Letters of Intent: A Word to the Wise

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Alan S. Petlak, Ballard Spahr LLP

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Letters of Intent: A Word to the Wise

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Prepared By:Alan S. Petlak, Ballard Spahr LLP

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Letters of Intent: A Word to the Wise

Alan S. PetlakPartner, Ballard Spahrpetlaka@ballardspahr.com424.204.4320

Material By: Alan S. Petlak & Nahal Zarnighian

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BACKGROUND

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Definition

• “Letter of intent” is not a legal term of art

• A written statement detailing the preliminary understanding of parties who plan to enter into a contract or some other agreement. Black's Law Dictionary (10th ed. 2014)

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Definition

Other documents that may be deemed to be a letter of intent:

• Memorandum of Understanding

• Agreement in Principle

• Letter of Understanding

• Letter Agreement

• Term Sheet

• Transaction Outline

A rose by any other name would smell as sweet

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Issue: Is it binding or non-binding?

• Generally, an application of contract law

• The test for enforceability of the LOI may differ between states

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Factors used to decide

The basic factors used in deciding whether a LOI is enforceable are:

1) expressions of intent to be bound;

2) the presence of open terms;

3) whether there has been partial performance; and

4) the customary form for such transactions

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Issue: Is it binding or non-binding?

1. Intention of parties

• The LOI will be a binding agreement if the parties intended to be bound – This is key

• Courts will first look to see if the plain language of the LOI manifests an intention by the parties to obligate themselves to the terms of the document

• Objective standard: Would an objective observer reasonably believe that the party intended to be bound?

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Issue: Is it binding or non-binding?

2. Open Terms• The fact that one or more terms of a proposed bargain are left

open or uncertain may show that the parties may not intend to be bound

• Alternatively, if the LOI contains all of the essential elements of the agreement a court may conclude that the parties intended to be bound

• Courts will expect a more formal agreement based on the complexity of the transaction

Ex. Selling an ice cream cone vs. selling an S&P 500 company

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Issue: Is it binding or non-binding?

3. Action of Parties

• One or both of the parties starts performing under the terms of the agreement and the other party accepts that performance

• If the parties act as if they have an agreement, but just have not worked out all of the deal points, courts may find that the LOI was a final agreement

• Under such circumstances, courts will fill in those final details using "gap fillers"

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Issue: Is it binding or non-binding?

4. Customary Form

Arguments regarding customary form are often centered on the following:

1. Because the entire market or all transactions of this type are always finally consummated with an informal LOI, the LOIshould be binding

2. Because the two parties always did their transaction in an informal manner with the LOI as the final instrument, the LOIshould be treated as binding

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Why do an LOI?

• An economical and efficient manner to move transactions forward because they are shorter and more informal so they can usually be drafted quickly

• Allows parties quickly to agree upon and document the key deal points without negotiating full agreement

• Allows parties to focus on the essential terms without having to be slowed down by the “details”

• Provides some assurance that the parties possess a legitimate interest in closing the deal

• Resolves preliminary issues prior to negotiating the details of the final agreement. Negotiations later on are more focused and straightforward so a final agreement can be reached more quickly and efficiently

• A party can feel morally committed to the terms even if the LOI is not “technically” binding

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Why not to do an LOI

• Some parties will shop the deal around or see whether other parties would be willing to beat the terms spelled out in the LOI

• A court may impose liability on a party based on the LOIwhen the parties did not originally intend for it to be a binding agreement

• Alternatively, if a party wants the LOI to be enforceable because it wants the deal, a court may conclude that the LOI is unenforceable because it is not binding

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BEST PRACTICES

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Drafting Tips: To make sure the LOI is not enforceable

State in clear and unambiguous terms that it is not an enforceable contract

• "The validity of said proposed agreement is subject and conditioned upon the parties agreeing upon and reducing to writing all terms and conditions necessary and incidental to the validity of said proposed agreement“

• "It is expressly understood that this letter agreement merely sets forth a preliminary statement of intentions with respect to the Contemplated Transaction,…[it] does not constitute an obligation binding on either party....A binding agreement with respect to the Contemplated Transaction will result only from the execution of a definitive agreement with respect thereto and will be entirely subject to the terms and conditions contained therein“

• "This is not intended to be a binding agreement . . . all communications between the parties are not contractual [and] it is intended that no legal rights or obligations shall come into existence . . . unless and until a mutually acceptable Purchase Contract is executed by both parties.”

