Letter of Intent: Gateway to a Deal

Your time is valuable. So is the business that you are thinking about selling or the business you intend to acquire. You may also be thinking that before running up professional advisor costs, your business folks should be able to put together a non-binding letter of intent (“LOI”) and then turn it over to legal counsel and other advisors. As discussed below, a party entering into an LOI may not be as free to walk away from the deal without consequences as is commonly thought. LOIs that included a covenant to negotiate in good faith have resulted in some courts award- ing reliance damages to a jilted party who shows that the other side ended negotiations in bad faith. Reliance damages permit the complaining party to recover out-of-pocket expenses and similar losses linked to its reliance on the other party’s agreement to negotiate in good faith. We will return to this good faith issue after covering other important elements of LOIs.

In general, a well drafted LOI represents an opportunity to cover key issues, confirm that a “meeting of the minds” has occurred, and avoid misunderstandings before spending significant time and money drafting definitive agreements. The LOI normally includes a description of the assets or stock being acquired, the liabilities being assumed, the deal structure, and related financial terms such as earn-outs, escrows, baskets, caps, working capital requirements, adjustments, and purchase price allocations. Financing contingencies and other conditions to closing are also included, such as obtaining consents of key vendors, customers, and banks. If seller personnel are to continue employment with the buyer post-closing, this condition should be included as well. LOIs also allow the parties to set forth their expectations regarding the timing of pre-closing activities such as due diligence, the securing of financing, and commencement of definitive document preparation.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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