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LOI drafting tips for meeting the client’s objectives

chapmanAs all in-house attorneys know, in most transactions of any complexity, the parties first execute a letter of intent, or LOI, or other preliminary document before proceeding to sign a final agreement.

These so-called “pre-contractual agreements” usually outline important deal terms and identify what further negotiations or steps must be completed before finalizing the deal. Invariably, the task of negotiating and drafting such documents falls to the in-house lawyer, either directly or through outside counsel.

How you craft the LOI may not only influence whether the deal comes together, but also whether you win or lose in court if it falls apart.

In the enthusiasm and rush to close a high-stakes transaction, no one wants to envision things going south. However, savvy in-house counsel must be keenly prepared for that possibility as they help their client think through the provisions of an LOI.

Naturally, knowing how to choose the right phrasing of key terms depends entirely on your client’s objectives.

For example, does your CEO want the LOI to bind the other party and limit its ability to back out of the deal? Or, alternatively, is your client interested in preserving its own ability to walk away for some reason, such as for a problem that turns up in due diligence? Knowing the answers to those questions is essential to putting the final document together.

Of course, most transactions are unique and involve dozens of material terms and moving parts, so no “one-size-fits-all” method is available for putting together a perfect LOI. Courts have, however, delineated some clear principles that in-house counsel should grasp fully before advising their clients.

At a high level, the most important concept is what language to employ so that the LOI either creates a binding obligation or does not, depending on your client’s objective. Knowing that, you will be in a better position to handle a dispute if the parties don’t proceed to closing and, instead, end up in litigation.

While this article deals primarily with Massachusetts law, a brief reference to New York law will highlight another point counsel should bear in mind: the sometimes stark differences in how courts of other jurisdictions treat identical language in an LOI.

Is the LOI binding or not?

Before your client executes an LOI, the most critical question is whether your client wants the LOI to be a fully binding document. While you may not necessarily share the answer to that question with the other side, your client’s view on the issue will drive the way you draft the language of the LOI.

For example, if your client wants to preserve its right to walk away from an ongoing negotiation for whatever reason, Massachusetts courts have recognized that including a “safe harbor” provision will accomplish that purpose. The Massachusetts Appeals Court has cited several examples of how to word such a provision.

Most notably, in Schwanbeck v. Fed.-Mogul Corp., 31 Mass. App. Ct. 390, 393 (1991), rev’d, 412 Mass. 703 (1992), the Appeals Court quoted the following language from an LOI: “Of course, this letter is not intended to create, nor do you or we presently have any binding legal obligation whatever in any way relating to such sale and purchase[.]”

In citing that passage, the court noted: “[h]ere is the sort of express limiting provision which we described in Goren v. Royal Investments, Inc., 25 Mass. App. Ct. 137, 142-143 (1987), as affording a safe harbor to parties who do not wish to be bound by a preliminary document.”

While the Supreme Judicial Court reversed the Appeals Court in Schwanbeck on other grounds, Massachusetts appellate courts have consistently upheld the enforceability of such safe harbor language.

Importantly, while explicit statements that the parties do not intend to be bound are enforceable, simply stating that the parties intend to later execute a more formal contract may be insufficient to prevent the LOI from being binding if a court finds that the parties have otherwise reached agreement on all material terms of the deal. See, e.g., Hunneman Real Estate Corp. v. Norwood Realty, Inc., 54 Mass. App. Ct. 416, 423 (2002).

Therefore, counsel wishing to make certain that their clients will not be held to the terms of a pre-contractual agreement are wise not only to choose language of the type suggested by the Appeals Court, but also to include other qualifying and conditional terms.

For example, including in the LOI a statement that the parties intend to “proceed to negotiate in good faith a definitive” final agreement coupled with an identification of the material terms left to be negotiated also will signal clearly that the LOI is not binding.  Schwanbeck, 412 Mass. at 706 (holding that such phrasing “is merely a promise made with an understanding that it is not to be legally binding, but only a statement of present intention”).

By including such language, counsel should be aware that, in contrast to Massachusetts, New York law holds that such language does create a binding obligation to negotiate in good faith toward a final contract. See, e.g., Brown v. Cara, 420 F.3d 148, 157 (2d Cir. 2005) (holding under New York law that parties’ expression in LOI of intent to negotiate in good faith toward final contract created “an obligation to negotiate the open issues in good faith in an attempt to reach the ultimate contractual objective within the agreed framework”).

When circumstances are reversed and your client wants to bind the other party at the LOI stage, matters are trickier because experienced business people, even those eager to complete a transaction, are justifiably wary of being bound too soon.

In addition, simply declaring in the LOI that it “constitutes a legally binding commitment” (which is a good start, by the way) will be of little effect if a court later determines there was no meeting of the minds over a material term.

The solution, then, in addition to stating clearly that the document is binding, is to draft it with as much detail concerning all the material terms of the deal as possible. When an LOI is unambiguous, “its interpretation is a question of law that may be resolved” by the court. Seaco Ins. Co. v. Barbosa, 435 Mass. 772, 779 (2002).

Therefore, if the parties reach the LOI stage after lengthy negotiations that have resulted in agreement on all material terms, then counsel wishing to preserve the deal should memorialize each and every one of those points in the LOI.

That is especially true when you or your client fears the other side may backslide or attempt to renegotiate deal points that you believe have already been agreed upon. While memorializing the terms of a deal can be touchy if the parties perceive that the transaction is not yet complete, it is surely better to know sooner rather than later if the other side is reluctant about being pinned down on areas where you believe there is agreement.

What happens if you end up in court?

While no one likes to imagine it, if a deal does fall apart, the frustrated party sometimes resorts to litigation (which, of course, may be you). If you have negotiated and drafted your LOI to meet your client’s objectives, you probably have taken a big step toward ensuring that any ensuing litigation goes your way.

For example, if your client was the one trying not to be bound and, in fact, chose to walk away from the deal, then the safe harbor and other qualifying language should set you up well to try for early dismissal of a case seeking contractual enforcement of the LOI.

Conversely, if you were the side seeking to create a binding obligation and the other side decided to renege, then your well-written LOI can provide the basis for seeking a preliminary injunction to prevent the other side from walking away and, potentially, trying to close a similar transaction with another party.

Either way, ensuring that the LOI is drafted unambiguously and informed by established precedent in the applicable jurisdiction will position your client to succeed in court.

Conclusion

Given the importance of drafting LOIs with an eye on how courts interpret and enforce them, here’s something all in-house attorneys should (but probably rarely) do before your client signs an LOI: run the document by a litigator first. Why? Litigators only see deals that have failed, meaning they are especially attuned to how courts will view the key provisions and language you’ve employed.

A seasoned litigator can provide an important double check to ensure your LOI is accomplishing your intended objectives, and, equally, he or she can draw your attention to provisions that may not be at the forefront of your mind.

For example, you may not have thought about including a choice of law provision in the LOI; but as illustrated above, if the contracting parties are from different states, the difference between whether one state’s law applies over another’s can determine the enforceability of the LOI.

Taking the time to think through such issues will prove to be time well spent if any bumps arise in the road toward the finish line of the deal.

Tyler E. Chapman is a partner at Todd & Weld in Boston. He has a general commercial litigation practice with a focus on real estate matters, complex business litigation and closely held business disputes.

 

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