By George M. Taylor, III
It is not unusual for a dealership lawyer to first learn of a sale transaction when he or she receives a signed Letter of Intent (LOI) from the client. There is a serious moment of anxiety when counsel realizes that the LOI has been drafted and signed without any lawyer input. It could be good (not likely), merely OK (the most common) or something disastrous (rare, but worth considering).
It is vastly better for counsel to be brought into the deal well before that point, but we lawyers work with the facts we have. Before you accept the spin by your business manager, your broker or the other side to the effect that the LOI is non-binding and does not deserve much attention, let me share with you the facts of what is probably the most significant case in the history of Letters of Intent. The case of Texaco Inc. v. Pennzoil, involved a fight between Pennzoil and Texaco over the acquisition of the Getty Oil Company, which at that time had massive oil reserves.
Pennzoil was first to the table and negotiated a “Memorandum of Agreement” with the Getty shareholder representatives, which, while not styled as a letter of intent, was intended to serve the same function. The parties then issued a press release disclosing the agreement. The document in question said that the parties had “agreed in principal” to a merger, but that the transaction was subject to subsequent board approval and would be more particularly described in “definitive agreements.” In addition to the press release, both sides communicated with others in a manner suggesting that the deal was in the bag.
Shortly after the document was signed, Getty found a better suitor and promptly renounced the agreement on the grounds that it was non-binding and had not, in any event, been approved by the board. However, the court in that case looked at the press release, the behavior of the parties and other factors, and concluded that the parties did in fact intend to be bound by the agreement. The result was a $10 billion judgment in favor of Pennzoil. The lesson is that sometimes things you intend not to be binding can be very binding, and the results can be disastrous. The further moral of the story: LOIs are serious documents that should be treated as such.
The phrase “letter of intent” can apply to a variety of written documents, ranging from an unsigned term sheet to a formal document of five to ten pages, as well as agreements in principal of the Pennzoil type. What generally distinguishes a letter of intent from a term sheet is that the former is signed while the latter is not. Because the statute of frauds requires many important agreements to be in writing and signed by the parties, the dangers of carelessly having a term sheet lying around are slight compared to the greater risks inherent in any written document that is signed by both parties. As a general rule, if both parties sign it the law is inclined to treat it as a binding agreement. Unless it is carefully drafted, that is.
All of which leads us to the most important principal guiding the preparation of any LOI – it must clearly state that it is intended to be non-binding. It may sound simple but for the fact that certain provisions of letters of intent are intended to be binding. The non-binding provisions are those outlining the deal terms – price, purchase terms, descriptions of the business, general outlines of reps and warranties, and survival terms.
Binding provisions include those requiring confidentiality and disclosure of information. Also binding is the single most important provision of a LOI, the “no-shop clause,” which contains a seller’s commitment not to offer the deal to anyone else as long as the LOI is in effect. Since there are some binding provisions, those binding provisions must have termination provisions, and termination generally occurs at a given date (30 or 60 days down the road) or upon notice by the parties. The no-shop clause is clearly the most important benefit received by any party to the LOI, and that benefit goes solely to the purchaser, who effectively gets the deal off the market for a period of time.
It is the no-shop clause that causes many practitioners to take the position that LOIs are too one-sided in favor of purchasers. Technically speaking, this may be true. However, besides the legal significance (and the fact that many buyers will not negotiate with a seller unless they know they are the only party at bat, at least until they figure out whether there is a deal to be had), letters of intent serve an important psychological purpose in getting the parties to reduce to writing the important business terms. This benefits both seller and buyer. LOIs furnish guides to counsel in drafting the definitive agreements, which agreements rarely differ significantly as to business terms from the LOIs on which they are based.
Can either party walk away from a well-drafted LOI any time it wants? The answer is pretty much yes (subject to notice and termination provisions), and this makes the document fairly worthless to us lawyers. But does a well-drafted LOI move the transaction in a positive direction and give it a better chance of becoming a solid deal? You bet it does. So, while we as lawyers discount the LOI as a tool of the M&A trade, they do have good value…provided they are drafted with care.
George M. Taylor is the chair of Burr & Forman’s Corporate Section, which consists of the Corporate and Tax Practice Group, the Banking and Real Estate Practice Group, and the Creditors’ Rights and Bankruptcy Practice Group, encompassing lawyers from the entire five-state footprint of the firm. He can be reached at (205) 458-5254 or gtaylor@burr.com.
