The letter of intent is a non-binding agreement between two or more parties, usually the funder and the company, on business financing. It is often the first step towards signing a formal agreement.
This article presents the letter of intent as an instrument to secure contract negotiations and gives tips on what companies should pay attention to when drafting it.
Letter of intent meaning
The Letter of Intent (LoI) in the narrower sense is a non-binding declaration of intent in the run-up to the conclusion of complex, economically significant contractual transactions, which indicates the sender’s willingness to conclude a contract with the counterpart.
In a broader sense, the letter of intent can also be understood as a mere negotiation protocol or a binding (preliminary) contract.
In contrast to an offer, it is typical for a letter of intent that it is not yet legally binding, i.e. there is no claim to the conclusion of the intended main contract. LoIs therefore often explicitly contain a so-called no binding clause. It is only intended to indicate the willingness to enter into serious negotiations on the notified contract under certain conditions.
A LoI may also contain an exclusivity clause, i.e. a prohibition on negotiating the same subject matter with other actors.
Types of letter of intent
If it is a negotiation between two parties, it can be called a bilateral letter of intent. If the negotiation talks involve more than two parties, it can be called a multilateral letter of intent.
A fine distinction is also made between a “soft” and “hard” Letter of Intent (LoI). We will look at the elements of the different types of LoI below.
”Soft” Letter of Intent
A “soft” letter of intent is a non-binding letter. It confirms that the designated parties are in contractual negotiations. Thus, this form of a letter of intent can be understood as a unilateral statement reflecting the representation of the negotiating position of the issuer.
In practice, this form can be used to have the document signed by both negotiating parties. The aim is to show the state of the negotiations and their seriousness. They are nonetheless legally non-binding, so there is no claim to the conclusion of the intended contract.
The purpose of a “soft” LoI is to be able to record individual provisions such as exclusivity clauses and confidentiality obligations as binding for a certain period!
“Hard” Letter of Intent
The counterpart to the “soft” LoI is the “hard” LoI. This is written in more concrete terms and contains legally binding declarations.
The “hard” letter of intent largely takes the form of a contract. It specifies essential elements of the contract, such as the contracting parties, the object of purchase and the purchase price.
In contrast, these essential elements do not include binding ancillary agreements, which have become binding, for example, through a “soft” LoI. These include confidentiality clauses.
Applications of a letter of intent
A letter of intent goes beyond a non-binding conversation or a feeler and is intended to emphasise the seriousness of negotiation talks. The Letter of Intent is often used by corporate boards.
The LoI provides an orienting framework that the negotiators are to flesh out in detail over a longer period. Examples are complex joint ventures or joint research institutes of independent companies.
As a rule, letters of intent can be used for a variety of contracts, e.g.:
- Orders,
- Purchase orders
- Purchase and sale,
- services,
- work performances and
- combination contracts.
Letter of intent format
Parties seriously interested in concluding a contract will strive to formulate the LoI as detailed and concrete as possible (e.g. the purchase of a company). In this way, a legally relevant trust can be built up in advance, which subsequently justifies a liability of the counterparty from a pre-contractual obligation.
Central aspects to be considered are:
The subject matter of the contract
In the subject matter of the contract, the interest in the acquisition of the company is stated first.
Non-binding nature
In whatever way, the letter of intent non-binding nature should be noted.
Due Diligence; Timetable
It is also not unimportant to specify a concrete schedule for the due diligence with which the potential buyer subjects the target company to an intensive examination before concluding the purchase agreement.
Purchase price
Due to the complexity of the purchase price determination and the associated high information requirement, it is, however, advisable to outline only basic features in the letter of intent and to discuss the details in the course of the subsequent contract negotiations.
In individual cases, however, it may make sense to specify the treatment of certain items (e.g. factoring, provisions, leasing) in the letter of intent if these are economically significant items.
Key points of the transaction
Another core content of a letter of intent is the key points of the transaction. At the same time, this section is the part of the letter of intent least amenable to generalisation.
The question of how detailed the parties want to proceed here, in particular how concretely individual regulatory items of the later purchase agreement should already be outlined, depends on the circumstances in the individual case.
Exclusivity
The seller’s exclusivity obligation aims in two directions: On the one hand, negotiations already started with potential buyers are to be terminated and, on the other hand, contacts with other interested parties are to be avoided.
