Understanding Boilerplate LOI Clauses in Small Business Acquisitions: Termination, Confidentiality, Expenses & More
For several months, we’ve been looking at how to structure a deal, and how to communicate that structure in a Letter of Intent (LOI). This has included whether to purchase assets or stock, how to think about purchase price, and optimizing for tax.
This is the final post in my LOI series. Until now, we’ve been focused on the core provisions of an LOI. But what about the other provisions? So called boilerplate: Standardized terms that all well-drafted LOIs include.
Boilerplate may require a little less thought, but it is still important to include and understand. So let’s take a quick tour through these less discussed provisions.
Binding vs Non-Binding — The Heart of LOI Clarity
In one of my first posts, I described LOIs as “largely non-binding document[s] that memorialize[] the parties’ preliminary understanding of [a] deal.”
Largely non-binding?
That suggests that LOIs are binding in part (which you should already knew if you read my blog regularly).
But how do you communicate whether an LOI is binding, and to what extent?
Simple: You include the following provision:
This letter reflects the intention of the parties, but for the avoidance of doubt neither this letter nor its acceptance will give rise to any legally binding or enforceable obligation on any party, except with regard to sections [______]. No contract or agreement providing for any transaction involving the business will be deemed to exist between the parties and any of their affiliates unless and until a definitive agreement has been executed and delivered.
But what sections should be binding?
In my last post, we saw that you should make exclusivity binding on the parties. In addition, the following binding sections are also worthy of discussion:
Termination
Governing law
Confidentiality
Expenses.
Let’s briefly look at each one in turn.
LOI Termination – What You Need to Know
In an ideal world, the LOI is followed by a signed purchase agreement. At that point, there is no need for the LOI; it has served its purpose. The parties are bound by the terms of the purchase agreement, which, if properly drafted, should offer you all the legal protections you need.
For this reason, LOIs usually terminate automatically upon the execution of the purchase agreement.
But the world isn’t always ideal. Deals sometimes die. And in that eventuality, the parties need an out. So another option is to terminate the LOI by mutual consent.
And what mutual consent is not forthcoming? The parties often set a date upon which the LOI terminates automatically. Between 60-90 days from signing is common.
Why the sunset condition? Sometimes, it becomes clear that the buyer cannot close. But the buyer refuses to concede.
In that case, the seller wants to be able to market the business again. And for that to happen, the LOI has to terminate for exclusivity to end.
If between 60-90 days doesn’t sound like a lot to you. The parties sometimes negotiate an automatic extension to give them more time to negotiate the purchase agreement.
These options are captured in the language below:
This letter will terminate and be of no further force and effect upon the earlier of: (a) the execution of the definitive agreement by buyer and seller, (b) mutual agreement of buyer and seller, or (c) [DATE]; provided that if the parties are continuing to negotiate the definitive agreement at that time, the term of this letter will be automatically extended to [DATE].
Understanding the Governing Law Clause
Almost all contracts include a provision specifying a choice of law, and LOIs are no different.
The parties intend that this letter be governed by and construed according to the laws of the state of [______], without giving effect to any choice or conflict of law provision or rule.
Does the choice of law in an LOI matter in the context of SMB M&A?
Candidly, not really. And I say that as a lawyer who likes to think that everything he writes matters.
Choice of law only really matters if one of the parties decides to sue. But in America, litigants generally pay their own legal costs. And the amount at stake at the LOI stage just isn’t worth that expense.
But you never know. Some people are petty. They sue even if it’s not in their financial best interests. So you still need a governing law provision. And you should choose a friendly jurisdiction.
What do I mean by friendly? Choose the law of the state in which you would like to litigate any dispute. Often this is the state in which you reside (because the courthouse is close by).
You could choose a “business friendly” jurisdiction like Delaware (assuming you don’t live in Delaware). But unless you intend to go to Delaware to resolve your disputes, this isn’t necessarily the best option.
Local courts know local laws best.
Dare I say local courts are also a touch parochial.
Let’s just say that walking into state court in South Dakota and asking the judge to rule on the basis of Delaware law because you heard that Delaware is where all serious litigation is done is unlikely to do you any favors.
Confidentiality in LOIs
But wait! I’ve already signed a non-disclosure agreement. Do I need a separate confidentiality provision in the LOI?
Not necessarily. In fact, if you’ve already signed a non-disclosure agreement (which is common), your LOI confidentiality terms can be as simple as the following:
This letter is confidential to the parties and their representatives and is subject to the confidentiality agreement entered into between buyer and seller on [DATE], which continues in full force and effect.
In fact, this is the best way to approach it. Having a separate confidentiality agreement embedded within your LOI could lead to ambiguity. And ambiguity is where most business litigation thrives.
Who Covers the Costs? LOI Expense Clauses
The parties usually clarify how transaction expenses are to be handled. But be aware that the general rule is the buyer and the seller each pay their own expenses.
The parties shall each pay their own expenses incurred in connection with the proposed transaction.
Are there exceptions? Yes. But they are rare in the context of small business transactions.
The buyer could ask the seller to pay for her expenses if the seller decides not to proceed with the transaction (unless by mutual agreement or because of a material change in terms).
The seller could also ask the buyer for a reciprocal fee (with a carve out for red flags uncovered during diligence).
But in two and a half years of focusing my legal practice on small business acquisitions, I have never seen this type of fee make it into a signed LOI.
They’re just not done. Or, at least, they are very rare.
And perhaps that is for good reason. Both parties are investing time and resources into diligence and negotiating the purchase agreement. So long as the parties proceed in good faith, paying for their respective transaction expenses is equitable.
In short, focus on getting the deal done. Don’t spent time fighting over transaction expenses.