Company principals sometimes grouse with their counsel over the need for and the attendant expense of a detailed letter of intent for a proposed acquisition transaction. Delaware’s two most important courts recently gave them a very good reason to go to the trouble of having one drawn up: it may save the deal they thought they had after they and their lawyers botch attempts to settle post-transaction disputes.
The case in question1 involved a typical private equity acquisition. The PE firm’s letter of intent (LOI) itemized several key deal points, including the desire for a comprehensive non-competition agreement (NCA) applicable to the individual sellers with the longest term permitted by applicable law, with limited carve-outs for sales to certain historical clients and operations of retained businesses. The executed NCA had a 10-year term with certain carve-outs as contemplated in the LOI. The transaction also included an indemnification escrow reserve for losses incurred in connection with ongoing product warranty actions.
As is often the case, disputes between the parties regarding entitlement to escrow funds and product warranty setoff amounts came to a boil shortly before the escrow release date. They decided to settle things at a meeting with their counsel and reached an agreement to distribute the escrow funds, with buyer’s counsel to draft a release to memorialize it. The initial draft was generated from a release utilized in a separate transaction by an attorney who did not attend the settlement negotiations and had no knowledge of the NCA or the transaction’s history. It was then revised by an attorney who had attended the settlement meeting but had not drafted any of the original transaction documents. The draft release was circulated to sellers’ counsel two days after the settlement negotiations. The parties approved and executed it without modification a few weeks later. Neither the parties nor their counsel made any reference to the NCA during the course of the release negotiations, and the executed release made no specific reference to it either.
Even so, a month later the sellers claimed the release discharged their obligations under the NCA. Unfortunately, buyer’s counsel not only missed but also included severely problematic language in the executed release. They overlooked the provision taken from the original form utilized in another transaction that provided the parties would owe no further amounts or obligations to one another in connection with the purchase agreement once the settlement payment was made. Making things worse, their actual revisions expanded the scope of claims released to include those from the beginning of time through execution of the release arising out of, or in connection with, the purchase agreement or the transactions contemplated by it. As a result, the Chancery Court was forced to acknowledge that these descriptive and temporal modifiers when read in unison rendered the sellers’ interpretation of the release initially plausible.2 But the Chancery Court ultimately ruled that the release did not discharge the sellers’ NCA obligations, and the Delaware Supreme Court affirmed.
So what saved the buyer’s bacon? A Delaware court initially attempts to interpret an ambiguous contract provision with the aid of extrinsic evidence that can include statements made in negotiation, the parties’ course of prior dealings and relevant trade or industry practices, which collectively may permit the court to ascribe a single objectively reasonable meaning to the ambiguous provision.3 The Chancery Court took into account the absence of discussion of the NCA during release negotiations and buyer’s counsel’s collective lack of knowledge of the terms of the transaction documents. But what the Chancery Court found to be the most compelling evidence was the letter of intent’s emphasis on and the parties’ negotiation of the term of the NCA as indicators of the NCA’s obvious value and therefore concluded it would not have been relinquished without discussion by the parties.4 In other words, the buyer effectively pleaded, “Don’t be cruel to a heart that’s true”, and the Chancery Court was persuaded by the evidence of the parties’ fidelity to the NCA despite the sellers’ strong plain text reading of the release.5
What is important to recognize here is that a future, perhaps slightly less seasoned, buyer may not have preserved or have access to, or be able to afford some or any of the other evidence the Chancery Court relied on in this case to persuade a court that a devious seller’s initially plausible interpretation of transaction documents is incorrect. In those situations a full throated, well developed letter of intent might be all a buyer has to support its own interpretation, which would then be worth its weight in gold. Finally, this case emphasizes the importance for buyers and sellers to utilize the same legal team members through the entirety of a transaction, from negotiation and drafting through closing and beyond and to review carefully the transaction documents they execute. Had the buyer done so in this case, it could have avoided significant litigation expenses and heartburn over a deal necessity that it might have lost in the absence of its LOI.