To Bind or Not to Bind?
Letters of Intent

A Letter of Intent (“LOI”), also commonly referred to as a term sheet, is an agreement between two (or more) parties that expresses the parties’ intent to pursue some transaction. The final definitive agreement and the underlying transaction can take many different forms, including Purchase Agreements, Mergers and Acquisitions, Farm-Outs, and Joint Ventures. Most of the time, LOI’s or some portion of them are non-binding. But if a LOI is non-binding, who cares if we get something wrong? We can just fix it in the definitive agreement, right? Wrong!

It’s true that a LOI – if properly constructed – doesn’t bind you to deal terms that can’t be changed, but LOIs are critically important for all parties and require expert advice from the outset, primarily for three reasons. First, it is critical to separate the terms of the LOI into two parts: one that includes legally binding terms and another that includes those that are not. Second, the LOI represents an important stage in the parties’ relative leverage, and failure to recognize and preserve that leverage in the LOI may result in a lost opportunity. For example, a prospective buyer of a company will want to ensure there are certain restrictive covenants in their definitive agreement preventing the seller from setting up shop right next door after the sale. One sure way to bring your negotiations to a screeching halt is to wait to bring this up until the negotiation of the final definitive agreement. Finally, a well-constructed and properly detailed LOI serves as a springboard for the quick and efficient completion of the deal by ensuring alignment on key points that (hopefully) won’t have to be negotiated later.

So now that we have discussed the ideal, let’s talk about the reality. Often, the business team negotiates the LOI and only presents the final LOI to their financial and legal advisors to “paper” the deal. Unfortunately, the result of this approach is that the LOI sometimes lacks key terms that perhaps should have been negotiated at the LOI stage to preserve leverage. It also results in a lost opportunity to facilitate an efficient deal process that sets the tone through closing and even the parties’ post-closing obligations. Additionally, many LOIs negotiated between principals lack specificity, which can lead to varying perspectives as the deal advances – often causing one or both parties to be dissatisfied or the deal not to reach closing. Sure, the purchase price is thrown in there, but what is the payment structure? Will it all be in cash? Does funding depend on the buyer’s ability to obtain financing? These questions should be discussed between the parties before signing the LOI. Other commonly left-out provisions include the parties’ indemnification obligations, exclusivity, termination conditions, and post-closing obligations.

As you can see, structuring an LOI isn’t quite as simple as scratching out the purchase price on the back of a napkin. An inadequate LOI can, at best, cause additional time and expense or, at worst, lead to potential litigation if things go south between the parties. However, if properly drafted, the LOI can provide much-needed certainty amongst the parties, limit conflict as the deal advances, and streamline the process of getting to a successful closing. As such, investing time and effort on the front end while preparing the LOI can save time, money, and headaches later down the road.

RR&A has attorneys with decades of experience advising private and publicly traded energy companies at all stages of their transactions. Because so many of our attorneys have spent time in-house, we understand the business and the legal risk in these situations. This is an experience most other law firms can’t offer. Contact RR&A at the earliest stages of your transaction to help evaluate legal and regulatory issues associated with your project location, develop your project timeline, and understand the legal needs at each project phase.

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Miranda Caballero

Miranda is an Associate at R. Reese & Associates and part of the Corporate and Transactions teams. To learn more about Miranda, visit her attorney page.

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