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Drafting Tips: Other points to considerLeave Material Terms Open

• An agreement that fails to specify material terms is generally an unenforceable agreement to agree

• Failure to specify material terms contemplates further negotiations and execution of a formal contract

• Make sure the Agreement sets forth the parties’ intentions

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Examples of Language

from Cases

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Laks v. Coast Fed. Sav. & Loan Assn., 60 Cal. App. 3d 885 (1976)

Letter of conditional commitment:

Coast Federal Savings, hereinafter referred to as Coast, is pleased to move from our letter of intent to commit, dated December 11, 1972, to this conditional commitment, as follows:

• Loan Amount: $7,000,000; which must be supported by appraised value with resulting loan to value ratio not in excess of 75%.

• Fees: 1% Non-refundable collected at time Commitment Letter accepted and an additional 1% Collected at time of loan closing.

• Construction Financing: Chase Manhattan Bank to be lead lender, Wells Fargo Bank to inspect and make progress payments, Coast to participate in not more than 70% of said loan. Coast to have the option of reducing said position and increasing Wells Fargo Bank's by same amount. Coast has begun conversation with Mr. Robert Bevins, Vice President, Wells Fargo Bank (213) 683—7259 in Los Angeles.

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• Funding: Interim Loan to be recorded no later than March 30, 1973.

• Appraisal: Must be acceptable to Coast, Chase and Wells; Coast acknowledges receipt of a feasibility study prepared by the National Feasibility Corporation. Said study is still under evaluation by Coast; please refer to correspondence between National and Coast.

• Ownership of proposed project between Ernest Laks and Richard Schubot to be clarified; Dunn & Bradstreet reports required on both. Final Limited Partnership Agreement subject to Coast review and approval.

• Property Management: Management of subject property subject to review and approval by Coast Federal. Resume of owners management history plus copies of Management Contract, if applicable, to be forwarded for review. Plans, specifications and detailed cost breakdown requested on proposed project."

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Court held this was not a binding contract because essential terms were missing:

• Silent on lead lender's loan commitment

• Lack of payment schedule

• Security for loan not identified

• Rights and remedies not specified in event of default

• Note: I would argue that this is a poor LOI because parties’ intention is not set forth clearly

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Drafting Tips: BeneficialSeparate Non-Binding Terms (Hybrid LOI)

• Typically, LOI will delineate certain provisions as binding Confidentiality Return of confidential materials Exclusivity/"No Shop" provisions Non-circumvention Termination

• Non-binding terms usually include the material points of the business deal Price and price adjustments Obligations of parties Management Deliverable Risk allocation

BEWARE: State it clearly

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Drafting Tips: More ExamplesPART ONE—NONBINDING PROVISIONS

The following numbered paragraphs of this Letter (collectively, “Nonbinding Provisions”) reflect our mutual understanding of the matters described in them, but each party acknowledges that the Nonbinding Provisions are not intended to create or constitute any legally binding obligation between Prospective Buyer and Prospective Seller, and neither Prospective Buyer nor Prospective Seller shall have any liability to the other party with respect to the Nonbinding Provisions. Only when a fully integrated, purchase agreement (“Purchase Agreement”), and other related documents, are prepared, authorized, executed and delivered by and between all parties, would there be a binding agreement. If the Purchase Agreement is not prepared, authorized, executed or delivered for any reason, no party to this Letter shall have any liability to any other party to this Letter based upon, arising from, or relating to the Nonbinding Provisions.

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Drafting Tips: More ExamplesPART TWO – BINDING PROVISIONS.

