Letter of Intent

Table of Contents

• What is a Letter of Intent?
• Distinguishing the Letter of Intent from other instruments
• Points covered in a Letter of Intent
• Legal significance of the Letter of Intent

What is a Letter of Intent?

The M&A process is a complex procedure that may be subject to numerous changes over the course of negotiations. For this reason, the potential contracting parties strive to avoid legal premises in the initial phase of the transaction in order to keep as many options open as possible. At the same time, there may be a need to outline the results of negotiations already achieved in a legally non-binding form, both to emphasize the seriousness of the business interest and to place the further transaction process on a more stable footing. These tasks are fulfilled by the Letter of Intent (LoI). It records both the key aspects of the transaction on which a fundamental consensus has already been reached (fixing elements) and the further steps of the transaction process (dynamic elements). It sets out the key points of the transaction on which fundamental consensus has already been reached (fixed content elements) and further steps in the transaction process (dynamic content elements).

Distinguishing the Letter of Intent from other instruments 

Preliminary Agreement

Unlike a Letter of Intent, a Preliminary Agreement is usually aimed at creating a legal framework that contains already binding provisions on key aspects of the transaction. A Preliminary Agreement therefore presupposes that the parties involved have already reached consensus on the essential economic and legal issues and that the agreement can be drafted with sufficient certainty. The main reason for concluding a Preliminary Agreement is that the intended main agreement is still subject to legal and/or factual obstacles. On this basis, the parties to a Preliminary Agreement generally have the possibility to compel the conclusion of the main agreement, if necessary, by legal action. However, the obligation to conclude a main agreement on the basis of the preliminary agreement only exists if the circumstances have not changed to such an extent that the expressly agreed, or otherwise evident, purpose is frustrated, or one party’s trust in the other has been lost.

Memorandum of Understanding (MoU)

The distinction between a Letter of Intent and a Memorandum of Understanding is not always straightforward. It seems appropriate to limit the MoU to cases in which the parties wish to record concrete results of previous negotiations, for example as an “interim result.” The current status of negotiations is thus jointly documented in writing. In contrast to the LoI, the MoU therefore primarily contains fixing elements, while dynamic elements—such as statements on the further course of the process—recede into the background. The MoU thus serves the purpose of preparing the main agreement and is therefore less process-oriented and more contract-oriented. The parties are free to give the MoU a stronger binding effect than the LoI, although in practice the MoU is usually just as non-binding due to its preparatory function.

In addition to information on the contracting parties and the object of purchase, an MoU typically includes:

• Aspects of the transaction structure (description of the shares to be acquired, determination of profit entitlement rights in the case of a share deal, or listing of the assets to be acquired and, where applicable, liabilities to be assumed in the case of an asset deal),
• Ranges for the purchase price and/or provisions on purchase price adjustments, including the form and due date of payment,
• Financing issues, such as confirmation of financing commitments including any restrictions, provisions on outstanding issues and stipulations on their resolution in terms of content and timing,
• Warranty and guarantee provisions, and
• Provisions relating to closing.

Overall, careful consideration should be given to whether the conclusion of an MoU is advisable. Negotiations over an MoU often take longer than intended, and the actual objective—finalizing the main agreement—can fade into the background. However, with competent advice, an MoU can significantly ease the negotiation process. This preserves results and increases the psychological barrier to later questioning agreements already made in the MoU.

Binding Offer

A Binding Offer constitutes a legally binding offer to purchase a company or shares in a company and must therefore already include the essential contractual terms. Choice of law and an arbitration clause should also be incorporated at this stage. During the binding period, for which the Binding Offer is submitted, the offer is in principle unilaterally irrevocable. Not least due to this irrevocability, the offer must specify the conditions indispensable from the purchaser’s perspective for the conclusion of the contract (e.g. regulatory approvals, clearance under antitrust law, a catalogue of representations and warranties, and a satisfactory due diligence review). In practice, it has often been observed that the offer is not expressly accepted but instead forms the basis for entering into the next phase of contract negotiations.

Points covered in a Letter of Intent (including sample wording)

Subject Matter of the Agreement

The subject matter section primarily expresses the interest in the acquisition.