Employment clause
Since business-sensitive data is usually exchanged during negotiations and contacts are made with employees of the target company, it is advisable to include an employment clause in the letter of intent.
Non-compete clause
Already in the letter of intent, the potential buyer can declare that an intention to purchase will only be declared under the circumstance of an agreed non-competition clause.
Costs
Sometimes the negotiating parties incur substantial expenses in advance of the intended contract. Even if this is not the case, a provision should nevertheless be made regarding the expenses of the negotiating partners.
Letter of intent example
Here’s the sample of the possible letter of intent:
Letter of Intent
between
the Company 1
and
the Company 2
1. Preliminary remarks
Company 1 wishes to convert its B-system and intends to use software from Company 2 in this respect and to additionally commission Company 2 with the project and introduction support.
Below, the parties reflect the state of their negotiations to date and the preliminary agreements. They do not yet establish any obligation to conclude a licence and service agreement. Rather, the parties have the right to refrain from further negotiations at any time without giving reasons until the corresponding contract is signed. The contract to be concluded later (main contract) shall have the following essential content.
2. The essential content of the licence and service agreement is to be concluded between Company 1 and Company 2 (main agreement).
The subject of the intended contractual agreement is the acquisition and installation of the “Special” software for a test operation. This test operation is to be transferred to live operation from ………(insert date) (if necessary, further details on the status).
The service part to be agreed upon should include concrete coordination and a concept for introduction and project support, live start support, for setting up and coordinating the interfaces as well as the necessary user training.
3. Time schedule
The parties agree to enter into talks as soon as possible to draw up a licence and service agreement in the spirit of this letter of intent to agree quickly.
Both parties are prepared to perform the preliminary work required for the conclusion of the contract in good faith and to work together in partnership to achieve the conclusion of the contract.*) They shall provide all information necessary for this purpose.
4. Entry into Force and Term of the Memorandum of Understanding
This Letter of Intent shall enter into force upon signature by both Parties and shall automatically terminate upon the conclusion of a main contract between the Parties, but no later than xx.xx.20xx, unless the Parties have mutually agreed in writing to extend the term of this Letter of Intent.
5. Confidentiality
The documents, knowledge and experience provided to the other party may only be used for this Memorandum of Understanding.
The above confidentiality obligation does not apply to information if and to the extent that
- such information was already lawfully in the other party’s possession before its disclosure to the other party and without any obligation of confidentiality;
- it has been published or otherwise become generally known through no fault of its own;
- they have been lawfully disclosed to it by one or more third parties without an obligation of confidentiality, i.e. without a breach of this Agreement by the receiving party, after the conclusion of the Letter of Intent;
- these are released in writing by the disclosing party to the other party;
– they have been made available to a third party by the disclosing party without corresponding obligations and restrictions.
6. Final provisions
Any prior oral or written agreements between the parties relating to the subject matter of this letter of intent shall be superseded upon its entry into force.
All agreements made between the parties to execute this agreement are set out in writing in this agreement.
Rights and obligations arising from this Letter of Intent shall not be affected by any change of form or restructuring of the business organisation of the Parties, even if this results in the spin-off of parts of the business or the creation of new legal entities.
Should any provision of this Letter of Intent be invalid, the validity of the remaining provisions shall not be affected thereby. The parties shall immediately replace the invalid provision with a valid provision that comes as close as possible to the economic purpose of the invalid provision.
Spanish law shall apply to this declaration of intent. The place of jurisdiction is (City).
Remark:
At this point, a conciliation agreement and/or arbitration agreement can be made if desired.
Company 1
Managing Director
Company 2
Managing Director
Conclusion
We note that a Letter of Intent is not legally binding, but it provides certainty about the intention of the negotiating partner. A declaration in advance can also give rise to rights and obligations, such as confidentiality and the actual intention to conclude a contract.
A letter of intent is very helpful for important negotiations such as a company purchase, long-term cooperation or other important projects. Negotiations often drag on for a long time. A letter of intent helps not to lose sight of the big goal.
We support you in drafting a letter of intent and accompanying the negotiations if desired. Contact our tax lawyers in Barcelona by email or phone.