Upon execution by Prospective Seller of this Letter or counterparts thereof, the following lettered paragraphs of this Letter (collectively, “Binding Provisions”) will constitute the legally binding and enforceable agreement of Prospective Buyer and Prospective Seller (in recognition of the significant costs to be borne by Prospective Buyer and Prospective Seller in pursuing this proposed transaction and further in consideration of their mutual undertakings as to the matters described herein).

A. Nonbinding Provisions Not Enforceable. The Nonbinding Provisions do not create or constitute any legally binding obligations between Prospective Buyer and Prospective Seller, and neither Prospective Buyer nor Prospective Seller shall have any liability to the other party with respect to the Nonbinding Provisions until the Purchase Agreement, if one is successfully negotiated, is executed and delivered by and between all parties. If the Purchase Agreement is not prepared, authorized, executed or delivered for any reason, no party to this Letter shall have any liability to any other party to this Letter based upon, arising from, or relating to the Nonbinding Provisions.

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Drafting Tips: No Shop Clauses• Recite the consideration separately

• Put a time limit

• Identify the property

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Drafting Tips: BeneficialNo Shop Clauses

"The Company agrees that during a period of sixty (60) days from the date of the signing of this letter of intent, the Company, its shareholders, board members, employees, affiliates, or any agents thereof shall not, directly or indirectly, take any action to solicit or support any inquiry, proposal, or offer from, furnish any information to, or participate in any negotiations or discussions with, any third party, or enter into any agreement or arrangement regarding any equity/debt funding or sale. Notwithstanding the foregoing, if neither the Company nor the Investors give written notice of its wish to terminate this letter of intent at least five (5) days before the end of the exclusivity period, the letter of intent shall remain in full force and effect, and the Company shall continue to negotiate exclusively with the Investors until the Company or the Investors give written notice of termination"

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Drafting Tips: Mistakes to AvoidExplicit Label

• Labeling a document "letter of intent" is not enough to preclude a court from finding that a document is an enforceable contract

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Drafting Tips: Mistakes to AvoidConduct

• Parties expectations may be inferred from the conduct of the parties and surrounding circumstances

• Plaintiff who occupied the property and ran the business pursuant to the LOI manifested both parties’ intent to be bound by LOI

• “The fact that Sandy's allowed CFS to take possession of the premises and to begin operating it as a restaurant strongly suggests both parties considered terms of the letter of intent as being binding without the need for the execution of additional documents.” California Food Serv. Corp. v. Great Am. Ins. Co., 130 Cal. App. 3d 892 (1982)

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GOOD FAITH DUTY TO NEGOTIATE

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Where States Disagree

• Even if a LOI is clear in expressing that it does not embody the final substantive agreement of the parties, a party may argue that the LOIis an enforceable “contract to negotiate an agreement” in good faith

• In such jurisdictions, courts may impose a "good faith duty of negotiation" relating to the parties efforts to finalize the contract

• These jurisdictions include California, New York, Illinois, Maryland, and Massachusetts

• Jurisdictions where this right is not recognized include Tennessee, Kentucky, Texas, Virginia, and Washington

• Note: If a party violates the duty to negotiate in good faith in jurisdictions that recognize that right, the aggrieved party is entitled to reliance damages

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CASE LAW

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California: Copeland v. Baskin Robbins U.S.A., 96 Cal. App. 4th 1251 (2002)• Baskin Robbins and Copeland commenced negotiations for the

purchase of an ice cream manufacturing plant

• After several months of negotiations an agreement took shape under which Copeland would purchase the plant's manufacturing assets and sublease the plant property

• Baskin Robbins would purchase seven million gallons of ice cream from Copeland over a three year period

• Baskin Robbins sent Copeland a letter outlining their proposed terms with a request that Copeland sign the letter and return it to Baskin Robbins together with the $3,000 deposit

• Copeland signed the term sheet and made the deposit and the parties continued negotiating over the terms of the agreement

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California: Copeland v. Baskin Robbins U.S.A. (cont.)

