COMMENT ON USING LOI FROM JANUARY 5 2016 ARTICLE
I have to disagree with some of your comments on the use of a LOI in doing a deal. I have found a LOI to be a very useful, almost necessary step in completing a deal - but then I always push to make the key business terms of the deal in an LOI non-binding. By the way it is possible to make some of the terms of a LOI binding and some not so. Secondly I always make sure the words non-binding show up in the draft of a LOI so there is no doubt about the status of the document.
When I am selling a company and getting bids from various buyers, once a winning bid has been determined, I almost always ask that winner bidder to put all important terms into a non-binding LOI. Many times terms are fleshed out more in an LOI than in an offer bid. The LOI stage allows both parties to see all the important terms that will be part of the deal but in a non-binding environment. Once the LOI has been signed, then the buyer can start their due diligence. The LOI is a good step along the way
Making a LOI binding is risky because at this early stage of discussions between a buyer and seller, neither party knows each other very well. I find most sellers do not want to sign a binding LOI at that early stage and I discourage them from doing so. Moving from a term sheet to a final agreement without an LOI is also problematic because often term sheets do not spell out all the terms in the deal. Finally I find it hard to believe that an LOI could ever be used as a closing document because there are so many more terms addressed in a closing document than are in a LOI. Most LOI that I see are 4-5 letter sized pages. Most purchase and sale agreements are at least 15 pages.
LOIs are a useful tool if used the proper way.
Harding Security Services Inc.
70 Shaftesbury Ave., Unit 10
Toronto, ON M4T 1A3
Here's the problem with the LOI, it's an undefined document. By that I mean that calling a document a Letter of Intent doesn't make it so. The wording of that document can change it to something that the parties may not have intended when it was prepared and signed. There are a slew of lawsuits dealing with whether a LOI is enforceable and what the LOI terms actually are. One reason for that is that LOIs are routinely prepared and signed before lawyers get involved.
By illustration, let me dissect a few statements you make, and most of my comments are because you're not an attorney and I readily admit that there are plenty of attorneys that don't know half what you probably know and shouldn't be dealing with LOIs or agreements in the first place:
- "I always push to make the key business terms of the deal in an LOI non-binding" This presumes that you know what terms are "key" and what words will make the document or those terms "non-binding". Since an LOI is not a standard form document the wording is almost always original. An LOI should be prepared by an knowledgeable attorney, and my point was that the attorney may as well draft the Agreement. If I said it's fair for you as broker to prepare a "term sheet" then I would mean a document with information but no signatures or terms of agreement.
- "possible to make some of the terms of a LOI binding and some not so" The stock and trade of lawyers are words, spoken and written. That's not the case with brokers or business people. Words matter and since anything is possible when words are complied into a document that forms the basis of the agreement, a knowledgeable lawyer should be the draftsman.
- "I almost always ask that winner bidder to put all important terms into a non-binding LOI." Who identifies what's important? Often litigation is necessary to adjudicate issues that someone thought unimportant at the time, or didn't think of at all. You want to leave that for a broker or business person or a trained and experienced lawyer?
- "Making a LOI binding is risky because at this early stage" That's exactly correct, and too many LOIs have been determined to be binding when one of the parties didn't intend that consequence.
- "often term sheets do not spell out all the terms in the deal" Here is a great example of a problem. You say that the Term Sheet isn't sufficient because it doesn't have all the terms in the deal. But if the LOI has all the terms in the deal then it could be binding even if it says its not. If it has all the terms in the deal then why isn't it binding? What is it's purpose as distinct to a Term Sheet?
- " I find it hard to believe that an LOI could ever be used as a closing document because there are so many more terms addressed in a closing document" Depends on the LOI. Calling it an LOI doesn't tell me what it contains and covers. It may very well cover all material terms and thus be considered a "closing document" or it may prevent a formal agreement from being drafted properly because a party insists on using the LOI terminology and terms. So, believe it.