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Legal Tips and Tricks: Deal Negotiations Using an LOI/MOU

Often, companies will try to secure a Letter of Intent or Memorandum of Understanding (“LOI/MOU”; the two expressions are used interchangeably) from a potential contracting counterparty, for the purpose of outlining the high-level terms of a contractual relationship and to help demonstrate the viability of a project. An LOI/MOU can be used for many purposes, including outlining broad terms of an asset purchase or acquisition agreement.

 

Such high-level outlining is helpful in many circumstances:

1. When securing financing:  it is useful to demonstrate to potential financiers your potential for orders.  Programs like Kickstarter are ideal for that purpose, as, not only are you able to demonstrate orders, paying customers are waiting to receive the finished product.  Use an LOI/MOU to build an order pipeline.

2.  When entering into merger/acquisition discussions:  to set the terms of the future agreement in advance before opening the financial and legal books and records of the company – so that, at a high level, the merger/acquisition value and terms are negotiated in advance.

After the LOI/MOU is settled and the formal agreement is being entered into, certain closing conditions are usually set out, including the statement that nothing has adversely affected the business in a material way since the time of the initial deal negotiation (this is referred to as a “MAC” or Material Adverse Clause).  This is important, to ensure that you are getting what you paid for.

 

3.  When developing the framework for any future agreement: an LOI/MOU can set “guiding principles”, to further the negotiations and discussion to ensure that the parties agree with the spirit of the proposed agreement.

 

Binding vs. Non-Binding Nature of the LOI/MOU

An LOI/MOU is often structured as an “agreement to agree” and not binding.  However, it is useful to include certain binding provisions.  Some consideration must be given to make the LOI/MOU binding, and perhaps this is the opportunity to explore a future business relationship, or something more tangible, such as $500 in cash.

Typically, the binding provisions to include in an LOI/MOU are:

  • Confidentiality: of the deal negotiations, and of information shared between the parties.
  • No-shop“: an agreement not to shop the proposed deal around to other suitors, which adversely affects the party that is disbursing, oftentimes, significant resources into legal and financial due diligence.
  • A “break-fee“: a dollar value penalty, often used to cover legal fees, in the event that a deal – usually an M&A deal – fails for any reason.
  • Termination date: this is useful to prevent the other party from taking the potential deal off the table from other buyers indefinitely.  A “time is of the essence clause” is good to include as well, for this reason.
  • Dispute Resolution provisions:  To plan for the worst, a good dispute resolution process sets out the forum (location) and rules for litigating/arbitrating the LOI/MOU.
  • Duty of good faith:  This places a general duty on the other party to ensure that they are not wasting your time and money through the exploratory process, which is useful to establish if you are forced to go to court to make a claim for expenditures wasted trying to close a potential transaction.
  • Costs:  It’s important to specify who is paying the legal bill up front, especially if you are concerned that the other party is going to try to charge you for it.  A limitation of liability clause is also good to include for this reason.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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You may be liable for expenses when a contract is broken

Expenses accrued prior to the formation of the contract
RELIANCE OR CONSEQUENTIAL DAMAGES (SHOULD BE LIMITED)

When two or parties enter into a contract, which is subsequently broken, the parties that were not responsible for breaking the contract may be entitled to damages resulting from the expenditures incurred after the formation of the contract as well as the expenditures incurred in negotiating the contract.

Anglia Television Ltd. v. Reed stands as precedence for this. In this case, Anglia (the “plaintiff”) contracted Robert Reed (the “defendant”) to star in a television production. The defendant had agreed to come to England to film for the production; however, the defendant later repudiated the contract and informed the plaintiff that he was no longer available to participate in the film. The plaintiff had already incurred large expenses in preparation for filming and sued for recovery of the expenses. The defendant claimed that the plaintiff was not entitled to these expenses because the expenses had been incurred prior him signing the contract.

The court found that the plaintiff could claim the expenses that were incurred before the contract was signed. However, there is a duty to mitigate damages, and the court found that these expenses could only be claimed against the defendant if it was reasonable for both parties to assume that the incurred expenses would be wasted and not reusable by the plaintiff if the contract was broken.

This case illustrates the importance of:

1. specifying which expenses are included as part of a contract and which expenses are external to the contract;

2. the importance of requiring each party to be responsible for their own costs in the term sheet preceding an agreement, or in an agreement itself;

3.

ensuring that contracts include a “break fee” or liquidated damages provision that sets out the quantum of expenses (if any) to be payable if the contract is broken;

4. a limitation of liability provision that rejects the application of “reliance” or “consequential’ damages.