• After further negotiations, Baskin Robbins wrote a letter to Copeland breaking off negotiations and returned the deposit

• The Court found that the LOI did not contain all essential terms so there was no binding agreement

• However, the Court held that the LOI created a good faith duty to negotiate and, as a result, plaintiff was entitled to out of pocket costs in reliance damages

• Note: Don’t forget the covenant of good faith and fair dealing

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Maryland: Falls Garden Condominium Association v. Falls Homeowners Association, Inc., 441 Md. 290 (App. Ct. 2015)

• Condominium Association adjacent to the Homeowners Association for 23 years thought it owned 67 parking spaces between the two developments

• Condominium Association later found out that it did not have title to the spaces

• The Condominium Association filed a complaint for declaratory judgment

• The parties entered into settlement discussions that led to an LOI which provided that the parties would enter into a lease with a term of 99 years for the parking spaces

• The Condominium Association did not enter into the lease as drafted and argued that the LOI was unenforceable

• The Homeowners Association moved to enforce the LOI

• The trial court concluded that even though the LOI did not state on its face whether the parties intended it to be binding, the LOI reflected the agreement that the parties reached and was therefore binding

• The Court of Special Appeals affirmed in 2013, finding the LOI was unambiguous and that “a reasonable observer would conclude the parties intended to be bound.”

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Delaware: SIGA Technologies, Inc. v. PharmAthene, Inc., 67 A.3d 330 (Del. Sup. Ct. 2013)

• SIGA was in the process of developing a new drug but required funding

• In 2006, SIGA and PharmAthene entered into a merger agreement, which provided that, in the event the merger failed to close, the parties would negotiate in good faith a license agreement consistent with the terms of a nonbinding term sheet between the parties attached to the merger agreement

• After the merger failed to close, SIGA terminated the merger agreement and the parties commenced negotiations regarding a license

• At the time of the license negotiation, SIGA’s drug had achieved some critical milestones, making the drug much more valuable than was the case at the time the term sheet was negotiated

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Delaware: SIGA Technologies, Inc. v. PharmAthene, Inc. (cont.)

• Subsequently, SIGA proposed economic terms for the license agreement that were “vastly different” from those in the term sheet

• PharmAthene sued SIGA claiming it was obligated to execute a license agreement on terms consistent with the term sheet

• The court rejected PharmAthene’s claim that the term sheet was a binding license agreement but ruled that PharmAthene was entitled to damages for breach of SIGA’s obligation to negotiate in good faith

• It found SIGA liable for damages in light of PharmAthene’shaving provided financial and operational support to SIGA based upon the nonbinding term sheet

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Delaware: Global Asset Capital LLC v. Rubicon US Reit Inc., C.A. No. 5071-VCL (Del. Ch. Nov. 16, 2009)

• Rubicon entered into an LOI with GAC providing that GAC would serve as a “stalking horse” for Rubicon should the company decide to auction itself in bankruptcy

• Along with confidentiality and no-shop agreements on the part of Rubicon, the LOI stated that the parties would promptly negotiate the language of a support agreement setting forth the terms under which GAC would serve as the stalking horse in a bankruptcy auction

• The parties further agreed that the LOI would terminate if Rubicon filed for bankruptcy before the support agreement could be finalized

• Soon after signing the LOI, Rubicon reached an understanding with its creditors that relieved its liquidity crisis and any urgent need to seek bankruptcy protection

• As a result, even though GAC forwarded a working draft of the support agreement, Rubicon failed to negotiate that draft with GAC

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Delaware: Global Asset Capital LLC v. Rubicon US Reit Inc. (cont.)

• GAC filed a lawsuit against Rubicon to enforce the LOI, claiming that by disclosing the existence and terms of the LOI to gain concessions from its creditors outside of a bankruptcy proceeding, Rubicon breached the confidentiality and no-shop provisions

• GAC sought temporarily to restrain Rubicon from further breach of the LOI and further sought to stop Rubicon from selling to another bidder in bankruptcy without recognizing GAC’s status as the stalking horse bidder

• In granting GAC’s motion for a temporary restraining order, the Court made clear that “sufficiently definite letters of intent do indeed create enforceable obligations“

• According to the Court, “parties enter into letters of intent for a reason. They don’t enter into them because they are gossamer and can be disregarded whenever situations change. They enter into them because they create rights.”

