By Vasilios J. Kalogredis, J.D.
Letters of intent are often touted as a “non-legally binding” way to get the parties to set forth in writing what the undertaking is among them relative to a transaction. Too often, parties will sign such a document, feeling that they have little or nothing to lose by doing so. My advice is to proceed with caution before signing any such document. As a general rule (and there are exceptions), I urge the parties to go right to the final documents and “dot all of the I’s and cross all of the T’s” rather than go through this interim step of a letter of intent, which has many potential traps.
It is not unusual for parties to believe they have reached an agreement in principle to buy/sell a practice, merge with another practice or agree to enter into another complex business transaction. In those circumstances, some of the parties may believe that negotiating definitive agreements will take a lot of time (which is probably true) and that if something were not put in writing immediately, the deal might fall apart.
This is understandable. It is true that in certain circumstances where the transaction is so complex that extensive negotiations will be required, that a letter of intent might serve as a useful interim measure which allows the parties to set forth in writing some measure of commitment. This article will address those matters, including several potential pitfalls.
Generally, the purpose of a letter of intent is to set forth the general terms of a transaction and specific points that might have been agreed to prior to the finalization of a definitive agreement. This is often pushed if one or more of the parties is unwilling to spend the time and money required to negotiate an agreement until a letter of intent has been signed. A seller might be unwilling to let the buyer go through the due diligence process without first obtaining a letter of intent.
Often times, the parties agree that it is important to have key terms of the transaction in writing (for example, the purchase price and how it would be paid), early in the game to avoid confusion later on. The acquirer may need a letter of intent to assist in the financing process. A buyer may be unwilling to move forward with negotiations unless and until the seller has agreed to a “no shop” provision and/or a “break up” fee.
One of the traps in a letter of intent, which some may view as a “casual/non-binding” document, is that certain provisions within the document may indeed have legal effect. Among the provisions which typically might be binding within a letter of intent are those set forth below.
The seller may grant the potential buyer access to information to allow the buyer to conduct its due diligence. Confidentiality is a very important aspect of things. The seller may not want the buyer to make use in any way of any information obtained in the course of the due diligence and/or negotiations process for any reason other than for the negotiation or consummation of the transaction in question.
Both parties might have an interest in prohibiting the disclosure of the terms being discussed by the parties and even the fact that the parties are negotiating at all. Many potential buyers do not want the terms to be disclosable for fear that the seller may use them to negotiate a better deal from someone else. It is not unusual for a letter of intent to state that any public announcements of the transaction must be approved by, or subject to, the reasonable approval of both parties.
A “no shop” clause is a very common provision in such documents. This is something that a potential buyer would very much like to have. It obviously puts that party in a much stronger position. For example, a “no shop” clause might prohibit the seller from soliciting (or perhaps even entertaining) any competing offers from prospective third party buyers. The seller may or may not want to be so restricted. If and when this is agreed to, sometimes the buyer is willing to pay an amount of money for this. Also, from the seller’s standpoint, a reasonable time limit on this provision would make a lot of sense.
A “break-up fee” is sometimes agreed to in the documents. This might relate to the seller having to pay a specified number of dollars to the potential buyer if the seller pursues a substantially similar transaction with a third party. Sometimes this is used in lieu of a “no shop” clause. Sometimes, the buyer would have to pay a “break-up fee” to the seller if it does not proceed in good faith towards consummation of the transaction.
Termination of a letter of intent also needs to be addressed. Sometimes, it ends as of a certain date unless extended in writing by both parties. In other circumstances, it ends as of the occurrence or non-occurrence of certain events. At other times, there is no end date to it in the document, but either party may end it on a certain number of days notice, in writing, to the other.
The allocation of expenses relative to the transaction is often included in a letter of intent as well. It might state that each party will bear its own expenses relative to the transaction. Whatever the understanding is, it should be set forth. Many of these letters of intent state that the parties agree to engage in good faith negotiations of the terms of the definitive agreements. This carries some real risks to it.
These often focus on the “deal points.” For example, there might be a general description of the structure of the transaction. The price or a method for determining the price might be set forth therein as well. It might be subject to due diligence.
