The Letters of Intent (LOI), as well as many other figures and structures typical of mergers and acquisitions of companies in the Spanish market, have been imported from the usual practices of the Anglo-Saxon M&A. Derived from the above, this figure is also known as Memorandum of Understanding (MOU), Principle’s agreement, Heads of agreement or terms, etc.
The purpose of the present document is to provide, in a generic way, the particularities of this type of document in Spain and make some recommendations regarding its use and elaboration.
The Letter of Intent lacks its own regulation in Spain but, obviously, it has its coverage by the basic principles of our civil law.
Being such a versatile document in its content and depending on the binding nature that one wishes to give it, it could be defined as a document signed by one or both parties in the pre-negotiation or pre-contractual phase of a transaction in which certain commitments, statements, intentions, wishes, etc., are declared to delimit the future negotiation process.
A very common mistake is to understand that, due to their name, they are not binding or obligatory, and nothing could be further from the truth. LOIs can become fully and legally binding contracts since their denomination does not predispose any content. However, as we shall see, this will vary depending on the transaction. In other words, the name given to the document will be the least important thing and the relevant part will be its binding content.
Being such a flexible document in its content, it can be used in different commercial transactions, although its most common use is in mergers and acquisitions, also known as M&A transactions.
In an acquisition operation and after a super-preliminary phase in which the different parties have been showing interest in the operation and have even advanced with important elements such as price, phases, etc., there comes a moment, before the detailed negotiation, in which the parties need or require (or simply as a good practice) that these conversations are materialised in a document. This document is the Letter of Intent and allows them to advance in future negotiations more clearly and probably faster.
As I said before, its content and objective are as varied as the operations carried out, i.e., there is no specific or obligatory content, but rather a common one, and its objective depends on what the party or parties wish to bind themselves to. This last detail is interesting, since, as explained in the definition, we can find Letters of Intent signed by both parties with a format similar or identical to that of a contract or, on the contrary, we can find those signed by only one of the parties as a letter or offer, which usually involve few commitments.
It is important to contextualise the moment at which a Letter of Intent is signed. It is normal that up to that moment the parties, and specifically the buyer, have received the information directly from the seller without having gone into much detail to contrast and much less to initiate a Due Diligence process. In this context, it is normal that the parties do not want to assume a strong commitment or obligation at the expense of analysing in detail the object of the purchase and the possible contingencies that may exist.
What we often find is a document in the usual contract format in which the parties are identified, the motives or motives that lead the parties to formalise the contract are explained, i.e., the commercial transaction is explained, and the clauses begin.
4.- Typical clauses
Although, as we have seen, the content can be very varied, there are common or frequently repeated clauses in this type of document:
(i) Confidentiality: in this type of operation, the seller usually transmits a lot of information to the buyer which, of course, would only be transmitted if the confidentiality of it is guaranteed, so it is not only usual but also advisable to leave it recorded. It may happen that the parties have signed a Non-Disclosure Agreement (NDA) before the signing of the Letter of Intent, which is not an obstacle to specifying it again or making reference to it.
(ii) Exclusivity: it is important for both the buyer and the seller to state whether there will be a period of exclusivity or not. The seller will most likely want to make it clear that it does not guarantee to negotiate exclusivity and that it will make approaches to other interested parties. Conversely, the buyer may want at least a period of exclusivity to be guaranteed.
(iii) Duration: it is customary to set a period for negotiations to prevent them from dragging on.
(iv) Expenses: it may happen that, on this point, the parties are in complete agreement and, in order to move forward and avoid it being a reason for breaking off subsequent negotiations, it is established how the expenses of the transaction will be shared or who will bear them.
(v) Due Diligence: it is very common for the buyer to want the seller to commit to collaborate and provide the necessary information for the seller to carry out its legal, tax and financial review of the target company.
