Letters of Intent

  • Authors: Anoop Chahal, Marc Laatu
  • Date: April 15, 2024Asset 21

Introduction

The letter of intent (“LOI”), also known as a term sheet or memorandum of understanding (“MOU”), can be an effective first step when buying or selling a business. The purpose of a LOI in a business transaction is to set out the proposed terms of the deal in simple and concise language. A well-crafted LOI will get the buyer and seller ‘on the same page,’ before they proceed with more time-consuming and expensive due diligence. There is no standard format for a LOI, but it will typically address the following key standard terms:

  1. The parties (Identify who is buying and who is selling).
  2. What is being sold (such as property, assets, or shares of a company).
  3. Price and payment terms.
  4. Any adjustments to the price that will occur on or before the closing date.
  5. The deposit, if any, and whether it will be refundable (and when).
  6. When ownership will transfer (referred to as the “closing date”).

These terms will vary depending on the deal, but they will be the focus of the negotiations between the buyer and seller. The LOI will also contain additional terms and conditions that are equally important to the transaction and will help shape the transaction. It may include the following terms:

  1. Binding vs Non-Binding

When an LOI is referred to as ‘binding,’ it means that it can be enforced in a court of law in the event the transaction falls through. The binding nature of the LOI is determined by the language used in the document and the actions of the parties involved. Lawyers often insert a clause in the LOI specifying that certain terms are not intended to create any binding contractual obligations. However, it must be noted that the Ontario courts have consistently held that such clauses will not necessarily guarantee that the LOI is non-binding on the parties.

If the LOI is considered non-binding, the parties involved may also keep certain terms binding, such as confidentiality or non-disclosure, non-refundable deposits, and the payment of professional fees (like lawyers, accountants, or agents).

Parties should consider making a LOI binding only when all the terms of the transaction have been agreed upon, or when ‘certainty’ of the transaction is important. A non-binding LOI may be more suited when the key terms are still subject to negotiation, or when the buyer has several conditions to fulfill such as obtaining financing, due diligence, or regulatory approval. A non-binding LOI may also be suitable when the seller intends to market the business to other potential buyers.

2. Exclusivity

An important consideration for buyers may be whether the seller can continue negotiating with other buyers. An exclusivity clause will typically provide the buyer with an assurance that the seller will only engage with the buyer for the sale going forward. The exclusivity clause is limited to a specific period, such as 60 days, after which the seller would be free to start negotiating with other buyers.

An exclusivity period can be beneficial to both buyers and sellers. Buyers like to know that they have secured the business for a period, and sellers are often comforted by the opportunity to focus their time and energy on one committed buyer. An exclusivity clause is an effective incentive to ‘get the deal done.’

3. Entering a Formal Agreement of Purchase and Sale

In most cases, a LOI, especially if they are non-binding, will include terms directing who will be preparing the formal agreement of purchase and sale (“APS”) and by when (such as 60 days) it will be prepared. Usually, the buyer’s lawyer will prepare the APS, which will expand on all the key terms and conditions contained in the LOI. This may include representations, warranties, or indemnities from the seller, hold-backs of the purchase price, post-closing transition assistance from the seller, or details about key employees that will need to be retained (or possibly terminated) before the closing date.

If the LOI is non-binding, and no formal APS is entered into before the deadline, then the non-binding deal will be terminated.

4. Due Diligence and Confidentiality

A key step following the signing of the LOI will be the buyer doing their due diligence on the business. This typically involves the disclosure of sensitive business information by the seller, such as financial records, employee details, customer and supplier information, leasing terms, and more.

A well-drafted LOI will contain a clause that acknowledges the confidential and proprietary nature of any sensitive information the seller shares. The clause should state that the information must not be disclosed or used for purposes other than evaluating the deal. If the transaction is terminated, the clause should also direct that all confidential information be returned to the seller, and all copies are destroyed.

While conducting their due diligence, a buyer may also inadvertently disclose to third parties that a transaction is in the works. Therefore, it is often in the seller’s best interest to include clauses in the LOI restricting disclosure of the transaction’s existence, such as press releases or public announcements. Additionally, the seller may include provisions restricting the buyer from sharing confidential information with others, such as their professional advisors.

Conclusion

A well-considered and diligently drafted LOI, signed by both parties, can go a long way toward ensuring a successful transaction. However, a poorly drafted LOI can be the final nail in the coffin of your business ambitions. Even if you are a seasoned business, leasing professional, underwriter, or bank loan officer – I would strongly suggest that before you sign anything you give the lawyers for the respective parties at the minimum an opportunity to review or comment on the drafts. Ideally, the lawyers should draft the LOI themselves for the best possible outcome.

If you need help or would like more information on entering a letter of intent, get in touch with our experienced team of business lawyers at CARREL+Partners LLP today.

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Disclaimer:

This publication is for general information purposes and is not to be taken as legal advice. The information within is current only to the date of publishing. If you have any questions regarding article content, please contact the author(s) directly.