Buying a business: What legal protection does a potential buyer have during the negotiations?May 10th, 2016
Making the least possible commitment while keeping the negotiations exclusive.
CATHERINE LAPOINTE, Partner, lawyer | Montréal
When it comes time to first set down on paper the general terms of a potential acquisition, quite often the prospective buyer has only sketchy knowledge of his target. At that point, some of the due diligence, most notably in respect of operational and financial matters, will only have been addressed superficially to arouse the buyer’s interest, and the legal due diligence will be embryonic at best. Furthermore, the financing for the acquisition is usually not yet secured. This is why, at this stage, the buyer is most often ready to continue the negotiating process, but while keeping his commitment, if any, to a minimum. However, the buyer will want to retain exclusive rights to negotiate the acquisition of the target for a certain period of time, and set a price that is acceptable to the seller, as well as to the buyer, barring surprises discovered during due diligence.
Letter of intent or offer letter?
In such a situation, the prospective buyer will most often want to sign a letter of intent rather than an offer letter. The two documents are similar in certain respects, but there is a fundamental difference between them. A letter of intent is a document outlining the terms and conditions that could apply to the contemplated acquisition, but it does not bind the signatories, except in respect of certain very specific and clearly identified clauses. Meanwhile, an offer letter binds the parties, who agree to purchase and sell, although it may be subject to numerous conditions, notably in favour of the buyer.
A letter of intent should nevertheless contain certain clauses that are binding on the signatories and that protect the buyer. Some of the most frequent are:
a provision that allows the buyer to conduct due diligence on the target (i.e., a detailed review of all of its aspects);
a clause obliging the potential seller to negotiate exclusively with the prospective buyer for a certain period of time;
a confidentiality clause concerning the discussions; and
certain obligations pertaining to the management of the business from the signing of the letter of intent to the closing date.
A letter of intent will also usually stipulate some conditions on behalf of the potential buyer. In view of the fact that, a priori, a letter of intent is not binding, these conditions are only included as an indication of certain things the potential buyer expects to see in the final documentation. They may relate to the obtaining of the various consents that are needed and the financing of the proposed purchase, the requirement for confidentiality, non-competition and non-solicitation clauses, the signing of employment contracts and, in the case of a purchase of shares, the “tidying up” of any irregularities identified in the minute book review, etc.
However, whereas in an offer letter the buyer should be careful to list all of the conditions he agrees to for the purchase of the business, in the context of a letter of intent, some potential buyers will instead attempt to submit a less detailed document, especially in smaller transactions. In such a case, the letter of intent will deliberately ignore certain things the buyer only wants to negotiate at a later stage of the process. The purpose of this approach is to obtain the other party’s signature more easily, “without scaring him,” and to have him bound as soon as possible by undertakings to keep the negotiations exclusive and to allow a full due diligence of the target. Some buyers will also use this method to limit the fees at a point where the deal is still uncertain.
Nonetheless, a potential buyer should not take the drafting of a letter of intent lightly, even if it is not binding in respect of the terms and conditions of the proposed acquisition. Indeed, the few clauses that are binding on the parties must be drafted so as to properly define the purchaser’s requirements and protections. Additionally, the purpose of the letter of intent is to establish the framework for the negotiation of the final agreements, and strategic choices must be made concerning the conditions the buyer wants and which he should address or enumerate right away. Finally, as regards the buyer’s protection, the greater the number of specific conditions the buyer asks to include in the letter of intent, the easier it will be to demonstrate, if he later breaks off negotiations, that he acted in good faith.
Negotiating in good faith – it’s an obligation!
In Québec, the parties have an obligation to act in good faith, not only in the performance of the sale contract they have signed but also when negotiating it, whether or not this obligation is expressly stipulated in a letter of intent. The Civil Code of Québec, without defining good faith, stipulates that no right may be exercised with the intent of injuring another or in an excessive and unreasonable manner, and therefore contrary to good faith. Accordingly, in Québec this is an objective standard of conduct, namely the obligation to act reasonably and with integrity, as well as proactively, like a prudent and diligent person would in the same circumstances.
A change of mind: what are the risks and consequences?
In concrete terms, a potential buyer who signs a simple letter of intent must act prudently if he later decides he does not want to go through with the acquisition. If he has no valid reasons, or if he acts abusively and causes the seller to suffer a loss, he will incur his liability and may be required to pay damages. And if the courts were to find that when the buyer, in a lack of good faith, broke off negotiations, the parties had agreed on the essential elements for the formation of a contract, they could even force the parties to proceed with the purchase and sale transaction if that is what the injured party wants.
Furthermore, the acts and omissions of the prospective buyer, such as what he may have said, what he wrote in his emails, and other exchanges or behaviour (such as the existence of secret concurrent negotiations) will be used to analyze whether he acted in good faith. The courts will also consider all the other relevant facts, such as how far the negotiations had progressed.
Finally, it has been established that in such a case it is not necessary to prove bad faith, just the lack of good faith, which is a less stringent burden of proof for it can be merely inferred from the facts, whether or not there was malicious intent on the part of the person accused of lacking good faith. It is important to note that this still does not impede the contractual freedom of the potential buyer who, so long as he acts reasonably and in good faith, will be able to end the discussions that were begun in connection with an acquisition he is no longer interested in, without incurring his liability.
Should you or one of your clients wish to break off negotiations entered into following the signing of a letter of intent, it would be worth analyzing the situation from a legal standpoint to determine what options are open under the circumstances and identify the risks of withdrawing from the deal so as to establish the best way to proceed.
This article contains general comments only and in no event shall be considered to constitute a legal opinion.
Catherine Lapointe is a member of the BCF mergers and acquisitions strategic team, which makes specialized expertise available to its clients in connection with the purchase and sale of businesses operating in every sector of activity.