binding obligations, (ii) confidentiality, and (iii) a period of exclusivity (also known as a “lock-up” or “no-shop”). It is important the letter of intent specify that, unless a term is identified as binding, it is not binding. Often, the seller and buyer will have differing opinions as to what provisions should be binding. For instance, a buyer of a business would likely want a binding exclusivity provision preventing the seller from shopping his or her business, where a seller would prefer to avoid such a provision to keep his or her options open.
Once it has been decided which terms will be binding, it is important to consider what binding provisions will survive. Ignoring this issue can lead to unintended, costly consequences. An example occurred in Turner Broadcasting System, Inc. v. McDavid. In Turner, Turner entered into a letter of intent to sell McDavid certain Atlanta sports teams. The letter of intent was generally non-binding and had the standard exceptions as described above, but only provided for the survival of the confidentiality provision.
Following expiration of the letter of intent, the parties continued to negotiate. Turner ultimately decided to sell to another buyer. McDavid then sued claiming a contract had been created obligating Turner to sell. Turner argued no contract had been created due to the definitive agreements requirement in the letter of intent. The court said that the definitive agreements requirement expired with the letter of intent, and Turner was bound by its actions (which the court said created a binding contract) following its expiration. The court noted that because the letter of intent only provided for the survival of the confidentiality provision, the parties did not intend for the definitive agreements provision to survive. This unintended consequence could have been avoided had the letter of intent provided for the survival of the definitive agreements requirement.
To avoid pitfalls like the ones in Turner, a letter of intent must be carefully drafted paying special attention to what provisions are binding and what provisions will survive. It is never too early to engage legal counsel with respect to negotiating and drafting a letter of intent. For assistance preparing a Letter of Intent, or if you have any questions, please feel free to contact any member of our Business, Corporate and Securities practice group.
© 2013 by Rich May, P.C. and David Wittmann. All rights reserved.
Disclaimer: This summary is provided for educational and informational purposes only and is not legal advice. Any specific questions about these topics should be directed to an attorney in our Business, Corporate and Securities group.
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