CHAPTER 4B LETTERS OF INTENT - DRAFTING CONSIDERATIONS

• Jurisdiction: United States

Oil & Gas Agreements: Purchase & Sale Agreements
(May 2016)
CHAPTER 4B
LETTERS OF INTENT - DRAFTING CONSIDERATIONS
Lee Fanyo ¹
Associate
Lewis, Bess, Williams & Weese P.C
Denver, CO

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LEE FANYO is an associate attorney at Lewis, Bess, Williams & Weese in Denver, Colorado. He advises public and private companies and their management on acquisitions, dispositions, financing and other matters that affect business operations. He has substantial experience in representing the energy industry. He currently serves on the Rocky Mountain Mineral Law Foundation's Special Institutes Committee. Colorado Super Lawyers® magazine named Lee a Rising Star in 2016. After graduating from the University of Denver College of Law, Order of St. Ives, Lee served as a judicial law clerk to the Honorable Justice Allison H. Eid on the Colorado Supreme Court. Before law school, Lee worked as an engineer where he assisted in the design of satellites and defensive missiles. He earned B.S. and M.S. degrees from the Colorado School of Mines.

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Table of Contents

§ I Introduction

A. What is a letter of intent?

B. Purposes of a letter of intent

C. Setting ground rules for the parties' transaction negotiations

D. When and why should parties avoid a letter of intent and negotiate definitive documents?

E. Then why do dealmakers use letters of intent?

F. Above all, use caution when drafting letters of intent

G. How do parties disengage from a letter of intent?

§II Binding Effect

A. Disputes over letters of intent are primarily related to binding effect

B. Principles of contract formation apply

C. Emails can create binding letters of intent

D. Several factors are used to determine whether parties intended to be bound by a letter of intent

1. Express language: A letter of intent must state that it is not binding if the parties do not want to be bound

2. Partial performance: The actions of either party after executing a letter of intent may evidence intent to be bound

3. Essential terms: Agreement on all essential terms may create a binding letter of intent

4. Complexity: Complex transactions are generally governed by formal written documents

E. Even if a letter of intent does not commit parties to a transaction, it may create a binding obligation to negotiate in good faith

§ III What to include in a letter of intent

A. Introduction

B. Disclaimers

C. Preface

D. Due Diligence and Access

E. Exclusivity

F. Good Faith Negotiations/No Obligation

G. Conditions to a Proposed Transaction

H. Confidentiality

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I. Choice of Law

J. Termination

K. Non-Binding

L. Assignment

M. Choice of forum

N. Counterparts and electronic signatures

O. Other provisions

§ IV Conclusion

§ I Introduction^{* *}

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Letters of intent have been characterized as "an invention of the devil [that] should be avoided at all costs,"² or "a gentlemen's agreement . . . which is not an agreement."³ Most attorneys recognize that letters of intent add value because they define preliminary relationships. But some attorneys dislike letters of intent because they seek to define a relationship about which the parties may be uncertain, leading to disputes if the relationship is not consummated as planned.

This paper will discuss drafting considerations applicable to letters of intent in various types of transactions. This Section I contains an overview of letters of intent, their purposes and various high level drafting considerations, including whether to use a letter of intent. Section II discusses the binding nature of a letter of intent. Section III discusses provisions that parties may want to include in a letter of intent and provides examples of them. This paper will not review every issue that might confront an attorney or dealmaker in drafting and negotiating a letter of intent. Instead, its purpose is to provide an overview of issues applicable to letters of intent and

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offer examples to guide parties in negotiations.