• The Court se forth the golden rule: If parties intend for an LOI to be nonbinding, they “can readily do that by expressly saying that the letter of intent is nonbinding.”

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Delaware: ev3, Inc. v. Lesh, No. 515, 2013, 2014 WL 8662370 (Del. Sept. 30, 2014), as revised (Apr. 30, 2015)

• ev3, Inc. acquired Appriva Medical, Inc. for $50 million plus up to $175 million contingent upon the timely accomplishment of certain milestones toward the approval and marketability of a medical device that Appriva was developing

• After it became clear to ev3 that the milestones would not be achieved, ev3ceased funding the development of Appriva's technology

• Appriva's former shareholders brought a breach of contract action against ev3claiming that milestone payments should be paid in full

• The shareholders argued that ev3 allegedly breached the following agreements:

(i) obligations in the acquisition agreement to fund and pursue regulatory milestones in ev3's "sole discretion, to be exercised in good faith"; and

(ii) a non-binding provision in the previously executed letter of intent in which ev3stated that it would commit to funding development and ensure sufficient capital to achieve the performance milestones

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Delaware: ev3, Inc. v. Lesh (cont.)

• Appriva pointed to the integration clause in the acquisition agreement which stated that the acquisition agreement constituted the entire understanding between the parties "other than the letter of intent"

• The LOI contained a provision delineating certain provisions as binding namely those addressing confidentiality, exclusivity and transferability and all others as non-binding

• The Delaware Supreme Court held that only the provisions specified as binding (and surviving) would be operative pursuant to the acquisition agreement "integration clause“

• Thus, the non-binding provisions of the LOI were non-binding, including the provision relating to ev3's commitment to fund the accomplishment of the milestones

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New York: Bed Bath & Beyond v. Ibex Construction, 52 A.D.3d413 (N.Y. App. Div. 2008)• Owner and contractor entered into a LOI that set forth

the price, scope of work and timing of a construction project

• The LOI was subject to the execution of a formal construction contract

• Court held that where “the plain language of the LOImanifests the parties’ intent to be bound by its terms and it does not contain an express reservation by either party of the right not to be bound until a more formal agreement is signed,” the LOI will be enforced

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New York: Amcan Holdings v. Canadian Imperial Bank of Commerce, 70 A.D.3d 423 (N.Y. App. Div. 2010) • Amcan Holdings, Inc. ("Amcan"), approached Canadian Imperial Bank of

Commerce ("CIBC") to obtain financing in the form of a revolving line of credit and a term loan for the purpose of acquiring another company and refinancing existing debt

• The term sheet provided that “[t]he Credit Facilities will only be established upon completion of definitive loan documentation, including a credit agreement…which will contain the terms and conditions set out in this Summary in addition to such other representations…and other terms and conditions…as CIBC may reasonably require.“

• The term sheet contained detailed descriptions of the credit lines to be provided, the amount of funding under each, amortization and interest rates fees, security, a proposed closing date and definitions of key terms

• CIBC broke off negotiations and the financing deal never went through

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New York: Amcan Holdings v. Canadian Imperial Bank of Commerce (cont.)• Plaintiffs filed a complaint for breach of contract based on CIBC’s failure

to close the loan, breach of the covenant of good faith and fair dealing, and fraud

• The trial court held that because the term sheet provided that the credit facilities would only be established upon the execution of loan agreements, the term sheet “was clearly dependent on a future definitive agreement, including a credit agreement. At no point did the parties explicitly state that they intended to be bound by the summary pending the final credit agreement.”