MAKING THE PARTIES WHOLE – BUT CAUTION: NO DOUBLE-DIPPING

If a contract is broken, a court will attempt to place both parties a position equivalent to the position that would have resulted from the contract being performed. As a result, when a contract is broken, an individual cannot claim for both profits and expenses, as this would result in double compensation. The reasoning for this is that a party would need to incur the expenses in order to make the profit.

Pitcher v. Shoebottom [1971] stands as a precedent for this. This case represents an example of disgorgement, the forced surrender of profits obtained by illegal and/or unethical acts. In this case, the plaintiff had made an oral agreement to purchase land from the defendant; however, the defendant subsequently sold the land to another party, thus breaching the contract between the plaintiff and the defendant. The plaintiff had made several prior payments towards the purchase of the land. The plaintiff sued for the payments made towards the payment of the land and for the profits that would have been accrued had the contract been completed.

The value of the land during the agreement was $2,000, whereas the value during the court trial was approximately $8,000. The court found that the plaintiff was entitled to this difference in value because the defendant had wrongfully attained those profits. The court also found that the plaintiff was entitled to have the payments made towards the purchase of the land returned. Finally, the court did not award the plaintiff with the expenditures that had been accrued prior to the agreement, such as the cost of surveying the land and investigating the title, because these expenditures would have been necessary if the if the transaction had been completed as planned. The court’s main objective was to allow the plaintiff to be a situation similar to the situation had the contract been performed.

This case illustrates the importance of specifying which expenses are included as part of a contract and which expenses are external to the contract. Should the contract be broken, it is important to disclose the expenses that can be recovered.

Unfulfilled contracts – damages will equal what is required to fulfill the contract.
When drafting a contract, ensure that you specify whether or not the outcome of that contract is guaranteed. If you find yourself in a situation where the outcome of the contract may be difficult to obtain, ensure that you include language that protects you from failure to deliver what you promised. For example, if you ensure that a certain procedure will cure an illness, ensure that the contract between you and the other party states your liability should the procedure fail.

If this liability is not explicitly stated in your contract, then a court will likely award damages to the patient that is equal in value to the difference between the value of what was promised and what was received.

Hawkins v. McGee [1929] stands as a precedent for this. In this case, Hawkins (the “plaintiff”) approached McGee (the “defendant”) to inquire about having the scars on his hand removed. The defendant guaranteed that he could remove the scars from his hand. The defendant used a skin grafting technique using skin from the plaintiff’s chest to remove the scars. The technique failed to remove the scars, and the skin graft further caused the plaintiff’s palm to grow hair. The plaintiff sued for breach of contract, and sought damages for the pain from the operation and the damage caused to his hand.

The court awarded damages that were equal to the difference between the value of what the plaintiff was guaranteed to receive and what the plaintiff actually received. The value was calculated as being the cost of correcting the error from the procedure and removing the scars. The court found that the plaintiff should be awarded damages that are equal to the amount needed to place the plaintiff in the position that the plaintiff would have been in had the contract been completed.

In another example, in Groves v John Wunder [1939], S.J. Groves & Sons Company (the “plaintiff”) leased a plant for excavating and screening gravel to John Wunder Co. (the “defendant”). The two parties agreed that the defendant would remove the sand and gravel from the property and leave the land at a uniform grade at the end of the contract. However, the defendant instead removed the richest portions of the gravel and failed to leave the property at a uniform grade. The plaintiff stated that the cost of bringing the property to uniform grade would be $60,000.

The court noted that the cost to the defendant, given their experience in performing tasks of this nature, would have been $12,160 had the contract been properly fulfilled. However, since the defendant had abandoned the project, the court found that the plaintiff was entitled to the cost to perform the part of the contract that had been breached. The contract required the defendant to leave the property at a uniform grade and the cost of performing this task at present was $60,000. Therefore, the plaintiff was awarded $60,000 in damages.

To avoid damages of this nature:

1.Avoid specific representations and warranties – unless you are certain you can achieve them.

2.Provide stages of approval within the contract that require offer and acceptance at the conclusion of any stage and the commencement of a new stage.

3.Make sure that you have the funds to fulfill the contract if you’re forced to make good on it.

