Many people have a strange fascination with letters of intent. There are good uses for letters of intent, but they can be very dangerous, as well. Using them to put off getting the lawyers involved, in particular, can result in a lot more lawyers than you wanted.
Anyone who thinks this is just the bellyaching of a worrywart lawyer (or, as some seem to think, a gambit to increase fees) should look this recent decision of the federal Ninth Circuit Court of Appeals (First National Mortage) and this recent opinion of the Delaware Chancery Court (SIGA).
Both cases result from short and simple summaries of deal terms that were later enforced as contracts by the courts. In First National Mortgage, the parties apparently intended their one pager to be enforceable. One of the parties (ironically, the one who later resisted enforcement) wanted to make sure it had an enforceable deal before paying lawyers to work out “the legalese and minor points.” In SIGA, the parties’ intentions are more murky: Pharmathene started negotiating a license to SIGA’s drug candidate. When it shifted its focus to buying SIGA outright, SIGA insisted on attaching the terms of the license to a letter of intent with regard to the acquisition, so it would have a backup in case the acquisition talks fell through (they did). The letter of intent provided that the parties would negotiate in good faith a license agreement with the attached terms if the merger talks failed.
What both of these cases have in common is that the parties decided to sign a set of ambiguously worded, incomplete terms, rather than just negotiating a real agreement, to save time and money in getting to a deal. In SIGA, the opinion notes that, at the time that talks shifted from licensing to merger, Pharmathene wanted to complete negotiation of the backup license (in case the merger fell through), but SIGA “objected to spending money on “a bunch of lawyers to sit around to work on a License Agreement that will never be used.”
In each case, the parties’ misplaced effort to keep the lawyers (and their fees) out of the process resulted in a mess, requiring them to spend huge amounts of money on lawyers to litigate over what they had done. First National Mortgage resulted in a jury award (upheld) of about $15 million. SIGA went to trial and could result in hundreds of millions in liability.
The bottom line is simple: If millions of dollars are at stake, it’s usually foolish economy to try DIY first and then bring in the experts to finish “the details.” There are lots of ways for you to screw things up beyond repair and relatively little savings to be had. Bring the lawyers in. Good deal lawyers serve a purpose. They help you refine your deal terms. They bring up contingencies you might not consider in thinking through the main points. Most importantly, they put the deal into a relatively unambiguous (alas, ambiguity is always there and sometimes needed), enforceable form so that when you’ve agreed, you’ve really agreed. If your lawyer is getting in the way of deals instead of helping you close them, you’ve simply got the wrong lawyer.
By the way, non-binding term sheets are a useful tool of negotiation. In many cases, it makes sense to negotiate a simple term sheet between the parties before putting the lawyers to work on complete documents. That doesn’t mean that you should keep the deal away from your lawyers at this stage, however. A lawyer can be very helpful (at little cost) at the term sheet stage in two ways:
First, you need your lawyer to make sure your term sheet is really not binding. That doesn’t have to be expensive. The issues involved are narrow and easily dealt with. That said, if you do a lot of similar deals, have the lawyer bless one form and reuse it.
Second, it’s usually a good idea to pass the terms by your lawyer for her thoughts, as opposed to drafting. She may raise important issues and it may be very difficult (occasionally impossible) to deal with them once a term sheet is agreed. Agreeing to a term sheet changes the dynamics of the negotiation. Even if it isn’t legally binding, a party who rethinks the terms later will be seen as “renegotiating.”
If you are going to use a term sheet, keep it simple, obviously incomplete (i.e. only primary terms) and expressly and completely non-binding. I continue to be perplexed by the tendency to use “term sheets” (especially in venture financing) that include large portions of the definitive contractual language. That is a waste of legal fees. Most importantly, never, ever, ever (EVER) enter into an agreement to negotiate another agreement in good faith.
As these cases illustrate, it’s easy to inadvertently create a document that’s enforceable and especially easy to create one that’s ambiguous enough to spawn years of litigation. Don’t let this happen to you. Let your lawyer help you before you get yourself into something you didn’t intend.