A Cautionary Tale for Would Be Business Buyers and Sellers

“Letter of Intent” – A Cautionary Tale For Would be Business Buyers and Sellers

I write this article today as a word of caution for readers, clients of Morgan & Westfield, and other professionals who may have read the popular article titled "What Is A Definitive Purchase Agreement”.

Even a document labeled “Letter of Intent” may be enforced by a court of law as a binding, enforceable agreement if the court determines that the parties intended the document in question to be a binding agreement at the time it is signed.

Regardless of what the parties might subjectively believe-- and just about every business person the author has ever consulted with, would subjectively believe that a “Letter of Intent” is nothing more than a preliminary, non-binding agreement that is intended to facilitate preliminary due diligence  ̶  a court of law’s determination as to whether a document labeled “Letter of Intent” might in fact be a binding purchase agreement, will not turn upon the parties’ professed subjective intentions. Rather, a court of law will look to the language contained within the document, itself, to determine what the intentions of the parties may have been, at the time they signed the document in question.

Are You Kidding Me?

No. And believe me, when a business owner is threatened with the potential loss of a company as a result of an adverse court ruling, he/she does not view the matter as a joke.

First and foremost, business owners thinking about selling a business, and prospective purchasers interested in purchasing a business, must understand that virtually any writing signed by a prospective seller and a prospective buyer can be characterized as a binding, enforceable contractual undertaking.  And believe me, if someone thinks they have negotiated a good deal they do not want to lose, they can  ̶  and likely will  ̶  claim that any agreement that benefits them, is a binding agreement.

What Do Courts Look At?

Under traditional principles of contract interpretation, a court of law is required to initially determine whether the language of a document is ambiguous as to parties’ intentions.  If no ambiguity is found to exist in the subject document, the intentions of the parties will be derived solely from the language of the document itself.  If, on the other hand, the terms of an alleged contract are deemed to be ambiguous or capable of more than one interpretation, evidence can be considered by the court, before reaching a determination as to what the parties may have intended or understood at the time they executed the subject document.

As if that is not all confusing enough, certain States will allow a court to consider extrinsic evidence (i.e., evidence other than the language of the document in question) to determine whether or not an ambiguity exists. In the view of the Illinois Supreme Court, for instance, an extrinsic ambiguity exists when someone who is familiar with the context of events surrounding the execution of the document in question, testifies that the document in question actually means something other than what it seems to mean.

How does this affect me?

Let me answer this common question with a personal story: In the Fall of 1999, I was engaged to represent a privately held printing company that had previously entered into a Letter of Intent with a prospective purchaser, pursuant to which the client had understood that he was only agreeing to cooperate with the prospective purchaser in facilitating some initial financial due diligence. During the course of the ensuing due diligence process, it became clear to the client that the prospective purchaser was not looking for financial information that would support the contemplated purchase price that had been set forth within the terms of the subject Letter of Intent. Rather, the prospective purchaser was looking for financial information that it could use for its own benefit, in attempting to renegotiate a lower purchase price.

Once the prospective seller understood the prospective purchaser’s apparent intentions, it terminated the due diligence process, and refused to allow the prospective purchaser any further access to either its physical work facility or its financial information. The prospective purchaser filed a lawsuit, claiming that the Letter of Intent was in fact a binding contract, and requesting that the Court enter an Order compelling the sale of the subject printing company, pursuant to the terms set forth in the signed Letter of Intent. Needless to say, the prospective seller was both surprised and upset by the lawsuit. Worse yet, the prospective seller was forced to incur hundreds of thousands of dollars in expert and related legal fees, defending the subject lawsuit-- which it was ultimately able to do.

An expensive lesson, to say the very least-- and one that M&W’s clients and readers (as well as their transactional attorneys) would do well to heed.

So How Do I Protect Myself?

If you are an owner thinking about selling your business, or a prospective purchaser thinking about buying an existing business, you should already know the answer to this question: Make certain you are working with knowledgeable third-party professionals before drafting and/or signing anything that pertains to the sale or purchase of a business-- even something as seemingly unobtrusive as a “Letter of Intent.”