4.Add language to the contract limiting your liability to the amount paid to you under the contract (or some other lesser amount). So a refund can be made of the money received.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Exorbitant Fees Leads to Demise of Distributor

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Read the article here.

This article is about a lawsuit alleging fraud by the supplier, who controlled the distributor, in the form of exorbitant distribution fees. “The effect of Weinstein’s (the supplier) scheme was to utilize the Distribution Agreement to transfer to Weinstein, as a result of Weinstein’s ownership of the Debtor, the Debtor’s cash by charging the Debtor above-market rates in the Distribution Agreement instead of the net revenues that could be obtained if the Distribution Agreement reflected market terms and industry norms.”

Agreements which are overly-biased in favour of one of the parties are more likely to be terminated early, or result in financial difficulties for the ‘junior’ party.

Read the article here.

Take away:

  • One sided distribution agreements are less likely to succeed.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Billing and Payment for Expenses Should Be Set Out in Detail in Consulting Contracts

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Read the article here.

While it seems obvious that billing and payment of expenses should be clearly dealt with in consulting contracts, many parties fail to address such details as: What happens if expenses are submitted late? Are original receipts required? How will payment be made? What types of expenses are covered? What is the procedure for authorizing expenses? Will verbal authorizations be accepted?

Other key concepts for consulting contracts include: ownership of IP, warranties by the consultant of the quality of their work, confidentiality, and cancellation/termination of the contract. Consultants should carefully review the contractual description of the project. It is important that both parties are clear on the extent of the work to be done. Equally important are any schedules to the agreement. These schedules often contain some of the most important details.

Read the article here.

Take away:

  • One of the key elements of a consulting contract deals with expenses. It should clearly define expenses and set out any budget restrictions, as well as a schedule for billing and payment.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Entering Into a Term Sheet is Hard Enough, Getting Out of One Can be Even Harder

As a company entering into a possible investment, when accepting an investor term sheet, consider the provisions relating to termination of that term sheet.  There’s nothing worse than being stuck in an unlimited holding pattern while trying to raise funds.

Here are some tips to make sure that your interests are protected.

  1. Set an automatic termination date (30 days, 60 days) that will provide sufficient time for due diligence and receiving and reviewing legal documentation.

     (The termination date can be extended after that day by written approval).

  2. Make sure that the termination provision is in writing (can be in a non-binding term sheet with certain binding provisions, including the termination mechanism).
  3. Avoid a term that requires the company to pay legal fees, unless the deal successfully closes.
  4. Honour the “no-shop/break fees” clause (if any) i.e. do not start shopping the deal around, or you may be on the hook for paying the agreed-upon break fees.
  5. Don’t start performing as if the deal has closed until it actually closes i.e. until funds are transferred, documents are signed, and so on.  The court has looked at “non-binding” deals in which the parties starting to work together, co-market and so on, and in some cases has considered that the deal had actually closed based on such (and other) performance by both parties.

     In doing so, the court has found that a “non-binding” term sheet is therefore binding.

Reviewing multiple term sheets can be tricky.  In some cases the investors will welcome co-investors, and will agree that a lead investor can protect their interest, can be responsible for management decisions, and so on.  In other cases, the investors will consider themselves competing.  When faced with multiple term sheets you as a company should consider the long term strategic relationship that you are looking to develop, trust your instincts, and make sure that you consult with your trusted advisors and legal counsel before selecting your investor.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Legal Tips and Tricks: Boilerplate Provisions Of Your Agreement

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Don’t ignore the boilerplate provisions of your agreements.  Although the language appears the same every time you read these clauses, subtle differences can and will make a difference in interpreting your commercial agreement or acquisition transaction documents.

By the time you get to the final page of your commercial agreements your eyes will have started to glaze over.  Words such as “amendment”, “assignment”, “waiver”, “severability”, and “arbitration” all seem vaguely familiar, but if you are reading someone else’s contract, make sure you read these carefully.  Clauses in this section of a contract are often considered to be “boilerplate” or standard, often repeated language.  Be cautious when reading this section of your contracts as the subtle nuances will work to your favour or against you.  Once you understand the intent of the clause, you can read a boilerplate clause more rapidly and with greater clarity.  It is also helpful if you or your counsel have a checklist of what is considered standard in your contracts, to compare against agreements that are sent to you.

Here is some helpful information on the “General Matters” clauses to help you to round out your agreements, and to make sure you’re aware of the risks and protections that are built in.

Amendment:  necessary to ensure that you are not inadvertently changing the agreement every time you have a discussion about it.  Amend in writing, signed by all parties.