A. What is a letter of intent?

A letter of intent, or LOI, is a written document that defines preliminary understandings among parties who are considering a transaction. The scope of letters of intent varies depending upon the transaction. Some may be a short bullet point list of the material economic terms of a proposed transaction. Others may include considerable detail and resolve complicated issues that are more typically negotiated in a later definitive agreement. Practitioners use a variety of terms to refer to letters of intent: term sheets, memorandums of understanding, indications of interest, and others - even an email can be a letter of intent.⁴ The name of the document may be relevant to determine the parties' intentions,⁵ but typically it is the substance of the document that matters.⁶ And parties intending to use a letter of intent as a guide to later negotiations, rather than as a binding document, should avoid calling a letter of intent a "contract" or an "agreement" - for obvious reasons.⁷

B. Purposes of a letter of intent

Letters of intent have several purposes, which depend on what the parties are contemplating. Normally, the purpose of a letter of intent is to memorialize the basic terms of the transaction which the parties may have been discussing and negotiating over the course of days or weeks, and to establish the proposed structure of the transaction, including price, the form of the transaction (for example, an asset sale, stock sale, or merger), the anticipated timing and other important issues.⁸ A second purpose is to give the parties legal advisors some guidance from which to prepare a contract. Letters of intent are also useful in building relationships among the parties, providing a basis on which a buyer may begin to access the seller's data, or for the buyer to lock the seller into a standstill period during which time the buyer can dedicate the time and effort necessary to evaluate and complete the transaction without the danger of another suitor

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offering a superior bid.

C. Setting ground rules for the parties' transaction negotiations

Letters of intent can be useful in defining the relationship among the parties to a prospective transaction.

First, each side may want to enter into a letter of intent as a way to jump-start the due diligence process, while also protecting itself from the risks inherent in that process.⁹ For the buyer, this means establishing exclusivity and other protections that will protect the money and time it expects to spend on legal, financial and technical diligence. For the seller, this means obtaining some assurance that the buyer is serious about pursuing a transaction so the seller can forego opportunities with other prospective buyers. Establishing informal rules in the letter of intent allows each party to move forward with the due diligence process that is critical to consummating a transaction. In this way, buyers are able to review the seller's records and assets to validate their purchase price against their required return on investment. At the same time, the seller may want the buyer to learn about its assets because, in the seller's view, that information will support the seller's price expectations.

Second, even when it is non-binding, executing a letter of intent brings with it an additional level of formality that establishes for the parties a slightly stronger, albeit loose, commitment that ongoing conversations do not establish. There is an intangible commitment associated with signing a document that outlines the manner in which the parties will proceed over a period of time. While signing a non-binding letter of intent may not obligate the parties legally, dealmakers may import significance to a written document. After all, the failure of a party to work in good faith toward a transaction after signing a letter of intent may carry consequences, most notably creating negative reputational issues for the party that walks away,¹⁰ even when the letter of intent disclaims a duty to negotiate in good faith.¹¹

Future potential deal partners may learn of a party's reputation for walking away from

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deals and proceed in a more cautious fashion in the next transaction. In industries where many transactions begin on a napkin or with a handshake, one's reputation holds significant value. So the letter of intent is important even if the document is not binding on either party.

D. When and why should parties avoid a letter of intent and negotiate definitive documents?

Sellers should try to avoid letters of intent because they give buyers significant leverage and sometimes a low-cost option to purchase the seller's assets. For that reason, sellers often offer buyers a proposed form of purchase agreement instead of negotiating a letter of intent so that the seller commits the buyer to a specific, fully negotiated transaction before it takes itself off the market. This strategy puts sellers in control of the transaction because the buyer must react to the seller's proposed terms. This strategy may also weed out buyers who are not serious about pursuing a transaction and can help avoid a protracted sale process. A slow sale process may be harmful to sellers because their assets may be declining in value and market dynamics change quickly.

For buyers, letters of intent are useful to commit the seller to exclusivity for a period of time. Even so, buyers may want to avoid a letter of intent and negotiate definitive documents when they prefer to flesh out details at the same time that they establish price and structure. That is because attempting to agree on complex legal matters and minutiae in a letter of intent is a wasted effort with an uncertain outcome. Better to negotiate details in the definitive document rather than in the letter of intent. In some cases, an overly detailed letter of intent can move parties farther apart instead of bringing...