1.Pre-contractual Relationship
During negotiations, the parties enter into a legal relationship governed by good faith. This requires each party to take into account the justified interests of the other party. At this stage the parties may rely on justified expectations created by the behaviour of the other party. Hence, the parties should reasonably avoid the other party from assenting on the basis of false assumptions.
This forms the basis for a duty to investigate (for instance in the form of a due diligence). The extent of this obligation depends on factual circumstances, including the nature and complexity of the anticipated transaction and the information, the existence or absence of specific knowledge and professionalism, the feasibility of a thorough investigation and the proportionality of advantages and disadvantages of the transaction between the parties.
Similarly, good faith may trigger a duty to disclose certain information to the other party. The extent of the duty to disclose depends on the same circumstances as indicated above with respect to the duty to investigate.
2. Pre-Contractual Liability
The good faith requirements may have the effect that negotiations cannot be abruptly discontinued. Case law distinguishes between three stages in the negotiations:
(i) Starting stage. Each party is free to discontinue negotiations without any obligation to compensate the other party;
(ii) Middle stage. A party can only discontinue negotiations provided that he compensates the other party for certain expenses;
(iii) Final stage. In general, a party is no longer free to discontinue negotiations. This is assumed when the other party could reasonably expect that some form of agreement would be reached.
If either of the parties were to discontinue the negotiations during the final stage, that party may be liable not only for the expenses of the other party but also for lost profits. For the party claiming damages, however, the burden of proving these damages may form a significant obstacle. A party may also seek a court order to impose an obligation on the withdrawing party to continue negotiating in good faith.
3. Preliminary Understanding
Parties may at some point during the negotiations decide to enter into a letter of intent (also: "heads of agreement", "memorandum of understanding", "agreement to agree", or any variation thereof) in order to reduce to writing a preliminary understanding of parties. A letter of intent can thus be described as a preliminary agreement ranging from merely a representation of the state of negotiations to a full binding agreement.
The basic requirement for the formation of an agreement is an offer and the acceptance of such an offer, i.e. a "meeting of the minds". Consideration is not required. Furthermore, one must be able to determine the subject of obligations under the agreement, i.e. the "essential elements".
4. Binding Force
In the Netherlands, a letter of intent can take various forms. With respect to the binding force of a letter of intent, substance prevails over form and it is not the title of the instrument which determines its binding force. All rules of law and principles for the formation of a contract and its interpretation similarly apply to binding letters of intent.
The binding effect of a letter of intent will be determined not only by the wording of the agreement, but also by the wording of the documents exchanged or signed between the parties as well as by any oral or other forms of communication that were instrumental to their "meeting of the minds".
It is not the professed subjective intent after-the-fact, but the expressed words and actions at the time of the agreement and the behaviour of the parties afterwards which prevails.
Furthermore, the capacity of the (negotiating) parties, the complexity of the contemplated transaction(s) and the degree of consensus with regard to the "essential elements" of the transaction(s) may have a significant influence on the binding effect of the letter of intent.
5. Escape Clauses
A letter of intent may contain escape clauses. Escape clauses purport to preclude the binding force and effect to an agreement. The escape clauses most commonly found are:
(i) "Subject to board approval": This proviso will be ineffective if the party relying on the clause was represented during negotiations by a representative of such board, or if such board was effectively kept informed and implicitly agreed to the "essential elements" of the transaction;
(ii) "Subject to financing": Financing is usually considered an "essential element" of any transaction and may sometimes be considered an implied condition to the transaction. This clause may thus be an effective escape from the binding force of an agreement. Moreover, this proviso will not easily be considered invalid because its fulfilment does not usually depend solely on the party invoking it;
(iii) "Subject to entire agreement": This proviso is ineffective if the letter of intent already contains the "essential elements" of the transaction and, according to the rules of interpretation of contracts, is considered binding on the parties thereto. An oral agreement concerning the essential elements negotiated between the parties is enforceable similarly to a written agreement. This type of proviso may easily be quashed in court as a formal defence which violates the good faith requirements.
Intent prevails over wording and a letter of intent containing such escape clauses may still be held binding on the basis of the parties' behaviour ex post facto, or become binding by ex post facto expressions of intent, orally or in writing, that supersede previously agreed provisions in the letter of intent. As a general rule, if a letter of intent is binding and contains all of the "essential elements", an action for specific performance of the agreement may be available.
6. Further Remarks
Obviously, the seller and the purchaser in a given transaction may have diverging interests in documenting the common understanding in a binding way at an early stage. From the above it follows that the one who wishes to arrive at a mutual commitment sooner rather than later, may find a detailed letter of intent a useful tool. Where deal essentials cannot be agreed upon yet, it will in any case be useful to provide for (and agree on) a number of underlying deal principals, such as who is responsible for drafting, what will the scope of representations and warranties generally be, procedures and terms of due diligence, structuring the transaction documentation and setting up various teams, with functionaries of both sides, which focus on specific transaction aspects and intergration of businesses following the completion of the transaction.
This concludes this general outline on letters of intent. Our next issue will be published at the end of February and deals with the question whether to choose an asset or share transaction in relation to a merger or acquisition under Netherlands law.
The content of this article is intended to provide a general outline of the subject matter. Specialist advice should be sought about your specific circumstances.
For further information please contact Mr J. Oerlemans on 31.10.4034 644, Loeff Claeys Verbeke, Rotterdam.
or enter a text search 'Loeff Claeys Verbeke' and 'Business Monitor'.
