Negotiating a contract can be a messy process. Parties often need to engage in several rounds of back-and-forth negotiation to find a mutually satisfactory deal, and many details are not settled until the agreement is in the final stages of drafting. Businesses often use a letter of intent (LOI) in these interim stages, especially in particular kinds of transactions, to create an environment conducive to faster and safer negotiation. However, to do this, it may be smart for some terms to be binding. We’ll explore some common binding terms that you might want to include in your own LOI.
1. Confidentiality
At some point during negotiations you may need to exchange sensitive information for the sake of commercial expediency, but the party with whom you are sharing the information might be a competitor; the deal might not close because of a failure to meet contingent conditions; or negotiations might break down.
In these situations, whether you are the buyer or seller, having your confidential information protected by a binding confidentiality clause in your LOI can deter misuse and give you legal recourse in a worst case scenario. Also consider defining the scope of your confidential informationto reduce ambiguity, and identify that the obligation survives the termination of the agreement. However, being bound to confidentiality can scare some investors away, especially at early stages of negotiation, and even more so if you’re just a startup.
See this article for some higher level considerations on confidentiality and obtaining funding.
2. “No Shop” Clause
Investors do not want to invest time and money into conducting due diligence, only to lose the deal because the target company has found another willing investor. The “No Shop” clause, typically insisted upon by the Investor, helps protect against deals with other interested parties (who might drive up the purchase price or start a bidding war) by putting a temporary freeze on negotiations with third parties.
No Shop Agreement: The Company agrees to work in good faith expeditiously towards a closing. The Company and the Founders agree that they will not, directly or indirectly, (i) take any action to solicit, initiate, encourage or assist the submission of any proposal, negotiation or offer from any person or entity other than the Investors relating to the sale or issuance, of any of the capital stock of the Company or the acquisition, sale, lease, license or other disposition of the Company or any material part of the stock or assets of the Company, or (ii) enter into any discussions, negotiations or execute any agreement related to any of the foregoing, and shall notify the Investors promptly of any inquiries by any third parties in regards to the foregoing.
Should both parties agree that definitive documents shall not be executed pursuant to this term sheet, then the Company shall have no further obligations under this section. Binding your counterparty to this clause may secure a legal claim if they use that period to scout out other options. Be aware though that “no shop” clauses aren’t always enforced.
3. Lack of Enforceable Agreement
It is in this clause that an LOI typically can state outright that none of the clauses in the letter are intended to be binding, and then list the exceptions. Typically, the list includes this clause itself; the clauses noted above; clauses such as “Non-Disparagement”, “Limitation of Liability”, “Expenses”, “Intellectual Property”; and any other clauses the parties want to be binding based on the context of the transaction. This is effective risk management for both parties, as it explicitly ends any chance of legal claims arising from what is essentially a stepping-stone to an actual fully binding contract.
Take-aways:
- Explicitly identify which terms are intended to be binding in your LOI
- Explicitly identify which terms survive the termination of the LOI