Monday, December 19, 2011

What Provisions of an LOI Should be Binding?

The Letter of Intent is an often use document intended to serve as an expression of interest of the parties to enter into a binding business transaction, including an investment, acquisition, distribution, licensing or other contractual relationship.  In essence, it serves as an outline of the important economic and legal aspects of the transaction and becomes the roadmap for the drafting of the definitive contract or transactional documents.  As the Letter of Intent (LOI) is usually intended as a non-binding document, the question is whether any of the provisions of the LOI should be binding on the parties.  As with any legal question, the answer depends on the specific facts and the desire of the parties, but in most cases there are provisions of the LOI that parties will likely want to be binding:  (1) No Shop Clause, (2) Confidentiality, (3) Remedies, (4) Due Diligence, and (5) Governing Law/Venue.    

The concept behind the LOI is that the parties have negotiated the essential terms of a business transaction and therefore wish set down these key terms in a writing that can be used to then draft the binding agreement.  In most circumstances, the LOI is a non-binding document because the parties anticipate that the eventual contract will need to spell out in detail the agreed terms.  Some people question the usefulness of the LOI since it is not binding, but in addition to providing a basis to then draft the binding agreements, it forces the parties to first negotiate the terms and then creates some accountability if a party seeks to drastically alter the terms when it comes to the final contract.  As an example, if a company agrees to sell its assets to a potential dollar for an agreed price, and then later in the contract changes it to more, the potential purchaser can point to the LOI and argue that the seller should stick to what it agreed.  Is that a legally enforceable claim?  No, but in most circumstances the party may recognize that it is bad business practice to renege on an agreed fundamental term.

While the parties may enter into a a non-binding LOI, there are provisions that they should still make binding.  As a practical matter, the LOI can include a statement that it is not binding, except with respect to certain expressly listed provisions.  Of course, the parties can then choose any of the sections to be deemed binding, but the following are the most common terms that will be included in an LOI.

1.  No Shop Clause.  A No Shop Clause is a provision in an agreement between a seller and potential buyer that precludes the seller from seeking other potential buyers during the period of the No Shop.  In simple terms, the seller cannot shop around the business or assets during the prescribed period.  The rationale behind the No Shop is that the potential buyer does not want the seller from using its offer to seek to obtain better offers from a third party or create a bidding war, resulting in a substantial waste of time and money for the potential buyer who is likely expending legal and accounting fees assessing the business opportunity.  The risk for the seller is that the potential buyer decides not to proceed, but this is a term a potential buyer will generally require and therefore a risk the seller will need to accept to move the process forward.  The No Shop clause will include a definite time period, and should include a clear statement as to the remedies available to the potential buyer in the event of a breach.  The remedies may be in the form of equitable relief (i.e., an injunction) or even a stated liquidated damages amount intended to reimburse the potential buyer for the costs incurred in connection with the broken deal.

2. Confidentiality Clause.  In many instances the Confidentiality Clause will have already been part of a Non Disclosure Agreement entered into prior to the LOI.  At the very least, the LOI can refer to the existing NDA and reiterate that the LOI is subject to the NDA, and a breach shall give rise to remedies as set forth in the NDA.

3. Remedies for a Breach.  If the LOI has provisions that are binding then there should be a separate provision setting forth the rights of the non-breaching party in the event of a breach of the LOI's binding provisions.  Therefore, inlcude a section stating in what circumstances equitable relief (injunctive or even specific performance) can be sought or if there is a right to specific liquidated damages for a breach of a binding provision.    

4. Due Diligence.  You may want to include a binding clause that requires the seller to provide the potential buyer an unfettered opportunity to conduct due diligence and have access to the information necessary to conduct the due diligence.  Unlike a No Shop, for example, including a binding due diligence clause is less common place, but if you are concerned about the seriousness of the seller or that it is just using the LOI to solicit offers after the No Shop expires, then you might want to consider requiring reasonable access and an opportunity to conduct due diligence.  The seller may balk on the theory that it is too difficult to define what constitutes adequate compliance, but the easy answer is that as buyer you should have unlimited due diligence, subject only to reasonableness as to notice and non-interference with the operations of the seller's business.           

5. Governing Law/Venue/Attorney's Fees.  The LOI should state the law that governs the (binding terms) and the court where claims can be instituted in the event of a dispute or a need to enforce the LOI.  Depending on certain factors such as whether you are likely to be the one bringing the claim and how deep your pockets are, you may want to include a requirement that the court award attorney's fees and costs to the prevailing party.  If you win the lawsuit, you can seek reimbursement of your legal fees and costs but the risk is that if you lose, you will be responsible for fees of the other party -- which no doubt can be quite substantial.

The lesson here is do not take the LOI for granted or view it as a waste of time.  First, if you spend the time to negotiate the fundamental terms of the transaction and then put the terms in an LOI, the parties will have a good structure to draft the definitive documents.  Of course, terms can change, as they often do, as a result of due diligence, but at least the LOI provides a starting point for the further negotiations.  Second, even a non-binding LOI should contain certain binding provisions that protect the parties in the interim period between signing the LOI and execution of the definitive agreement.   

Disclaimer:  This Article is for discussion purposes only and does not constitute legal advice or create an attorney-client relationship.  You should seek the counsel of an experienced lawyer with respect to your business law matters.



  1. Brilliant, I'm in the process of writing a LOI for a possible merger and realised that I hadn't emphasised enough on Due-Diligence, thanks to you, I'll better it with all your really good tips!


  2. I am glad you found the post helpful. Good Luck with the transaction.