If you are buying a business, regardless of the scope of the operations and purchase price, there are a number important legal issues you need to consider before signing the purchase agreement. The next several installments of the blog will address the issues that a buyer should address when purchasing a business. The first installment in the series discusses the role of the Exclusivity Agreement when considering the potential transaction and the terms that should be included if the parties agree to exclusivity while the due diligence is conducted and the purchase agreement is being negotiated.
1. What is an Exclusivity Agreement/No Shop?
An Exclusivity Agreement or No Shop is a separate agreement or a provision in an Letter of Intent between the seller of a business and the potential buyer prohibiting the seller from seeking to transfer the business or assets to anyone else during a defined period. In simple terms, the seller cannot shop around the business or assets during the prescribed period.
2. If You are the Buyer, You Should Demand Exclusivity.
If you are considering the purchase of a business or its assets, you should demand exclusivity for a reasonable period necessary to complete due diligence, negotiate and finalize the purchase agreement. As a purchaser, you want to preclude the seller from using your proposed deal as an opportunity to shop around the business. Without the exclusivity restrictions, the seller can freely seek a better offer from a third party or even create a bidding war between you and another interested buyer. The minute you begin engaging in due diligence and enter the process of negotiating the purchase agreement, you not only will be incurring substantial costs in terms of actual out-of-pocket expenses (business advisers, lawyers, accountants, etc.), but also the intangible loss of time and the inevitable distraction to your current business operations. The seller's initial reaction to a demand for exclusivity may be to refuse to enter into a No Shop, in which case you need to decide whether to demand exclusivity as a non-negotiable condition. If the seller is refusing to agree to exclusivity, another approach is to let the seller know you are exploring other similar businesses -- assuming this is a viable argument -- and you will simply switch your efforts to other potential opportunities.
3. What is the Proper Place for the Exclusivity Terms.
The exclusivity terms can be incorporated as a provision of a Letter of Intent (i.e., the No Shop Clause) or as a stand-alone agreement. Generally, however, the LOI is not a binding agreement but rather a road map for the potential transaction. Therefore, the LOI should clearly state that notwithstanding its non-binding nature, the provisions of the No Shop Clause (exclusivity, term and remedies, as discussed below) are binding on the parties.
4. What are the Essential Terms of the Exclusivity Provision/No Shop Clause?
The exclusivity agreement should be carefully drafted, but that does not mean it needs to be complicated; instead just make sure there is a clear and concise agreement/clause that defines (a) the Term (period) of the exclusivity, (b) the remedies in the event of a breach by the Seller, and (c) governing law/forum for disputes and enforcement.
(a) Term: The exclusivity agreement should set a clear time period that commences on signing the agreement and terminates in a specific number of days. Often, parties will agree to ninety days for the exclusivity period, but whatever the period be sure if you are the purchaser that there is sufficient time to conduct due diligence, draft and negotiate the purchase agreement.
(b) Remedies for Breach: The No Shop should expressly set forth the remedies available to the potential buyer in the event of a breach. The remedies can include a right to equitable relief (such as an an injunction), a right to damages or (as I often prefer) a stated amount for liquidated damages which reimburses the potential buyer for reasonable costs of due diligence, attorney's fees and other reasonable costs. The remedies provisions should require the seller reimburse the buyer for attorney's relating to enforcement of its rights and a waiver of any bond (i.e., deposit of a bond with the court) that may otherwise be required to seek equitable relief.
(c) Forum: Include a governing law clause and forum selection provisions so that you can require the breaching seller to defend any claim in a convenient forum. Also, since the buyer is looking for ease of enforcement of its rights in event of a breach of the no shop, incorporate a provisions allowing for service of process by regular mail (to the extent permitted by the law of the jurisdiction where the seller is located in the case of a foreign party).
5. Exclusivity is Not the Same as a Requirement to Sell.
In the same way it is important to understand what a No Shop is, it is equally important to understand what it is not. The exclusivity required by a No Shop is not the same as an obligation for the seller to complete the transaction and sell the business or assets. The exclusivity requirement only precludes the seller from marketing the sale of the business or entertaining other offers during the exclusivity period. While you should include language requiring the seller provide the potential buyer a reasonable opportunity for the to conduct the due diligence, in reality if the seller decides not to proceed it can let the exclusivity period expire without executing a binding purchase agreement. This does not mean the exclusivity agreement has no value, as in fact it is an important aspect of negotiating the purchase of a business (or the assets of the business) because it prevents the seller from shopping your potential deal while giving the parties the opportunity to finalize the transaction.
The next installment in this series discussing issues relating to buying a business willexamine transactions involving the purchase of stock of the seller compared with a purchase of the business assets.
Disclaimer: The discussions in this blog do not constitute legal advice nor create any attorney-client relationship. You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.
Showing posts with label Letter of Intent. Show all posts
Showing posts with label Letter of Intent. Show all posts
Wednesday, April 18, 2012
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.
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.
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