Letters of Intent – To bind or not to bind?

Letters of Intent – To bind or not to bind?

Robert Maratta
Posted January 7, 2018 Category: Businesses

Thinking about buying or selling a business? You might be considering signing a “term sheet” or “agreement to agree”, sometimes referred to as a “Letter of Intent” or “LOI”. This document lets you put some basic expectations down on paper before getting things formalized. However, if you are not careful at this stage, what you may be doing is signing a binding LOI, whereby you could be legally bound to some very basic and potentially onerous terms before you complete any due diligence on the transaction.

This was the case in the 2009 Ontario Court of Appeal decision of Wallace v. Allen. The Wallace decision involved two friends and neighbours, Graham Allen and Kim Wallace. Allen was retiring and Wallace expressed an interest in purchasing and continuing Allen’s business. After weeks of negotiation, they executed a document which they described as a “letter of intent.” A share purchase agreement was subsequently negotiated and drafted, but Allen ultimately decided that he did not wish to complete the transaction. Wallace sued Allen to force him to carry out the transaction on the terms of the LOI.

At trial, the court held that the LOI did not create binding obligations between the parties. The Ontario Court of Appeal overturned the trial decision and held that the LOI was binding. In reaching this conclusion the Court of Appeal considered that the language in the LOI was sufficiently detailed and that the essential provisions were all contained in the LOI. The court determined that the language in the LOI demonstrated an intention to be bound, and such conclusion was bolstered by the fact that Allen had subsequently announced his retirement and Wallace as the new owner. As a remedy, the court did not order that the transaction proceed in accordance with the LOI, but instead ordered Allen to pay Wallace damages of $560,000 based on the time that it would have taken Wallace to find a new investment opportunity.

The Wallace decision outlines the importance of carefully drafting an LOI. It also shows why it is crucial to wait until the deal has officially closed before making announcements on the expected outcome.

When drafted properly, LOI’s are a great way to suggest a purchase structure and schedule without making any formal commitments before due diligence and the negotiation of a share or asset purchase agreement. To avoid the difficulties in the Wallace decision, the most common type of LOI is a “hybrid” LOI, whereby the parties explicitly agree that the basic terms of the transaction (e.g., price, payment structure, and anticipated schedule) are non-binding, but that the parties are bound to certain terms during the negotiation phase (e.g., confidentiality, exclusivity or “no-shop” agreement duration of due diligence period and/or transaction costs).

However, on a more practical level a good deal of thought must be put into the terms of even the most carefully drafted LOI. Even though a carefully drafted LOI may not legally bind the parties, it sets the stage for the deal and the buyer/seller will refer to its terms when negotiating the definitive share or asset purchase agreement. As such, after signing an LOI it can be useful to emphasize that the non-binding terms are merely guidelines, but that some terms can and do change, especially as a result of material discoveries during the due diligence process.

Involving your legal and tax advisors before signing an LOI almost always strengthens your negotiation position and strategy. Our business law group is happy to advise and help draft LOI’s if they are appropriate for your proposed transaction.

Robert Maratta
Posted January 7, 2018 Category: Businesses

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