M&A Vocabulary – Understanding Experts: “Letter of Intent (LOI)”

The contracting parties of a company acquisition often wish to establish their mutual expectations regarding content and process at an early stage of the planned transaction.

Particularly due to the resources the seller must provide for due diligence and subsequent contract negotiations, the seller generally has an interest in the potential buyer declaring their fundamental acquisition intent.

It can also be important for the buyer to communicate in writing to the seller the seriousness of the proposed transaction. This is especially true when there are multiple interested buyers. For this purpose, the negotiating partners typically enter into a so-called letter of intent (LOI). The term, which originates from Anglo-American law, is considered under German law to be a Letter of Intent (LOI), which is not specifically defined by statute. In most cases, it is the seller who unilaterally requests this letter of intent from the prospective buyer, but in practice an LOI is sometimes also signed by the seller as a bilateral declaration. In this case, the term Memorandum of Understanding (MoU) is frequently used.

As a pure letter of intent, the LOI lacks the intention to create legal obligations. This is how the LOI can be distinguished from a preliminary contract, which typically establishes a legally enforceable claim to conclude the main contract.

Although an LOI is thus specifically not intended to create an enforceable claim to conclude the corresponding company purchase agreement and is intended to be largely non-binding, individual components of the LOI can very well be declared binding between the negotiating parties. This means that in the event of a breach of such a binding agreement, liability for damages may arise or even contractual penalties may become due. This is particularly relevant for exclusivity clauses or confidentiality clauses. If the seller negotiates in parallel with other interested buyers, for example, even though they committed in the LOI to conduct contract negotiations exclusively with the specific potential buyer for a certain period, this may give rise to liability for damages.

When an LOI with the content described above is present, it is referred to as a “soft” LOI. In practice, so-called “hard” LOIs are also conceivable, although certainly rare. A hard LOI exists when the contracting parties, beyond the mere letter of intent, also reach a binding agreement on essential contract components of the company acquisition, such as the purchase price or its calculation method. In this case, the corresponding agreement is already legally binding with respect to the purchase contract to be concluded later.

An LOI should essentially be structured so that it first names the contracting parties of the company acquisition and reflects the current status of negotiations. The transaction itself should be described as specifically as possible and the most important deadlines for the planned course of the acquisition should be stated. In addition to exclusivity clauses and confidentiality obligations, an LOI can and should also contain statements on conditions for continuing contract negotiations or terminating them (possibly depending on the results of due diligence).

It is obvious that particular care should be taken when drafting an LOI, especially to provide clarity regarding the question of the binding nature of individual agreements and to avoid misunderstandings and ultimately legal disputes from the outset.

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