If you are working with a third party on a term sheet, letter of intent or memorandum of understanding (an “LOI”) on what you view as a non-binding basis, make sure to say so explicitly in the LOI.
Businesses use LOIs with each other all the time to negotiate and to develop a set of deal principles to be used in a final agreement, on anything from an acquisition to a significant commercial agreement, or conceivably even a key employee hire. Primarily they serve as discussion documents for the many high level points that need to be agreed upon (in concept) before it makes sense to negotiate final agreements. Most people involved in the development of an LOI assume there is no final deal until the final documents are fully negotiated, signed and delivered.
In some states, there are theories of contract law that could, under certain facts, bind you to negotiate in good faith with the other party, or worse, bind you to the essential terms of the deal.
A recent case out of Delaware has attracted attention both because of the breach of duty to negotiate in good faith that was found and because of the implications it has in determining damages for breach of that duty. In Siga Technologies and a second appeal, the parties had entered into a merger agreement that contained a provision requiring that, if the merger fell apart, the parties would negotiate in good faith with respect to a license agreement (on terms that had been previously set down in a term sheet). The merger did not occur and in the context of the license agreement negotiations, Siga Technologies proposed terms that were significantly different from those in the term sheet. Ultimately, the Delaware high court (in opinions that would seem to apply equally to both Delaware and New York law at least on the damages point) determined that such an agreement to agree could be breached by actions in “bad faith” (in this case, by Siga’s proposal of terms contrary to the term sheet), in the “conscious doing of a wrong because of dishonest purpose or moral obliquity.”
This case obviously involved a transaction that was farther along than where an LOI is usually being worked out, and the provisions in Siga involving the license agreement included an affirmative agreement to negotiate in good faith, which is often not something found in an LOI. In any event, the duty to negotiate in good faith is not new law (though the damages determination is). Nevertheless, the case shows that even in circumstances where the final, definitive document has not been agreed upon, nor signed nor delivered, it is possible to end up with an obligation to negotiate in good faith.
While we assume that most parties to potential deals negotiate in good faith in the business sense, if they are doing so on the assumption that, at the end of the day, they can walk away from the deal, LOIs and anything else that could be considered an agreement to agree, should take pains to preserve that assumption. The last thing that anyone wants is a legal action or a remotely credible threat of action following on the heels of a deal that didn’t get to signing.
- To the extent possible, LOIs should explicitly state that there is no obligation of either party to a final transition until the definitive agreements are completed and signed by the respective parties, and if approval is needed (management, board, stockholder, etc.) it’s a good idea to note that too.
- LOIs should also explicitly disclaim any obligation to negotiate in good faith (if you can get your prospective partner to understand that you are trying to preserve your, and their, ability to withdraw from working on the deal and not trying to add a right to negotiate in bad faith).