Example

"With this letter, we would like to express our interest in acquiring all shares in […] GmbH, located in […], from you. The acquisition shall be effected either directly by us or indirectly through an affiliated company, domestically or abroad, and is subject to the condition that the purchase agreement, still to be negotiated, is concluded."

Non-Binding Nature 

The non-binding nature of the Letter of Intent should be clearly stated.

Example

"This letter exclusively reflects the mutual intentions regarding the transaction. Binding obligations concerning the transaction arise solely from the execution of the purchase agreement. In particular, this letter does not give rise to any claim to conclude the purchase agreement. The parties retain the right to cease further negotiations at any time without providing reasons."

Due Diligence; Timeline

Specifying a concrete due diligence process is also important, allowing the prospective buyer to conduct a thorough review of the target company prior to executing the purchase agreement.

Example

"As soon as reasonably practicable, you will allow us, following the signing of this letter and in accordance with applicable legal provisions for you and the company, to conduct a customary due diligence review concerning the financial, legal, tax, operational, and environmental matters of the company."

Purchase Price 

Due to the complexity of determining the purchase price and the corresponding need for detailed information, it is advisable to outline only the general principles in the Letter of Intent and discuss details during subsequent contract negotiations. In individual cases, it may be sensible to define the treatment of specific items (e.g., factoring, provisions, leasing) in the context of the purchase price if they are economically significant.

Example

"Subject to the assumptions listed below, we are willing to pay a purchase price of EUR […] (the “Purchase Price”) for the shares. The Purchase Price is based on the following assumptions: (i) the company will be acquired free of third-party liabilities and after deducting available liquidity; (ii) the company has a customary and sufficient level of working capital for its business operations; and (iii) during our due diligence, no material liabilities or risks are revealed that were not disclosed to us prior to the signing of this letter."

Key Terms of the Transaction

Another core component of a Letter of Intent is the key terms of the transaction. This section is the least suitable for generalization. The level of detail, particularly regarding which elements of the future purchase agreement should already be outlined, depends on the specific circumstances of the individual case.

Example

"We assume that the completion of the transaction is subject to certain conditions precedent, in particular that (i) all necessary corporate and regulatory approvals, including antitrust clearance, have been obtained, and (ii) no material adverse changes occur in the company or its business between signing the purchase agreement and completion of the transaction."

Exclusivity

The seller’s exclusivity obligation has two aims: to terminate ongoing negotiations with other potential buyers and to avoid contact with other interested parties.

Example

"The seller shall immediately terminate all negotiations and other contacts with third parties concerning a potential sale of shares in the company, or all or a substantial part of the company’s business or assets, or any other disposition thereof."

Employment Clause

Since business-sensitive information and employee contacts are often exchanged during negotiations, it is advisable to include an employment clause in the Letter of Intent.

Example

"As long as no purchase agreement is concluded within the timeline set forth in this letter, the buyer shall not hire or solicit employees or former employees of the company for a period of […] years."

Non-Compete Clause

The prospective buyer can declare in the Letter of Intent that the acquisition interest is conditional upon an agreed non-compete arrangement.

Example

"Upon closing of the transaction, the seller agrees, upon request, to enter into a non-competition agreement, committing not to engage in any business that is similar to or competes with the seller’s business for a period of […] years."

Costs

The negotiating parties may incur substantial expenses in advance of the intended agreement. Even if this is not the case, a provision regarding the parties’ costs should be included.

Example

"Unless otherwise stated in this letter, each signing party shall bear its own costs incurred in connection with this letter."

What legal significance does a Letter of Intent have?

A Letter of Intent constitutes either a unilateral declaration of intent or a contract. It may obligate one or both parties to certain conduct, from which preliminary performance obligations and/or (pre-)contractual ancillary duties can arise. A Letter of Intent is typically a non-binding statement intended to confirm that the party or parties to the letter are engaged in negotiations toward concluding a contract. It does not, however, create any obligation to conclude the intended main agreement (no binding effect). However, individual provisions agreed upon within the Letter of Intent—such as exclusivity clauses and confidentiality agreements—are binding for the duration agreed upon.

For individual legal advice regarding exclusivity agreements, please feel free to contact our law firm directly. Do you have another concern in the field of corporate law? Learn more about our corporate law advisory services.