(vi) Commitments regarding the conduct of the business: the buyer may want the company to carry out normal trading activities during the negotiation phase, or to invest in a particular area or development, etc. The selling party will want these expenses will be reimbursed if it incurs some investment derived from the buyer’s requirements and the transaction does not take place.
(vii) Delimitation of the content: in addition to the above, and on points that will be made clear in the sales contract, the points on which an agreement satisfactory to both parties must be reached are usually delimited by way of enunciation.
(viii) Binding: This is one of the most important and most common clauses in this type of document. In this clause, the parties will establish which contents of the Letter of Intent are non-binding and which are binding. The wording of the individual clauses may or may not confer such binding or non-binding nature, but the opportunity is often left for a separate clause specifying which clauses are non-binding and which are binding.
(ix) Applicable law and jurisdiction: as we mentioned before, since we may find in this type of document obligations for both parties and as these are, in many cases, foreign entities, it is more than advisable to define the law that will apply to the document and the jurisdiction to which any discrepancies that may arise concerning its interpretation and compliance will be submitted.
As I mentioned in the definition, a very common mistake is to interpret that because we are dealing with a Letter of Intent, its content is not that of a contract or that it is not binding. We can find ourselves, and in fact, it happens very often in practice, with documents that grant an absolute binding not only on the general content of a letter of intent but also, and more dangerously, on the future content of the SPA or share purchase agreement.
Understanding the above, the Letter of Intent is going to be a document with the binding and content that we want, distorting or not its use, but with the binding content that has been determined. In other words, although it is not the object of the LOI, if we define and fix the price of the purchase in it, this determination, although it would have to have been determined in the contract of sale, will be able to be completely binding.
The problem with Letters of Intent arises when, given their flexibility, their use is distorted and they are intended to be used as a summary or “pre-contract” of the SPA, trying to include or bind the parties on future issues as much as possible. This, in itself, is not a problem if both parties agree and are aware of the binding nature of their statements or commitments. The problem arises when the transaction does not take place and one of the parties that have been bound at some point in the document understood that, because it was in this format, it was not going to be binding.
In my opinion, to understand the main problems arising from this type of document, it is necessary to differentiate between what some authors define as the proper and improper content of Letters of Intent. The proper content would be that of confidentiality, exclusivity, duration, due diligence, legislation and jurisdiction, etc., i.e., the content that is intended to bind the parties and about which there is, in principle, no doubt. The improper, on the other hand, is the content that is added referring to the future contract and that, for obvious reasons, is to be left as undetermined as possible and, therefore, with no or little connection.
It is very difficult to find a LOI that does not have both proper and improper content. In fact, it is the norm. This duality is what makes it very important to pay special attention to the wording given to the letter; the proper content should be drafted with forcefulness and clearly reflecting the parties’ obligation; the improper content, on the other hand, should be drafted in accordance with the parties’ intentions. In many cases, and unintentionally, the wording of the improper content hides, from a legal point of view, suspensive conditions and/or option contracts. Again, and as I said before, this is not a problem per se and they can perfectly coexist with the usual content of the letters. The problem arises when the parties or one of them does not know the effects of these.
The easiest thing would be to recommend the drafting of this type of document without improper content, but it would not be operative to the wishes of the parties, so my recommendation is to be as concise and clear as possible in its drafting; to take every opportunity (although it may seem repetitive) to make clear the binding or non-binding nature of each of the clauses; and finally, to be very rigorous in the drafting of legal figures such as suspensive conditions or option contracts that are frequently encountered.
As we can see, in this type of document, due to the diversity they present and the lack of their own regulation, special attention must be paid both to their use and their drafting. One of the disadvantages that we find in trying to conclude or determine their effects is that, due to the heterogeneous nature of their content and use, case law has also been very diverse.
Undoubtedly, we are faced with a tool that is not so practical from a legal point of view but from a functional perspective, which allows the parties to give, at a time when no document is strictly necessary, a certain formality to their conversations, to move forward and to provide protection to certain extremes such as confidentiality and exclusivity.