In cannabis contract negotiations, it's common for the parties to execute an early-stage document called a letter of intent ("LOI"). An LOI may also be called a term sheet; naming it one over the other has no legal significance. I love these little agreements and today I will tell you why.
LOIs are used in most cannabis real estate and M&A transactions, but they can be used for any kind of contract negotiation. Parties typically circulate an LOI early in a cannabis deal, when they are dialing in big-picture terms like purchase price and payment terms. Unless the LOI is completely binding (more on that below), it won't contain many of the terms that find their way into final agreements, which are commonly referred to as "definitive agreements." It will, however, include most or all of the high-level deal points.
In complex deals, you may see longer LOIs that include complex provisions, but even those are much more abbreviated than definitive agreements. In very simple deals, an LOI can be one or two pages; and in the simplest of deals, I'll dump the high-level "LOI" terms into the body of an email, and proceed to drafting once we have a green light from the counterparty.
Overall, memorializing terms in a well-built LOI is often the most efficient way to proceed in dealmaking. Definitive agreements will flow naturally from a good LOI.
Reasons to have an LOI
The odds of success in most deals increases, exponentially, when an LOI is used.
Related, a primary function of an LOI is to ensure the parties agree on key terms before investing outsized time and money on legal. There are few worse feelings in lawyering (and, I image, for a business) than drafting a suite of contracts, only to have the counterparty respond "this isn't really what we agreed upon." Nearly as deflating is to receive fully lobotomized drafts in return, or even replacement agreements.
An LOI can also serve as an "offer" of sorts. This is more common when the parties are working through brokers, or have only had limited, preliminary discussions. Beware, though, of parties who routinely circulate LOIs without seeming to strike any deals; or who circulate LOIs advertising other deals they have on deck. Often, these parties are not serious; or they may be collecting LOIs to try to raise funds off that paper. It's effectively the same thing.
Finally, LOIs can be very effective in anchoring negotiated deal terms, at least to start. Nearly all LOIs will have an expiration date, which may keep a transaction afloat through that time.
Binding versus nonbinding versus hybrid LOIs
LOIs are usually nonbinding, or nonbinding with just a couple of binding terms (e.g., confidentiality, exclusivity). It's very important, though, to be clear about the status of an agreement: state law varies on the enforceability of LOIs when the status is not clear. Like a binding LOI, a nonbinding LOI can also serve as extrinsic evidence in a dispute if a transaction goes south, including through drafting or execution errors in definitive agreements.
Hybrid LOIs, including those limited to confidentiality and exclusivity clauses, are most commonly tailored toward sellers in real estate sale or M&A transactions, or lessors in lease LOIs. From the buyer/lessee's point of view, these provisions can be paramount– a buyer can suffer by inking an LOI, only for a seller to sit on it while shopping for a better purchase price. Sometimes, payment will be required to lock in these terms.
As to binding LOIs, they are less common, more comprehensive, and more risky. By definition, a binding LOI lacks many of the terms in a definitive or "final" agreement (including even material terms). There is always risk that one side could simply stop negotiating definitive agreements following binding LOI execution, if that party feels the LOI benefits them where a definitive agreement will bring constraints.
Common problems in LOIs
Some of common problems we see with LOIs are as follows:
- Sloppiness. Some companies will try to save on legal costs and repurpose old LOIs. The result is a contract that may contain terms that don't match the current deal, or are inconsistent with what the parties thought they were proposing. I don't need to explain further why this is a problem.
- Binding v. nonbinding issues. Lack of clarity on this point can cause real damage. In some cases, courts have found LOIs to be binding where parties have disagreed on whether they were intended to be bound.
- Failing to address regulatory concerns. Most cannabis industry transactions raise regulatory issues. I've seen many LOIs that need restructuring to square with regulations. Nobody wants to ink an LOI only to have to propose material changes to the deal after the fact.
- Failing to include material terms. I've seen some real beauties in LOI land, but even the worst LOIs typically address keystone issues like purchase price and how/when a party is paid. However, other critical terms may be lacking, only to cause headaches later. LOIs shouldn't be mind-numbing tomes, but a half-assed or deficient LOI can be equally problematic.
Cannabis companies that use LOIs should consider working with attorneys who can put together simple yet sufficient documents. Having a good LOI can save a lot of time, legal fees, and headaches down the road. And in most deals, it increases the chances of a closing significantly.
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