• The appellate court stated that while the term sheet was extensive and contained specific information regarding many of the terms to be contained in the definitive loan and credit agreements, it did not change the fact that defendants clearly expressed an intent not to be bound unless and until the definitive agreements were entered into

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Georgia: Turner Broadcasting Systems, Inc. v. McDavid, 303 Ga.App. 593 (2010)

• McDavid signed a letter of intent to purchase the Atlanta Hawks and the Atlanta Thrashers in addition to arena rights from Turner Broadcasting (“Turner”)

• The LOI expired but both sides continued to negotiate

• The Court found an oral contract based upon Turner's verbal expressions and actions following the expiration of the LOI

• Verbal expressions: Turner's CEO, "we have a deal" and the principal negotiator stated that the "deal was done“

• Actions: consulted with McDavid on certain operational matters including hiring a general manager and head coach, drafting an internal memo to employees announcing the sale to McDavid, and scheduling a closing

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Georgia: Officemax v. Sapp, 132 F. Supp. 2d 1079 (M.D. Ga. 2001)• Sapp and OfficeMax entered into negotiations regarding the possibility

of leasing a portion of Sapp's property for a retail store

• Each party signed a LOI that contemplated a 15-year term with four renewal options for the lease of 23,500 square feet, "with the exact configuration subject to OfficeMax's review.“

• The LOI also included a "non-shop" clause that prevented the landlord from initiating or pursuing discussions with third parties relating to the lease of the referenced premises

• Sapp violated the no shop agreement by negotiating with a third party competitor, Staples and Staples signed a lease

• OfficeMax brought an action for breach of an agreement to lease, breach of contract, and damages, asserting that the LOI constituted an agreement to lease the premises

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Georgia: Officemax v. Sapp (cont.)

• The Court found that the LOI was not enforceable because many essential terms were not resolved

• In particular, the use restrictions the tenant sought to impose on the rest of the center was not discussed in the LOI and was subsequently the subject of significant discussion and negotiation

• The Court further found that the non-shop clause was not enforceable as a separate covenant because tenant provided no consideration, its duration was undeterminable from the document, and it failed to adequately describe the property encompassed by the clause

• Because OfficeMax reserved the right to review the configuration of the premises and the site plan, the court concluded that the location was subject to change and the description therefore was inadequate

• Accordingly, the Court held that OfficeMax had no contract or agreement to enforce, and Sapp had no liability or obligations to OfficeMax

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Virginia: Marketplace Holdings, Inc. v. Camellia Food Stores, Inc., 64 Va. Cir. 144 (2004)

• The chairmen of Marketplace Holdings and Camellia Food Stores signed a LOIconcerning the plaintiff's proposed purchase of the defendant and its subsidiaries

• The LOI contained a fixed purchase price and provided that the acquisition would be a stock purchase

• The agreement included a clause which stated "The parties will use good faith efforts to execute the Stock Purchase Agreement within twenty-eight (28) days for the execution of this Letter of Intent“

• The Virginia circuit court held that an agreement to negotiate is not enforceable

• The Court strongly criticized the approach taken in Copeland, finding no meaningful distinction between an "agreement to agree" and a contract to negotiate in good faith, whose breach "is an ill-defined cause of action founded upon a nebulous agreement. It injects uncertain liability into contract negotiations; the jilted party can easily allege a failure to negotiate in good faith"

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Texas: Texaco, Inc. v. Pennzoil Co., 729 S.W.2d 768 (Tex. App. 1987)

• Memorandum of agreement between Getty entities and Pennzoil for the purchase of Getty Oil

• MOA set forth the stock purchase price, agreement to restructure Getty within a year, and was subject to the agreement of the Getty board

• MOA's stock purchase price was rejected by the board

• Pennzoil accepted a counteroffer authorized by the board

• After the parties issued separate press releases, Texaco made a better offer and the Getty board withdrew its counter offer and entered into an agreement with Texaco

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Texas: Texaco, Inc. v. Pennzoil Co. (cont.)

• Pennzoil sued Texaco for intentional interference with contract

• The court found Texaco liable for tortious interference

• The court determined the intent of the parties by looking at the press releases which was worded in indicated terms ("seller will"), not hypothetical ones

• In addition, the press releases which made a reference to future agreement established timing and not as a precondition of the agreement

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FINAL THOUGHTS

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• Be Clear, Be Clear, Be Clear

• And, sometimes, actions speak louder than words

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Notes