Letters of intent for the acquisition of an enterprise: their purpose and the obligations they create
This article appeared in French in the October 2022 issue of the Journal des Parcs industriels published by the Corporation des parcs industriels du Québec.
A letter of intent is the generally recommended formal first step in transactions involving the acquisition of one or more businesses. Although the content may vary depending on what the parties agree to, this article provides an overview of the usual contents of a letter of intent and the obligations it creates for the parties concerned.
1. What is it for?
A letter of intent allows the parties to set out the broad outlines of the proposed transaction and the terms they have already agreed upon in writing. These include things like the purchase price, payment terms, any potential adjustments to the purchase price, conditions precedent, the need to provide for employment contracts and non-compete and non-solicit undertakings in the final contract, as well as whether negotiations are exclusive or not and the confidentiality of such negotiations. In other words, the primary purpose of such a document is to set down in writing the terms that have been negotiated and lay out the steps that need to be taken – including the due diligence period – before the sale contract is signed.
Contrary to an offer to purchase, which obliges the parties to complete a given transaction, the parties who have signed and accepted a letter of intent will generally agree that it is “non-binding” so that they can withdraw from the process more easily along the way.
Despite the non-binding nature of the letter of intent, the fact remains that the parties are subject to a general obligation of good faith enshrined in the Civil Code of Québec.1 In Wykanta Canada Limited c. Lafrance, 2020 QCCS 1003 (“Wykanta”), the Quebec Superior Court recently defined to what extent this obligation of good faith binds the parties in negotiations subject to a non-binding letter of intent.
2. What are the obligations of the parties to such a letter?
The obligation of good faith allows the negotiating parties to expect that each one of them will act with diligence, honesty and transparency, even if they agree that they are not obliged to complete the transaction. The obligation of good faith may have two facets: the obligation to provide information during due diligence and the obligation to make reasonable efforts to continue negotiations.
2.1. The obligation of good faith and information (due diligence)
Once the letter of intent is signed, the parties generally begin the due diligence period during which the buyer conducts a detailed investigation of the company it wishes to acquire, including its financial situation, contracts with customers and suppliers, employment contracts and disputes involving the company.
During this period the seller has an obligation to inform the buyer diligently and fully and give the buyer all information that is likely to influence his or her decision to conclude the transaction in question, or the terms on which the seller would be prepared to enter into it.
This obligation to provide information is not limited to the transmission; it also requires that the information be given within a reasonable time limit. Such a reasonable time limit may be established in relation to the closing date set by the parties in the letter of intent. That means that the seller cannot disclose material information to the buyer a few days before the set closing date; the buyer must have enough time to process the information and make decisions accordingly, or to negotiate the terms of the transaction after becoming aware of such information. Here are a few examples of information that the doctrine and case law have recognized as being material enough to affect the buyer’s decision:
- The financial projections of the company to be acquired
- Employee information (collective agreements, CNESST files, employment contracts)
- Claims from customers or suppliers
- The company’s business practices.
2.2. The obligation to continue negotiations
Notwithstanding the initially non-binding nature of a letter of intent, the doctrine and case law have recognized that there are times when things like the length of the negotiations or the parties’ behaviour can turn it into a true offer or promise to contract. One example would be where the parties have negotiated for a very long time and incurred significant costs while doing so. If the parties with to conclude a promise to contract, however, they will have to agree on all the essential elements of the final contract, including the object of the transaction, the sale price and payment terms, the conditions precedent for closing the transaction and any other items that directly and materially affect the parties’ decisions to contract. The parties will then be required to make reasonable efforts to continue negotiations and sign the contract, i.e., complete the transaction.
It should be noted that one party cannot validly claim that the other party has not complied with a condition of the letter of intent if the first party has not reasonably assisted the other party in fulfilling it. In the above cited Wykanta case, since the defendants withheld the information the plaintiffs needed to obtain their financing, the court concluded that they could not then turn around and criticize the plaintiffs for failing to provide proof of irrevocable financing within the deadline in the letter of intent.
A party who wishes to revoke a letter of intent on the grounds that it is “non-binding” and categorically refuses to close the transaction after several months of work and negotiations may not be entitled to do so.
Please contact our Mergers and Acquisitions team for any questions related to an acquisition or in connection with this article. Our team will be able to support you at every step of your acquisition transactions, including the drafting and negotiating of a letter of intent.
1 CQLR c CCQ-1991, art. 1375.