Assignment:   important in the context of mergers and acquisitions or reorganization of your business, an individual or company should be able to assign an agreement to a holding company owed by them.  As well, the contract should be assignable to an acquiring company (who may see the contract as part of the assets they are acquiring).  Language can be included that allows a rejection of the assignment if the acquiring company is in direct competition with either party.  In many contracts only one party is permitted to assign the agreement (for example, an employee would not have a right of assignment as it is their personal service that is sought).

Enurement:  coupled with the assignment clause, this clause, if properly drafted, will extend the benefits of the contracts to successors or assigns.   In the case of a successor – this ensures that your estate has the right to benefit from an active contract.  In the case of an assign, this would extend the benefit to an acquiring or merging third party to the contract.

Waiver:  this clause preserves your rights in the event that you have been relaxed about enforcing your contract and your counterparty tries to assert that the contract has therefore become more relaxed as a result.  The “doctrine of waiver” is the legal concept that continuing or repeating waiver of a certain right can be construed as an ‘intentional relinquishment of a known right.’  This doctrine is to be avoided with a no waiver clause, so that your negotiated rights are not diminished because you are “being nice”.  Make sure to include language that requires a waiver to be in writing.

Costs:  if there is an ongoing expense (legal or otherwise) that could result from negotiation of an agreement, a costs clause should be included to clarify which party is paying for the ongoing legal expense.  The costs clause is not to be confused with the “expenses” clause – which deals with ongoing expenses that are incurred in performance of an agreement.  An expenses clause is usually found in an employment or consulting agreement, whereas a costs clause might be found in an M&A agreement.  In the context of M&A, a break fee is sometimes included to compensate a party for the legal process, once the transaction reaches a certain stage (usually due diligence).

Dispute resolution: consider whether you would rather deal with a dispute via negotiation, arbitration or litigation (or by climbing a ladder past each of these).   Many parties prefer to end the dispute in final and binding arbitration, as the costs and length of time taken to litigate can be ugly.

Notice:  when a party to an agreement is actively trying to terminate a contract, they will often rely on the method and location of delivering notice clause to take the position that the contract was not (for example) properly renewed.  Tricky counterparties could take the position that notice in person or via email is not the required method for notice under contract, and therefore, that the renewal period has expired.  Keep an eye out for this especially in lease renewals or the renewal of an exclusive negotiations period in the context of an M&A transaction.

Severability:  a contracting party may place clauses in a contract that create a period of non-competition or an interest rate for non-payment that might in the future violate a changing law.  This clause is intended to sever an offending provision and to flag to the court that the contracting party had intended to be reasonable, to avoid the court from setting aside the entire agreement as “unconscionable.”

Headings:  a well-organized contract contains plenty of headings at the beginning of each section (similar to in this article) that will allow a reader to navigate a contract quickly.  In contrast, a clever counterparty may remove the headings to make the contract less readable if they are looking to discourage negotiation.  Some law firms/companies will hold on file an internal and external version of a contract, with only the internal version containing headings.   A reasonable lawyer cannot help but be annoyed by this, as it takes away from the basic principle of consensus ad idem or “meeting of the minds”.  The headings may not capture the meaning of the contract and this clause will flag that issue to the readers so that they do not rely on summary text.

Entire Agreement:  parties may be relying on internet brochures, or advertisements or information outside of the contract, to come to an agreement.  The entire agreement clause will specify that all outside information is superceded by the contract.  Understanding this, the contracting party should carefully read the contract before signing and either strike out items that were not part of the deal, or add any additional items in, and ask the counterparty to initial the changes.  This is a good rule for everyday life contracts (rental car agreements, apartment rental agreements, insurance agreements) as well, in which standard form contracts may not capture some of the pre-contract discussions.  An experienced counterparty will not have a problem with making those changes.

Counterparts:  not everyone is always able to be in the same room at the same time to sign an agreement.  This clause specifies that parties can sign separately and that scanned-in or faxed-in signatures, once collected, form the agreement.  A careful person will ask that every page of the agreement be initialled and that the entire agreement be scanned in and sent together.

These are but a few of the commonly used clauses that are found in the General Matters section of most contracts.  Check out www.clausehound.com – a free source for legal language (which I am a contributor to).  Bookmark here for a list of generally used clauses with sample language provided, and do a quick double-check before signing your contracts to see if you have missed any standard clauses.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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