What you need to know about M&A letters of intent

Preliminary outlines of proposed M&A deals—whether called letters of intent (LOIs), term sheets or memoranda of understanding (MOUs)—allow parties to sketch out fundamental terms quickly before expending substantial resources on negotiating definitive agreements, finalizing due diligence, pursuing third-party approvals and other matters. M&A letters of intent appear simple (they aren’t) and as something that can be advanced without lawyers (they shouldn’t be). The opportunities for later re-trades and selective lapses in memory on key points are reduced. In addition, an LOI can facilitate discussions with debt and equity financing providers as well as allow preliminary discussions and filings with antitrust and other regulators. Lastly, some would argue that they create deal momentum and foster an emotional commitment to do the deal or, at a minimum, work towards getting one done on the agreed-upon terms. Often the parties produce a hybrid preliminary document that presents a non-binding outline of the main deal terms with certain binding provisions (such as exclusivity and confidentiality provisions as well as termination, governing law, choice of forum and other miscellaneous provisions).

There are also downsides.

While LOIs may save time and expense in the long run, they may have the opposite effect, as the parties engage in protracted negotiations on only a subset of a deal’s terms. Management time and focus may be diverted. Alternative opportunities may be missed and markets may move against the parties in the meantime. In some cases, parties reduce their lack of a workable deal framework into an LOI, with a hope of papering over differences, kicking the can and praying to make progress later. In some cases, public disclosure obligations may be triggered. And, of course, there’s the risk of leaks, exacerbated by the desire of some to tout the term sheet to the world, or shop it to other bidders.

An even greater risk, however, is that, if negotiations fail, a court may conclude that an LOI is, in fact, something more than a non-binding description of terms—either a fully binding agreement itself, capable of being enforced, or an agreement to negotiate in good faith. For example, in 2013, the Delaware Supreme Court held that an agreement to negotiate in good faith in accordance with a term sheet is an enforceable obligation and that the failure to negotiate in substantial conformity with the term sheet will, under certain circumstances, result in liability for expectation (or “benefit-of-the-bargain”) damages.

There is also a converse risk of a court failing to enforce what the parties may have thought was a binding agreement or certain of its provisions that they expected to be enforceable.