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:
- 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.
- 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.
- 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.