The Letter of Intent in the Context of the Purchase or Sale of a Business

Article #73, by Me Gilles Thibault on Lundi, octobre 22nd, 2007
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Transactions for the purchase or sale of a business are complex and high risk operations. A potential buyer often wants to take the time to know the business before committing to the purchase. To do so, he will need to analyze information about the target business. The seller, on the other hand, wants to ensure that such information, which is sometimes sensitive to disclose, will not be used to the detriment of the business in the event of the failure of the transaction. It is primarily in this context that the letter of intent is used. It aims to provide the parties with a framework that allows them to conduct their negotiations with confidence, but also to ensure the effectiveness of the latter by establishing a framework and deadlines for their conduct. It may therefore be a very useful instrument in a sale or purchase of business transaction. However, the parties must pay particular attention to how this document was drafted, as it can play a decisive role when it becomes necessary to make an assessment of its legal value.

The letter of intent is generally issued by the purchaser, either on its own initiative or upon invitation by the seller, and is often the first written expression of the parties’ position in the process of formalizing the agreements leading to the sale or purchase of the business. In practice, it is never designed as a contract binding upon the parties in its entirety. Most letters of intent used in commercial transactions contain both mandatory provisions and non-mandatory provisions. However, these letters almost always claim not to be binding upon their issuers. This explains why many conflicts on this subject are ultimately resolved based on whether the letter of intent was binding or not.

For instance, in Théberge v. Durette, the Court of Appeal held that the letter of intent was not a simple letter stating the intent of the parties to continue negotiating an eventual sale promise, as the letter contained all the material elements of a sale promise. The Court therefore decided that the letter should be treated as an offer to sell. In Gestion Réseau sélection inc. v. Châteaux Marigot inc., the appellant argued that the acceptance by the respondents of the letter of intent constituted agreement on the conditions of sale, which enabled him to force the respondents to pass title. But the Court of Appeal did not agree with this reasoning. The Court decided that the respondents had undertaken, at most, to negotiate in a confidential and exclusive manner and that there was no agreement on the conditions of sale, including on the price.

It must be acknowledged that the rules applying to a letter of intent depends mainly on how the latter’s provisions are drafted. Some versions may be more or less binding than others on the persons agreeing to such letters. Consequently, the biggest risk in drafting a letter of intent is creating obligations that go beyond the intention of the parties, which is why it is necessary to distinguish between the provisions which are, by their nature, binding upon the parties and the provisions which are merely useful for the transaction, as well as understanding the risks inherent in their drafting.

Binding Provisions

Traditionally, the parties provide, in their letters of intent, terms whose binding force result from the essence of their provisions, or from the very specific guidelines they specify. For instance:

Commitment to Privacy: Sometimes the parties opt to execute a formal non-disclosure agreement prior to the exchange of any due diligence review material, but this non-disclosure agreement may also be inserted as a mandatory provision in a letter of intent. Consequently, even if the parties fail to reach a final agreement on the transaction, the confidentiality agreement will continue to be binding upon the parties.

Obligation to negotiate in good faith: although most letters of intent state that they are not binding upon the parties, they however contain specific provisions requiring the parties to negotiate the business sale or purchase contract in good faith, and in compliance with the procedure described in the letter. It is important to note that the obligation to negotiate in good faith is a legal requirement, but it is possible to remind the parties of their obligation in the letter of intent. This obligation can play an important role in the event of an unjustified decision to break off negotiations, unless the parties have expressly provided that negotiations can be discontinued at any time and without cause.

Exclusivity provision: this provision servest to prevent any further negotiations with other potential buyers. It becomes mandatory if it is accepted by the seller.

Non-binding Provisions

Some common provisions found in letters of intent are purely indicative and are not binding upon the parties. They include the following:

Confirmation of interest: this provision states the purpose of the talks and the goal pursued by the parties. This provision is usually located at the beginning of any letter of intent and serves to confirm the seriousness of the buyer. Sometimes such an interest is stated in a separate document to highlight the willingness of the author to effectively conduct negotiations for a final agreement. In such case, the document is called the “letter of interest” and is issued prior to drafting a letter of intent. For a example of a letter of interest, see the template found in the online Business Precedents published by Edilex inc..

Statement of price: a letter of intent usually states a tentative price for the transfer. This statement of price, since it is merely a general indication, is not binding upon the buyer who typically makes such a proposal, but it allows the seller to better determine whether the feasibility of the project. It is also the decisive factor in convincing the seller to grant exclusive negotiations rights to a buyer.

Overall negotiation process schedule: the schedule is often established through several provisions of the letter of intent and includes all the different steps required to complete the negotiations. As a rule, the parties have no obligation to follow these steps as they are mere indications on the structure of the negotiations. In addition, the procedure described in this schedule may become irrelevant if the parties decide to prematurely break off negotiations.

Major risks of the letter of intent

Given the informal nature of letters of intent, most of the parties to a transaction often try to prepare this document by themselves, without the assistance of legal counsel. In doing so, they run the risk of being bound by obligations they did not intend to create. To avoid unfortunate surprises, we recommend to have these letters reviewed by legal counsel, to avoid disputes on the binding force of the content of all or part of the letter of intent.

It is important to note that the courts may decide, based on the evidence offered by a party, that the letter of intent meets all requirements of a complete contract, and thus is fully binding on the parties. The use, in the letter of intent, of certain phrases like « we agree » or « the parties accept », of of legal terms such as « offer » or « acceptance », or the the behaviour of the parties may, in some case, weigh heavily on the interpretation that the court will make of the binding force of the letter of intent.

For a sample letter of intent – purchase of assets or of a letter of intent – purchase of shares, we recommend consulting the templates found in the online Business Precedents published by Edilex inc..

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