Letters of Intent Without a Final Contract are Just a Piece of Paper
Letters of Intent are often a good place to start negotiations for all types of transactions. I’ve written about this before (see post HERE). They can be very helpful in setting the parties’ expectations and helping to draft the contract. They work well as checklists for the essential points to be discussed. However, LOIs should never be considered to be the final contract document, nor should they be considered to be binding on the parties as they do not contain all of the essential terms of the contract.
Most LOIs contain language making it absolutely clear that the LOI is non-binding and is merely an expression or outline of the parties’ interest in entering into a more formal, binding agreement. Until such an agreement is executed, the parties have no formal obligation to each other except perhaps, confidentiality and exclusivity for a specific period of time.
When an LOI gets too specific and a contract is not ever signed, disputes can and do arise. One or both parties might look to the LOI to “enforce” some right or a provision. But, because the LOI is not binding, there is nothing to enforce.
This situation recently came across my desk. The client signed a LOI to sell the stock of his business nearly 6 months ago. There were at least 5 occasions in the LOI stating that the LOI was not binding on the parties. The LOI provided that the parties would “promptly” negotiate and execute a Share Purchase Agreement containing the economic terms in the LOI and regular and customary terms for similar transactions. It provided that the Share Purchase Agreement would contain a 90 day due diligence period. And, the LOI stated that if the Buyer “waived Due Diligence” and the Seller thereafter “failed to close,” Seller would reimburse Buyer’s due diligence costs up to $150,000.
Prior to and after the execution of the LOI, the Buyer conducted extensive due diligence on Seller’s company. Negotiations for the SPA began in earnest but were difficult for many reasons. Both sides felt that the other side changed the business terms. At the end of about 4 1/2 months, the Buyer agreed to “waive Due Diligence” by amendment to the LOI, yet Seller continued to provide financial records of the company that Buyer requested. About 2 1/2 weeks later, Buyer broker off negotiations and made demand for reimbursement of its due diligence expenses, the entire $150,000.
Seller retained me to address the due diligence reimbursement issue. What were Seller’s rights? Seller’s obligation to reimburse the expenses arose under the LOI. But, the LOI, by its terms was not binding. Of course, the Buyer could easily argue that this was one of those provisions, like confidentiality, that is binding. However, Seller’s obligation to reimburse had 2 conditions precedent: 1) Buyer waive Due Diligence and 2) Seller fails to close.
Buyer argued that it had waived due diligence per the 2nd Amendment to LOI. I’m not sure that it did because the parties never entered a contract. The LOI said that the contract would have a 90-day due diligence period. Did Buyer waive that provision of the LOI or was it the provisions of the LOI allowing it to conduct due diligence prior to signing the contract?
But, assuming, for argument’s sake, that Buyer did waive due diligence, the 2nd condition precedent was not satisfied. Seller could not have failed to close because Seller had no obligation to close. There was no binding contract. No one agreed to anything – not the price, not the terms, not the closing date – nothing. Therefore, Seller had no obligation to reimburse Buyer.
LOIs can be great. But if you never get to contract, all you have is a piece of paper and no rights. My client, in this case, looks like it will lose this deal, but it will not have an obligation to pay Buyer. This is a good result. The Buyer, who was the more sophisticated party in this transaction and a bit of a bully, blew it. They should have pushed for the contract ASAP so the due diligence clock would start. Their strategy, whatever it was, backfired.