Is a Letter of Intent Legally Binding?
By Hailey, Date published: 2022-05-14
Typically, a letter of intent between two parties expresses the preliminary commitment to engage in business with one another in a deal.
The contents of the letter will stipulate the heads of terms governing this prospective transaction and is intended to assist the parties involved by painting a broad picture of what the deal will consist of before the finer details are resolved.
A party that has signed a letter of intent may be legally bound to its terms depending on how it is drafted and what is contained within it.
In commercial transactions, it is not uncommon for letters of intent to include a provision stating that the letter is non-binding. In the absence of this, it is possible for a lack of intention to be construed from strong non-binding language. Here are some examples:
In transactions where a letter of intent is used; for example, an M&A transaction, the parties will not typically be bound by its terms. As such, it will not transfer the actual ownership of the target company to the buyer.
Certain provisions within the letter of intent may expressly state that certain procedural terms are to be binding, while others should be non-binding.
An exclusivity period provides the purchaser of the asset a set period of time to obtain further information about the target through due diligence and to negotiate the terms of any formal documentation. While the buyer engages in this due diligence and clarifies the terms of the share purchase agreement or asset purchase agreement, this clause provides that the seller cannot engage in selling the target to any third party.
Depending on the jurisdiction this transaction falls under, the law may dictate that negotiating in good faith is not enforceable. Thus, a letter of intent may provide that the seller agrees not to engage in business with any other party other than the purchaser for a specified period of time. This clause can thus lock both parties in and provide assurance for the buyer in an enforceable manner.
Confidentiality clauses, also referred to as non-disclosure agreements or NDAs, protect the parties from certain information being released by the seller or the target to the purchaser over the course of the transaction’s lifespan. During due diligence, the purchaser obtains access to a plethora of highly confidential information.
It is of essence to the seller that this information is not disclosed to the public or used unfairly by the buyer. Therefore, an enforceable confidentiality clause protects the seller from the risk of information being disseminated.
The letter of intent may also include a provision requiring the buyer to pay a deposit. The specifications surrounding how the deposit should be made, for how much, and procedures following potential termination of the contract should also be included within a binding provision of the letter.
If the transaction does not proceed, the purchaser will want to retrieve the deposited amount while the seller may wish to retain it. Thus, enforceable provisions regarding the deposit are important to include within the letter.
Restrictive Covenant Clauses
Similar to the provision accounting for confidential information, restrictive covenants protect the seller and the target from the buyer potentially exploiting sensitive information released to it. Essentially, this clause will stipulate certain prohibitions on conduct during the course of the transaction.
Such as restrictions on poaching employees or customers of the target, and other confidential information which may have been obtained during its due diligence procedure.
Consequences of non-binding terms
A letter of intent may have legal consequences even if its provisions are expressed to be non-binding. For example, it may be used as evidence in legal proceedings should the matter become litigious, or in tax proceedings to determine the commercial substance of a transaction in the context of the application of anti-avoidance provisions.
Similarly, a letter of intent and its non-binding terms may be used as part of a public announcement about the proposed transaction’s heads of terms. It is therefore important to note that even if provisions are stated as non-binding, they may still be used to support future claims against parties.
While a letter of intent, in a commercial context, is generally considered non-binding unless expressly stated otherwise. It remains vital that provisions within it are drafted with care. Consult Zegal’s team of experts to ensure that your letter of intent includes the appropriate amount of detail to assist in setting out the key commercial terms.
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