While the Spice Girls may not be your first choice when seeking legal advice, it is prudent when drafting a letter of intent (“LOI”) or term sheet to make sure that you tell them what you want, what you really, really want.1
In the course of negotiating most proposed corporate transactions, the first step is for the parties to set out the agreed upon terms of the transaction in a document such as an LOI or term sheet. In many instances, these documents are made subject to entering into a more definitive agreement, often stating that the parties agree to negotiate the terms of the definitive agreement in good faith. The parties may intend for the LOI to be a binding commitment to complete the transaction, or merely a non-binding “agreement to agree”. Great caution should be exercised to ensure that the intentions of the parties are clear in the LOI.
Clearly State Your Intentions
In Canada, the question of whether an LOI constitutes an enforceable agreement or merely a non-binding expression of intent consists of two elements:
- Are the terms of the LOI sufficiently detailed and clear so that the contract is not void for vagueness or uncertainty? Does the document include all of the essential provisions to be incorporated in a definitive document, or does the LOI contemplate the negotiation of additional significant terms of the deal which are not described?
- Did the parties to the document intend to be bound immediately upon signing the LOI, with the more definitive agreement intended to embody the precise terms of the initial agreement or was it their intention that their legal obligations be deferred until a definitive agreement was settled?
In Wallace v. Allen, two friends and neighbours, Graham Allen and Kim Wallace, negotiated and signed a letter of intent for the sale of Allen’s business.
After signing the letter of intent, Wallace and Allen began the process of negotiating a share purchase agreement, and set a specific date to sign the purchase agreement and close the transaction. On the agreed upon closing date, Allen was ready to complete the transaction. He was informed by Wallace’s lawyer that Wallace, who was vacationing at the time (with Allen’s knowledge and approval), had not signed the paperwork to close the deal. At that time, Allen decided not to complete the transaction. Wallace then sued Allen for damages and an order for specific performance, requesting the transaction to be completed.
The Ontario trial judge dismissed the action, finding that the parties, in entering into the letter of intent, did not intend to form a binding contractual relationship until the final share purchase agreement was signed. Wallace appealed this decision.
Ultimately the Court of Appeal in Ontario found that the facts supported a finding that the parties had entered into a binding agreement when they signed the LOI. The Court’s analysis was as follows:
Was the letter of intent void for vagueness or uncertainty? The Court noted that the parties entered into the letter of intent after weeks of negotiation, and the facts suggested they had acknowledged that all of the terms they considered necessary or essential to the transaction were agreed upon and set out in the signed letter of intent. The letter of intent could not be regarded as non-binding because of vagueness, uncertainty or a lack of agreement as to the essential terms.
Did the parties intend to be bound by the letter of intent? The use by the parties of contractual-type language in the letter of intent (such as references to “this agreement” and statements such as “it is agreed” and “upon acceptance”) suggested an intention to be bound. The letter of intent did contemplate entering into a further agreement, but it did not state that the letter of intent was expressly subject to entering into that further agreement. Rather, the letter of intent suggested that the further agreement would simply be a formality that may result in the wording of the letter of intent changing but not the substance. Wallace began to work in the business immediately after signing the letter of intent and also began to incorporate his sons into the business with a view to transitioning management. For his part, Allen announced his retirement and the sale of the business, while introducing Wallace as the new owner. This conduct reinforced the Court’s opinion that the parties intended to be bound by the letter of intent.
In Hartslief v. Terra Nova Royalty Corporation, Alan Hartslief brought an action against his former employer, Terra Nova Royalty Corporation, seeking a declaration that a binding settlement agreement had been reached by the parties following extensive negotiations between their respective solicitors. Terra Nova disputed the existence of a binding agreement and argued that it was the parties’ joint intention that a binding settlement would only arise upon the signing of a definitive document.
The Court found on the totality of the evidence, viewed objectively, that an agreement had been reached and that the signing of a formal agreement was not intended by the parties to be a condition precedent. The Court relied on the general principles set out by the Ontario Court of Appeal in Bawitko Investments Ltd. v Kernels Popcorn Ltd.
“When [the parties] agree on all of the essential provisions to be incorporated in a formal document with the intention that their agreement shall thereupon become binding, they will have fulfilled all the requisites for the formation of a contract. The fact that a formal written document to the same effect is to be thereafter prepared and signed does not alter the binding validity of the original contract.
However, when … the understanding or intention of the parties, even if there is no uncertainty as to the terms of their agreement, is that their legal obligations are to be deferred until a formal contract has been approved and executed, the original or preliminary agreement cannot constitute an enforceable contract… The execution of the contemplated formal document is not intended only as a solemn record or memorial of an already complete and binding contract but is essential to the formation of the contract itself …”
If You Don’t Want a Binding Commitment, Make Sure You Say So
Businesspeople often use LOIs as a framework for discussing the terms of a transaction. However, often a person who is party to an LOI does not wish to be bound to proceed with a transaction before having had an opportunity to, for example, finalize due diligence or properly articulate the agreed upon terms in a definitive agreement.
When preparing a non-binding LOI:
- State explicitly in the letter of intent that it is the parties’ intention that the letter of intent be non-binding (or that only certain provisions are to be binding) and that binding commitments will only arise upon execution of a definitive agreement.
- Include a provision stating that the parties will, following the execution of the letter of intent, negotiate and enter into a definitive agreement which will contain the agreed upon terms in the letter of intent, as well as other customary provisions. If practicable, the parties may wish to expressly disclaim any duty to negotiate in good faith.
- Include a list of conditions upon which the completion of the transaction will depend, if already determined. A good example is a condition in favour of the buyer (if the transaction is a purchase and sale) providing that the completion of the transaction is conditional upon the buyer being satisfied with its due diligence.
- Avoid the use of “agreement-type” language. Refer to the informal document as a letter of intent or term sheet, or some other title that is consistent with characterizing the document as “an agreement to agree”, which is not binding.
- If the letter of intent includes covenants regarding confidentiality of information or non-solicitation of employees, customers or suppliers, provide in the letter of intent that these provisions are intended to survive termination of the letter of intent and will be binding on the parties, whether or not a definitive agreement is entered into and/or the proposed transaction closes which is not binding.
- Limit the remedies to preclude lost profits or the recovery of costs for anything other than a breach of any binding terms that are specifically described.
If you have questions about letters of intent or term sheets, contact Clark Wilson’s Corporate Finance & Securities Group.
1Wannabe, by the Spice Girls, released November 1996.