|Philadelphia Business Journal Supplement on Mergers & Acquisitions
Mergers and acquisitions (M&A) can be an inartful song. The buyer and seller each want the song to go its way, and neither one is really satisfied with the other’s music. Leaving the details floating in thin air could send the whole deal out on a sour note. A Letter of Intent (LOI), competently drafted and accepted by both parties, is a key to keeping the deal humming and the parties moving forward on a positive basis.
The LOI should be a pre-contractual document that establishes the parties’ preliminary points of understanding at an early stage in the transaction. A properly-drafted LOI will contain just the right mix of binding and non-binding provisions with an eye towards a future, more definitive contract. In the right hands, an LOI can be more than just psychological assurance signifying that all the talking has actually accomplished something. The well-considered LOI can benefit both parties in several ways by
• saving time and money,
• providing a preliminary framework,
• protecting each party’s interest, and
• limiting legal liability.
In the long run, drafting an LOI will be less time-consuming and more inexpensive than hammering out a premature contract. An acquisition agreement without benefit of the framework of an LOI may be incomplete, cause delays, and lack focus as to important business points. Taking time out to draft an acquisition agreement at the very start of the deal can in many cases undermine momentum and delay understandings on key deal points.
An experienced M&A attorney can draft a cohesive, effective LOI in several hours despite the potential enormity of the deal. This will ultimately shorten the timeframe and lessen each party’s anxieties.
Also, the quick timeframe of using an LOI as the first step enables the dealmakers to visualize the framework before engaging in detailed or less salient discussions. An LOI should not bog down the merger process, unless you let the LOI drafting process become too complex. The framework allows each party to delineate clearly its interest and key financial expectations in the contemplated transaction as outlined in the LOI.
Unfortunately, some aberrant decisions and sloppy LOIs have chilled the legal community’s temptation to use an LOI in mergers. Representing the worst-case scenario of an LOI gone awry, Pennzoil v. Texaco is a reminder that an ambiguous two-page LOI can become an unintentionally binding contract with costly results. However, a carefully-drafted LOI provides tremendous benefit and protection to both parties.
During the sometimes long and complicated merger process, negotiators will cover numerous potential topics of consideration. An LOI effectively memorializes the early milestones, creating reference points and preventing either party from having a sudden case of selective amnesia. At the very least, the LOI shows the outline of what was intended by the parties at the start.
Aside from an obvious catastrophe like the Pennzoil case, more subtle dangers exist with an improperly-considered LOI like the inclusion of an agreement to negotiate in good faith. Even a precise and well-drafted LOI can be weakened by an agreement to negotiate in good faith. Although dealing with a lease agreement, in Channel Home Centers v. Grossman, the Third Circuit held that a detailed LOI containing a provision to negotiate in good faith formed an option contract, thereby binding the parties to the terms of the LOI for the length of negotiations. The court did not address the parameters of the option contract, but the case illustrates how inserting such language into an LOI can negate the LOI’s strengths. The absence of the good faith provision does not give a party license to run negotiations unfairly, but it affords the parties added flexibility and removes another potential stumbling block in the LOI’s overall effectiveness.
The LOI efficiently mixes binding and non-binding provisions that allow parties to stake out their positions and protect their interests. The strength of the LOI lies in its ability to establish clear understandings in certain areas and to provide flexibility for more discussions or choices later in the process.
For example, it is often advisable for a buyer to use an exclusivity provision in the LOI to require the business to be taken off the market for some period of time while negotiations proceed and a definitive agreement is prepared and signed. All this happens in a truncated fashion, allowing each party’s confidence in the outcome and focus to remain high.
At the very beginning, an experienced M&A attorney can maximize the potential for closing the transaction by drafting an LOI that clearly models the framework of negotiations and precisely delineates the key business terms of price, structure, and the like. The goal is to close the transaction, and the LOI can be an important step at the start of the negotiation process.