Often times, there are ancillary agreements which will also need to be finalized before the transaction may actually take place. For example, in a sale of a practice these agreements might include employment agreements, leases, non-competition agreements, assignment and assumption agreements, payor contracts, and the like. Sometimes, other covenants that would become effective after the execution of the definitive agreements would be set forth. These could include getting the consents of all necessary third parties, making all of the necessary filings, conducting the business in the ordinary course, and the like.
At times, conditions to closing are also listed. This might include financing contingencies, getting the necessary third party consents, getting the governmental approvals, getting on the hospital staff, etc.
The letter of intent can serve as evidence to third parties that there is an “agreement in principle.” Sometimes, the signing of a letter of intent can be a real momentum boost. Despite the fact that the letter of intent may or may not involve some non-binding elements to it, once something has been signed by the parties, there is often created a sense of moral obligation that the contemplated transaction should be consummated.
There can be, however, a number of potential problems. Once signed, a letter of intent, even if it is truly non-binding, may place the seller at a true negotiation disadvantage by creating an expectation of the consummation of the transaction on the part of third parties (including employees, institutions, vendors, patients, etc.) The potential is there for breaches of confidentiality. During the due diligence process by a prospective buyer after the execution of a letter of intent, but before definitive agreements are signed, will afford the buyer access to a great deal of information concerning the practice.
Even with confidentiality provisions, the risk is present that the buyer and/or its representatives may make improper disclosures of this information, or even use this data to compete with the seller. The seller can be greatly hurt by a “no shop” clause which would prevent the seller from conducting any discussions with other potential buyers. If the deal does not take place, potentially valuable time to get a deal done could be lost.
It is not at all unusual for the letter of intent process to end up taking much more time than the parties contemplate. In some cases, that is a main reason for my pushing the parties to go straight to the negotiation and ultimate execution of definitive documents. For example, when getting to the key terms of the “agreement in principle,” the parties may easily get bogged down in detailed discussions. This can result in a premature hardening of positions. Nevertheless, sometimes that is a good way to go since dealing only with the easy things in the letter of intent may later hurt one or both parties in negotiating all of the “tougher terms.”
There are negotiation disadvantages of having a signed letter of intent in place, as well. Once terms are incorporated into such a document, even if supposedly “non-binding,” a party seeking to renegotiate these points will be at a disadvantage substantively and, perhaps even more importantly, “morally.” Unfortunately, this can happen in a situation where the parties rush to sign a letter of intent “quickly” without thinking about all of the ramifications.
Can a Non-Binding Letter of Intent Become Binding?
One of the attractive elements of a letter of intent is its purported non-binding nature. However, courts have found letters of intent to create binding obligations, even if the letter itself does not explicitly state that it is binding. This is part of the uncertainty and potential risk of any such undertaking.
In determining whether the parties intended for the document to be binding, all of the words of the document are evaluated (careful drafting is critical); the context of the negotiations are reviewed; the courts will look to see whether either or both parties have fully or partially performed their obligations; they will look to see whether there were any issues left to negotiate; and they will also look to see whether the subject matter was complex enough to require a definitive written agreement.
If the parties do not want this letter of intent to be legally binding, it is important for the document to clearly state that. For example, it might state that this letter of intent is not a legally-binding document and that neither party will be bound by its terms (unless there are any terms that you want to be binding) unless and until a definitive agreement is executed. This is essential.
If a court determines that the parties intended to be bound prior to the execution of a definitive agreement, courts have given that effect to the undertaking. This can be true even if certain issues have not been finalized. Depending upon the significance of these open issues, courts might supply commercially reasonable terms for those unresolved issues or contractually obligate the parties to negotiate a resolution of those issues in good faith.
This duty to negotiate unresolved terms in good faith (which some letters of intent actually specifically state within them) have imposed liability on parties who are deemed to have acted in bad faith or who refused to negotiate in good faith.
A letter of intent certainly has its place in certain circumstances. It can be useful at times. The important thing is to understand what its legal significance is and where you are, or are not, bound by execution of it.
It is important to have your attorney review things carefully and advise you whether or not you should execute such a document and, if you do, what it means to you.
Vasilios J. Kalogredis, J.D., is Founder and President of Kalogredis, Sansweet, Dearden and Burke, Ltd., a boutique health care law firm in Wayne, Pennsylvania.