Canada: Letters of Intent – Part II

Last Updated: February 25 2017

Introduction

This is the second of two Practice Guides discussing the use of Letters of Intent in M+A transactions, particularly private M+A transactions, and some issues and considerations in relation thereto. The first Letter of Intent Practice Guide provides an overview of the use of Letters of Intent and their use. This Practice Guide summarizes matters often included in a Letter of Intent.

How Much Should be Included in a Letter of Intent?

The first Letters of Intent Practice Guide discusses strategic considerations regarding how much to include in a Letter of Intent, as compared to leaving certain issues to be negotiated as part of the Definitive Agreement. It also includes advice regarding the extent to which parties should retain assistance of legal counsel before finalizing and agreeing to a letter of intent, even where most of the provisions may be expressed to be “non binding.”

What Matters Are Typically Included in a Letter of Intent?

Letters of Intent often include:

  • The non-binding agreement of the parties regarding the amount of the Purchase Price (often subject to a price adjustment provision) and the manner of payment (e.g. payable in cash, securities of the acquiror, or a combination thereof), as well, in most cases, as the timing of payment (e.g., payable in full at the time of Closing, or whether some portion may be deferred and payable post closing (other than under an escrow or holdback), and if so what amount or percentage may be deferred (and, in such case, in some cases the Letter of Intent may address any security that is intended to secure the deferred portion of the purchase price). In some cases a Purchaser may be reluctant to agree, even on a non-binding basis, to some of these terms, possibly including the total purchase price, prior to completing its due diligence. In some such cases, Letters of Intent specify agreement upon the agreed upon terms based on certain stated key assumptions to be verified by the due diligence process (e.g. an assumption that the target company has no “indebtedness”).
  • The structure of the proposed Acquisition transaction (e.g. whether the transaction is intended to be an asset purchase or share purchase). In some Letters of Intent, however, the Purchaser may specify that it retains flexibility to change the structure, on a mutually agreeable basis, for example, to reflect tax considerations.
  • Whether, in addition to the basic purchase price, there is intended to be any earn out under which an additional purchase price may potentially be paid depending on achievement of agreed upon specified agreed upon milestones over some agreed upon specified post closing period (and, if this is applicable, the Letter of Intent likely will often specify, in less technical detail than will ultimately be specified in the Definitive Agreement, the agreed upon milestone thresholds).
  • Whether there is intended to be any purchase price adjustment, such as a working capital adjustment, and if so, it is not uncommon for the Letter of Intent to specify a proposed base or target amount of working capital (e.g., based on preliminary information) (e.g. based on information in a Confidential Information Memorandum that may have been provided to the Purchaser by a target company’s financial advisor).
  • The proposed deadline, or anticipated date, for closing (often reflecting “wishful” thinking on the part of both parties) and also usually a “drop dead date” reflecting a deadline by which, if the parties have not entered into a Definitive Agreement, any exclusivity obligations cease to apply and the parties will discontinue negotiations (unless they agree otherwise).
  • The intention of the parties to cause their respective legal counsel to commence preparation of a draft Definitive Agreement and to negotiate the terms thereof. In some cases, this is intended to follow after a further period during which the Acquiror is to conduct due diligence. In some cases, Acquirors seek to specify that their legal counsel is to prepare the initial draft of the Definitive Agreement (or the Definitive Agreement and other related transaction documents).
  • Although generally not expressed as legally binding, Letters of Intent usually include features that are legally binding, most notably:
    • Exclusivity – A no-shop covenant by the target company prohibiting the target company from soliciting other potential acquirors or negotiating with other prospective purchasers for a limited period.
    • Access – A general covenant (which can be short and simple) pursuant to which it is agreed the Purchaser will be permitted access to the target company and its books, records and documents. In many cases, however, the Purchaser is restricted in the ability to contact employees of the target company without express approval of the target company. (In some Letters of Intent, the access covenant is included as one of the covenants that is expressed to be binding. In others it is instead part of the non-binding provisions).
    • Confidentiality – Letters of Intent often include covenants of the parties to not disclose information regarding the proposed transaction and, if there is not a separate Confidentiality or Non-Disclosure Agreement in place, obligations (e.g. of the Acquiror) not to disclose confidential information.  If there is no Confidentiality or Non-Disclosure Agreement in place, the Letter of Intent should include appropriate provisions ensuring that the Purchaser may not disclose or use (except for purposes of assessing and completing the proposed Acquisition) confidential information it may obtain as part of its due diligence.
  • Some Letters of Intent address the following additional matters, but these are generally less common:
    • Restrictive covenants regarding actions the target company may take between the date of the Letter of Intent is entered and termination of the Letter of Intent (or the Definitive Agreement being entered into).
    • Restrictive covenants restricting the Acquiror from soliciting employees, customers or suppliers of the target company.
    • Certain intended key Conditions Precedent for completion of the proposed Acquisition (or specifying that the Definitive Agreement will include specified Conditions Precedent). For example, where applicable, an Acquiror may wish to expressly specify that the completion will be subject to it obtaining financing. As these typically are negotiated as part of the Definitive Agreement, this is likely not strictly necessary, except perhaps to help make clear that the Letter of Intent does not give rise to any binding obligation to complete the proposed Acquisition and to record that the parties have reached agreement on at least some of the conditions that must be satisfied before they are wiling to be bound to complete the transaction. To the extent that the parties can identify key regulatory or third party approvals, authorizations and consents that will be required, which may take a considerable time to obtain, it may be desirable to expressly refer to obtaining such consents as a Condition Precedent and also make reference to the parties making application for such consents, perhaps even prior to the Definitive Agreement being entered into.
    • Some Letters of Intent include certain representations and warranties (e.g., regarding title to the shares to be sold under a Share Purchase transaction), but that is not very common. Some Letters of Intent alternatively specify that the Definitive Agreement will contain representations and warranties that are “customary” for the type of transaction. Some instead specify that the Definitive Agreement will include certain representations and warranties which are specified on a non-exhaustive basis.
    • Some Letters of Intent for Asset Purchase transactions refer to the major assets being acquired and liabilities the Purchaser is agreeing to acquire (although this may not be determined until the Acquiror finishes its due diligence), and any significant assets that the parties agree are excluded. In a Share Purchase transaction, if applicable, any major assets that one intended to be disposed of prior to Closing, or any material liabilities that are to be repaid before Closing, may be specified. In some cases, the Letter of Intent may seek to address the allocation of the purchase price among asset classes, but this is often left to the Definitive Agreement.
    • As noted above, in some cases the parties seek to reach agreement or some other key deal structure matters, such as escrow or holdbacks,  guarantees or indemnification obligations and indemnification Caps or break fees. In many cases, however, these matters are left to be negotiated as part of the terms of the Definitive Agreement.
    • Letters of Intent in some cases either confirm that each party is to bear their own expenses in connection with the proposed transaction or, in some cases, may contemplate an Acquiror agreeing to pay for a portion of a target company’s expenses (which, if applicable, should likely be one of the provisions expressed to be binding). Some Letters of Intent address responsibility for payment of broker’s fees.
  • As a general comment, like Acquisition Agreements, Letters of Intent are not standard “off the shelf” precedent documents, and matters covered (or not covered) and terms and conditions included, vary considerably. Often Letters of Intent may, at least initially, be prepared without involvement of legal counsel. However, it is strongly recommended that Letters of Intent be prepared with the involvement and assistance, and with appropriate legal advice obtained from, legal counsel.

