The Ties That (May) Bind: Ensuring Letters Of Intent Do Not Impose Binding Obligations On Parties

• Published date: 17 December 2020
• Subject Matter: Corporate/Commercial Law, Litigation, Mediation & Arbitration, M&A/Private Equity, Contracts and Commercial Law, Trials & Appeals & Compensation
• Law Firm: McCarthy Tétrault LLP
• Author: Canadian M&A Perspectives, Daryna Kutsyna, Claire Gowdy and Chrystelle Chevalier-Gagnon

Non-binding letters of intent ("LOIs"), which sometime take the form of 'indicative term sheets' or 'memorandums of understanding', can be useful tools to start negotiations between parties in a commercial transaction. These documents, typically lay out the principal terms of a transaction and facilitate negotiations of a binding agreement between the parties.

LOIs are most useful when parties can set forth the main points of a proposed deal, such as the structure of the transaction or purchase price arrangements, without committing to a legally binding contract. However, recent Ontario jurisprudence confirms that, based on certain language of the LOI or the behaviour of the parties, LOIs may be interpreted as binding even where the parties explicitly intend for them not to be. As such, it is key to draft the LOI with purpose and be mindful of your actions during negotiations.

Risks and rewards of LOIs

There are several important advantages to using an LOI in the course of a transaction. Entering into an LOI signals to the parties - and in certain instances to the public - that the parties are serious about the potential deal, and it lays a foundation to further negotiation, thus creating deal momentum. An LOI also allows parties to set out their basic understanding of the key business terms they want to achieve before investing time and money into hiring a team of advisors and negotiating the full deal. The increasingly popular "Hybrid" LOIs, or LOIs that have both binding and non-binding terms, help the parties protect themselves during negotiations, such as through committing to confidentiality, exclusivity and non-solicitation terms.

Signing an LOI may also come with some hazards. Negotiating through an LOI may increase the costs and tensions of a transaction by requiring a separate round of negotiation. LOIs, which by their nature are shorter than definitive legal documents, can be internally incoherent and lend themselves to varied interpretations and expectations by the counterparties. An LOI may also create unintended disclosure obligations for reporting issuers by triggering material change and/or early warning reporting. The most critical risk of an LOI, however, is the possibility of a binding obligation being unintentionally imposed on the parties. In the private equity space, this can be of particular concern given the prevalence of investor or third party rights of first refusal that could be triggered by a party inadvertently creating...