In the course of negotiating a proposed business transaction, it is common practice for the parties to set out the agreed upon terms of the transaction in an informal document, such as a letter of intent or term sheet, often signed by the parties pending the preparation of a more formal agreement. The parties may intend for the informal document to be a binding commitment to complete the transaction, or merely a non-binding “agreement to agree”. A recent Ontario Court of Appeal decision provides important lessons on the use of these informal documents as means of settling the terms of a business transaction.
The case of Wallace v. Allen concerned two friends and neighbours, Graham Allen and Kim Wallace. Allen was retiring from his business and agreed to sell the business to Wallace, an entrepreneur and investor. The parties negotiated and signed a letter of intent for the sale of the business.
After signing the letter of intent, Wallace and Allen began the process of negotiating a share purchase agreement, and targeted a specific date to sign the purchase agreement and close the transaction. On the agreed upon closing date, Allen arrived at his lawyer’s office to sign the necessary documents and complete the transaction. He was informed by Wallace’s lawyer that Wallace, who was in Florida with family at the time (with Allen's knowledge and approval), had not signed the paperwork to close the deal and had not provided his lawyer with funds to close the transaction (although this was an error, as Wallace had indeed deposited funds in his lawyer’s trust account for that purpose). At that time, Allen decided not to complete the transaction. Notwithstanding Wallace’s subsequent requests to close the deal, Wallace continued to maintain his position Wallace sued Allen for damages and an order for specific performance, requesting the transaction to be completed.
The trial judge dismissed the action, finding that the parties, in entering into the letter of intent, did not intend to form a binding contractual relationship until the final share purchase agreement was signed. Wallace appealed this decision.
The Enforceability of Letters of Intent
In Canada, the question of whether an informal document constitutes an enforceable agreement or merely a non-binding agreement to agree consists of two elements:
- Are the terms of the informal document sufficiently detailed and clear so that the contract is not void for vagueness or uncertainty? Does the document include all of the essential provisions to be incorporated in a formal document, or does the document contemplate the negotiation of additional significant terms of the deal which are not described in the informal document?
- Did the parties to the document intend to be bound immediately upon signing the document, with the more formal agreement intended to embody the precise terms of the informal agreement or was it their intention that their legal obligations to be deferred until a formal agreement was settled?
Ultimately the Court of Appeal found that the facts supported a finding that the parties had entered into a binding agreement when they signed the letter of intent. The Court's analysis was as follows:
Was the letter of intent void for vagueness or uncertainty? The Court noted that the parties entered into the letter of intent after weeks of negotiation, and the facts suggested they had acknowledged that all of the terms they considered necessary or essential to the transaction were agreed upon on and set out in the signed letter of intent. The letter of intent could not be regarded as non-binding because of vagueness, uncertainty or a lack of agreement as to the essential terms.
Did the parties intend to be bound by the letter of intent? The use by the parties of contractual-type language in the letter of intent (such as references to “this agreement” and statements such as “it is agreed” and “upon acceptance”) suggested an intention to be bound. The letter of intent did contemplate entering into of a further agreement, but it did not state that the letter of intent was expressly subject to entering into that further agreement. Rather, the letter of intent suggested that the further agreement would simply be a formality, that may result in the wording of the letter of intent changing, but not the substance. Wallace began to work in the business immediately after signing the letter of intent and also began to incorporate his sons into the business with a view to transitioning management. For his part, Allen announced his retirement and the sale of the business, while introducing Wallace as the new owner. This conduct reinforced the Court's opinion that the parties intended to be bound by the letter of intent.
Avoiding a Binding Commitment
Businesspeople often use letters of intent as a framework for discussing the terms of a transaction because it provides some level of assurance that the parties are approaching the negotiation process seriously. However, it can be equally assuring to a person who is party to a letter of intent that they are not be bound to proceed with a transaction before having had an opportunity to, for example, finalize due diligence or properly articulate the agreed upon terms in a formal agreement.
When preparing a non-binding letter of intent, consider the following recommendations:
- State explicitly in the letter of intent that it is the parties’ (party’s) intention that the letter of intent be non-binding and that binding commitments will only arise upon execution of a definitive agreement.
- Include a provision stating that the parties will, following the execution of the letter of intent, negotiate and enter into a definitive agreement which will contain the agreed upon terms in the letter of intent, as well as other customary provisions.
- Include a list of conditions upon which the completion of the transaction will depend, if already determined. A good example is a condition in favour of the buyer (if the transaction is a purchase and sale) providing that the completion of the transaction is conditional upon the buyer being satisfied with its due diligence.
- Avoid the use of "agreement-type" language. Refer to the informal document as a letter of intent or term sheet, or some other title that is consistent with characterizing the document as "an agreement to agree", which is not binding.
- If the letter of intent includes covenants regarding confidentiality of information or non-solicitation of employees, customers or suppliers, provide in the letter of intent that these provisions are intended to survive termination of the letter of intent and will be binding on the parties, whether or not a definitive agreement is entered into and/or the proposed transaction closes.