When sell a business, the buyer and seller often first set out the main terms in a letter of intent (LOI). In practice, we frequently see LOIs stating that they are “non-binding.” That is rarely the best wording. After all, the parties do want the agreed-upon terms to apply, but they do not want to be obligated to proceed with the transaction if the agreed-upon conditions are not met.
Subject to the guiding principles
The key terms in the LOI—such as how the purchase price is determined, the intended closing date, and agreements regarding the seller’s role after the acquisition—form the basis for the detailed terms in the transaction documentation. In that sense, you are bound by them. You cannot renege on what has been agreed upon without good cause, and, in principle, the other party is not required to accept a new condition that you only think of later.
Subject to the transaction
On the other hand, you are not obligated to proceed with the transaction as long as any agreed-upon conditions precedent have not been met. With a condition precedent, the obligation arises only when the agreed-upon event occurs. Examples include a satisfactory outcome of the due diligence process, securing financing, or obtaining approval from an internal body or a third party, such as a landlord. If the condition is not met, the other party cannot force you to proceed with the transaction.
Be sure to phrase it this way: you are only obligated to proceed with the transaction under certain conditions. This is clearer than saying “the LOI is non-binding.” That phrase leaves open what obligations you are actually bound by—such as confidentiality, exclusivity, and costs—and invites debate about what terms still apply.
What can you do?
- Be specific about the terms. What does “satisfactory” mean? A term like “due diligence” doesn’t have a fixed definition, so define its scope. For example, agree on the extent to which a deviation from the initial assumptions would allow a party to terminate negotiations or adjust the price. A risk that you were already aware of but did not include as a condition will often be your responsibility. Are you dependent on the other party to fulfill a condition—for example, to provide information or obtain approval? If so, formulate that condition as specifically and objectively as possible.
- Make every effort to fulfill the conditions. If you fail to do so, you generally cannot rely on them. Furthermore, anyone who personally prevents the fulfillment of a condition runs the risk that the condition will be deemed to have been fulfilled. Therefore, provide the necessary cooperation, for example, by submitting information (in a timely manner).
- Agree on a time limit. Without a time limit, the court will determine what is reasonable after the fact. Also agree on what happens if the time limit expires without anyone having invoked the condition.
- Arrange for the allocation of costs. Agree on who will bear the costs of due diligence and advisers if the transaction falls through, and whether there is a cap on those costs. Document any agreements you make in writing.
- Give advance notice. Do not abruptly break off negotiations, and do not raise expectations that you cannot fulfill.
In conclusion
A Letter of Intent (LOI) is not just a formality. Clearly define your obligations, the conditions, and the timeframe. This can prevent unpleasant disputes later on.