Do I Need a Lawyer to Prepare or Review My Draft Letter of Intent?

This issue is discussed in the first Letters of Intent Practice Guide.

However, we recommend that parties (particularly target companies or target company shareholders) have legal counsel review and comment on a draft Letter of Intent and provide advice before it is finalized or executed.  As noted in that Practice Guide, among other factors to be considered:

  • Legal counsel should provide advice regarding whether the Letter of Intent in fact achieves the parties intentions regarding only setting out a non-binding expression of intent, rather than a binding mutual agreement that is intended to be supplemental by a subsequent Definitive Agreement.
  • Despite reflecting only a non-binding agreement regarding certain terms, some of those terms (e.g., complicated purchase price, earn out or other concepts) may require greater technical precision in drafting to ensure the intention of both parties is correctly captured.
  • There are strategic considerations in relation to the potential impact of decisions regarding which items potentially should be included in the Letter of Intent, including risks that a proposed Acquisition transaction may prematurely get “bogged down” or derailed attempting to negotiate specific deal points, and the potential impact on negotiation of other key terms and conditions to be included in the Definitive Agreement.

Any other Useful Tips or “Hacks”?

One concept we have seen that can be useful for Vendors is to include in the Letter of Intent a provision which provides that, if either party has reason to believe the other party has requested or is seeking or will seek a material change to the deal terms outlined in the Letter of Intent, other than as may be reasonably required to address any due diligence matters identified after execution of the Letter of Intent, they may give notice to the other party requesting the other party affirm that the other party will not request or seek any material change to the deal terms outlined in the Letter of Intent (other than as reasonably required to address due diligence matters) and the exclusivity covenant will terminate if the Acquiror fails to provide such affirmation within a specified time (e.g. two business days).

Any Last Advice?

Just repeating the comment noted above, which is worth emphasizing: Letters of Intent are not standard form “change the name” precedents. The terms that are included in Letters of Intent vary considerably and are (or should be) the subject of negotiation. The appropriate matters to include in a Letter of Intent, or seek to negotiate, can or should vary depending on the facts and circumstances of the particular proposed Acquisition.

And of course, ask a good lawyer for advice.

This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

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