M&A: Can you back out when a better deal comes along?

(Editor’s note: Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs. He submitted this column to VentureBeat.)

A reader asks:  I’m the founder and CEO of a successful startup and we’ve been trying to sell certain non-core assets (including some IP) to a competitor.  Their CEO sent me a letter of intent, which I signed and emailed back to him last week.  Now I just received a much better offer from another company and was wondering if I can back out of the first deal.  I’ve seen some articles that imply letters of intent are non-binding – so I just wanted to make sure.

Answer:  Whether a particular letter of intent (LOI) – sometimes referred to as a “term sheet” or “memorandum of understanding” – is binding or not depends upon the precise language used and the actions of the parties.  Many companies typically do not want an LOI to be binding because many of the material terms of the deal have not been negotiated (and they do not want a Court to start filling in those terms in the event of litigation).

There may, however, be certain provisions that both parties do want to be binding.  For example, in the acquisition context, the acquirer would generally want to prevent the seller from shopping the deal subsequent to the execution of the LOI.  Accordingly, a so-called “no shop” provision is generally included in these notes and deemed binding.

If you’re preparing an LOI, though, here are three things to keep in mind.

Use clear, consistent language – LOI’s are sometimes drafted and signed by business people without vetting by the lawyers.  As a result, one party often finds itself in the awkward position of having a binding agreement on its hands when that was never the intent.

As noted above, the language in the LOI is critical in determining whether it’s binding.  If you’re not looking for a firm commitment, you must include very specific language signaling that, such as:

This letter is merely an expression of intent and is intended to serve as a basis for negotiating a definitive agreement and the related documents; it does not constitute, and will not give rise to, any legally binding obligation on the part of the parties hereto and is expressly subject to the execution of such agreement and documents.

The letter should also include words such as “would” (e.g., “the purchase price would be $_____) as opposed to “shall” or “will” and “this proposal” or “the possible transaction” as opposed to “this agreement” or “the deal”.

If any provisions will be binding, you should add clear language to the effect that: “Notwithstanding anything in this letter to the contrary, the following obligations will be binding on the parties hereto:”

Act in a manner consistent with the LOI – While the language in the LOI is critical in determining whether it is binding, the actions of the parties post-signing is just as important.  Many startups have gotten themselves into trouble when, despite the language in the LOI that it is non-binding, they have acted as though an agreement has been reached.

For example, if the LOI is “non-binding,” don’t have drinks to “celebrate the deal” or send “congratulatory” emails.  Nor should there be any partial performance by any party.

Include language that there is no duty to negotiate in good faith – It is generally a good idea to include language in the LOI to the effect that: “Neither party hereto has an obligation to negotiate a definitive agreement in good faith.”  The reason for this is because many courts have imposed this duty (even if the LOI is silent with respect to this issue).

You don’t want to run the risk of walking away from a “non-binding” LOI thinking that there’s no problem – only to be handed a summons and complaint suing you for failure to negotiate in good faith.  This is a gray area and big companies (with deep pockets) can exploit this issue if you’re not careful.

Startup owners: Got a legal question about your business? Submit it in the comments below or email Scott directly. It could end up in an upcoming “Ask the Attorney” column.

Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.