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Is Your Letter of Intent Legally Binding?

Is Your Letter of Intent Legally Binding?

You’re a business owner and you’re considering selling your business and retiring. Your employee has indicated that they are interested in buying the business and you and your employee discuss the terms of a potential sale. After some discussions you both sign a one-page document that you have termed the “Letter of Intent” or “LOI”. The LOI addresses some of the terms of a potential sale, such as the purchase price, payment of the purchase price and that the employee will be acquiring the shares of the business. The LOI indicates that it will be reduced into a binding agreement of purchase and sale by the parties within 30 days from the signing of the LOI recognizing there are additional details to be finalized once you both engage legal counsel. 

The next day, your employee begins her due diligence and starts shadowing you as you meet with employees, customers and other contacts involved in business operations. The 30-day period approaches and passes and neither party insists on the timeline or raises it as an issue. Eventually, your solicitors prepare a formal agreement that’s ready for execution. However, in the meantime, your employee’s due diligence has uncovered some additional issues, which has led to some uncertainty regarding who will pay certain costs and the relationship with your employee has soured due to lack of communication. The economics of the deal have changed and you decide that the deal is off; you no longer wish to sell your business to the employee, however, your employee still wants to buy the business and has their lawyer send you a demand letter accusing you of walking away from a binding transaction. You were always of the view you had merely entered into a non-binding LOI and are now concerned about the legal implications1Fact scenario derived from Wallace v. Allen, 2009 ONCA 36. 

The above scenario is typical where parties engage in “big picture” negotiations at the outset of a transaction with the view that the details can be worked out in due course, however, the parties may have different understandings as to what exactly was arranged in the negotiations of the LOI.

Generally, when considering whether an LOI is binding, a Court will consider the true legal intention of the parties with respect to the document that was signed and will examine a number of factors, including the conduct of the parties, the specific language used in the LOI and whether the terms of the LOI were sufficiently definite to be enforceable.

The Court will consider whether the conduct of the parties after signing the LOI demonstrated that all parties considered themselves legally bound to the terms of the LOI. If the answer is yes, the Court may conclude that the LOI is a binding and enforceable agreement. It is important to note that naming the document “Letter of Intent” is not conclusive as to whether the parties intended the arrangement to be legally binding and will be only one piece of evidence taken into consideration along with how the parties acted in respect of the agreement, i.e., if your LOI clearly states that it is not intended to be binding, but the parties have acted as though it was binding, the Court may still find that an enforceable contract exists. Some examples of conduct that may suggest the parties intended the LOI to be binding include advising other employees that the owner was retiring, introducing the purchaser as the future owner of the business, advising clients and customers that the owner was retiring and that the purchaser was acquiring the business, or the purchaser depositing funds representing the purchase price in their solicitor’s trust account.

In terms of the specific language used in the LOI, the Court will examine the wording to see if there is evidence that the parties intended to be bound. Use of typical contractual language such as “it is agreed”, “upon acceptance” or “this agreement” may show that the parties wanted to go beyond a mere informal, non-binding document and that they wished to attach contractual obligations to the LOI. The LOI may also specifically identify certain provision of the LOI as binding, include specific conditions to signing the definitive agreement (for example, the purchaser’s satisfaction with their due diligence) and consider the payment of a deposit by the purchaser and what happens to the deposit should negotiations cease, which will help guide the Court.

The LOI must also not be void for uncertainty as basic principles of contract law will continue to apply regardless of the name of the document. For example, where the document does not clarify if the transaction will be a share sale or an asset sale, specify a date for the change of control or where the consideration for the transaction is not clearly set out, the Court may find the parties never came to a consensus ad item and therefore did not enter into a binding contract2See Vandal v. Cousineau, 2015 ABCA 408. 

If the LOI is found to be valid and binding, a prospective purchaser may, depending on the circumstances, request a remedy of “specific performance” which would require the vendor to proceed with the transaction and complete the sale of the business. Alternatively, if “specific performance” is not an appropriate remedy, the prospective purchaser may be entitled to damages for the lost opportunity of the deal. In either case, expert evidence would likely be required to determine the purchase price or quantify the amount of the damages.

If you are considering selling your business, an LOI can be a helpful tool to identify key terms and set out the general transaction structure and focus negotiations and help avoid misunderstanding between the parties, however, they can also unintentionally create binding obligations. A properly drafted LOI should clearly specify that it is intended to be non-binding and that the parties will start negotiating and ultimately enter into a definitive agreement with respect to the transaction, include a list of conditions required for closing and explicitly identify provisions of the LOI that are intended to be binding. The team at Carscallen LLP can help you at the outset of the sale process and ensure that the obligations created by the LOI are as intended and assist you with each stage of the subsequent transaction. 

  • 1
    Fact scenario derived from Wallace v. Allen, 2009 ONCA 36
  • 2
    See Vandal v. Cousineau, 2015 ABCA 408
*This update is intended for general information only on the subject matter and is not to be taken as legal advice.

Posted: April 17, 2023

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