Key Considerations of Letter of Intent (LOI) in M&A

This article was co-authored by Sarah Dibbern, Vice President at Statesman Business Advisors

Every merger or acquisition deal is different, and whether it needs a Letter of Intent (LOI) is a discussion between a willing seller and a willing buyer. The LOI can reduce wasted energy and resources during the next steps (or even determine if there are any next steps) and some bumps and bruises during negotiations are easier to overcome before the parties have undertaken the due diligence process or incurred the costs associated with negotiation of definitive agreements.

Is the LOI necessary?

LOIs are more common in negotiated private transactions than in public transactions, where potential disclosure obligations must be considered. Is it necessary? Not always. But it can be helpful to avoid “deal killer” issues early and make sure the parties’ intentions and expectations are aligned. LOIs usually contain an outline of the anticipated terms during the M&A transaction process and an agreement between the parties to work only with each other for a period of time and to keep the negotiations confidential. Sometimes, because of timing or cost constraints, the parties skip the LOI altogether and go straight into purchase agreement negotiation, which can speed up the transaction but may also lead todifficult negotiations.

Is an LOI binding?

Don’t be fooled. Just because it’s called a Letter of Intent does not mean it’s not binding.

If an LOI does not contemplate the negotiation of a definitive agreement AND contains all of the terms of the proposed transaction, a court could interpret the LOI as a binding agreement. To avoid this issue, most LOIs will contain an express provision that says something like:

Except for the sections on Exclusivity and Confidentiality set forth below, this LOI does not create any legal obligations between the parties. The parties intend to negotiate Definitive Agreements setting forth the terms of the proposed transaction. Neither party has any obligation to enter into the proposed transaction except, and to the extent, expressly set forth in the Definitive Agreements (which shall not include this LOI).

How Non-Binding Is Non-Binding?

Just because the terms aren’t binding doesn’t mean they don’t count.

Remember Pennzoil v Texaco? That case was based upon an LOI between Pennzoil and Getty Oil Company. Even though the LOI was non-binding, Texaco’s inducement of Getty to terminate the LOI and enter into an agreement with Texaco resulted in a $10 billion judgment against Texaco. So, even though the LOI wasn’t binding on the parties, it did create a reasonable expectation of a transaction.

There is another line of Texas cases that held the parties to a non-binding LOI had created a partnership to pursue the construction of a pipeline. It also found that one party breached a fiduciary responsibility to the other party. See, Energy Transfer Partners v Enterprise Products or read more here. That case was eventually overturned because the LOI said that the proposed partnership would be formed only if it was approved by the respective boards of directors – which it wasn’t. But it took a while, and the M&A bar heaved a collective sigh of relief when the Texas Supreme Court finally did the right thing and overturned the lower courts.

What is Good Faith?

Another consideration is the obligation to negotiate in good faith. Some states do not recognize an implied obligation to negotiate in good faith. But others do. It’s a complicated issue and not easily explained in the context of a short article. Texas recognizes the implied duty of good faith and fair dealing in certain contexts and not in others. Suffice it to say: you don’t want to go down this dark alley in connection with your nascent transaction. Even those states that don’t recognize an implied duty of good faith do recognize an express obligation to negotiate in good faith if the LOI says that the parties will negotiate the terms of the transaction in good faith. So, the outcome of a claim based upon the obligation to negotiate in good faith might depend on which laws govern the LOI and the exact words that are used (be sure to see our series on Boilerplate Terms here.

Even if the terms truly aren’t binding and there is no obligation to negotiate in good faith – it’s damned hard to get the other party to agree to terms in the definitive agreements that are different than the terms that are in a signed LOI.

And The Binding Provisions?

Well, those are contracts – and they are binding on the parties. They usually provide:

• A period in which the seller agrees to negotiate only with the buyer (and to notify the buyer if they receive any competing offers)
• Access by the buyer to the seller’s books, assets, and personnel for due diligence purposes (including limitations of the due diligence inquiry if there are sensitive areas)
• For operation of the business in the ordinary course while the definitive agreements are negotiated
• In public companies, prohibitions on issuing or acquiring shares in the target company (aka a “Standstill Provision”)
• If the parties haven’t already signed a Non-Disclosure Agreement (NDA), the LOI should include provisions for confidential information protection, ensuring the terms of the LOI, the negotiations, and any due diligence materials remain private.

Are You Thirsty for More?

Check out more information on the M&A process with Structuring your M&A Deal and the Role of Non-Disclosure Agreements in M&A Transactions. Already have your LOI? Stay tuned for the next steps in the M&A dance.