How to Draft a Letter of Intent (LOI) or Term Sheet

Complex transactions typically involve a main agreement (sometimes called the definitive agreement) and one or more related documents (called ancillary documents). Before entering into a complex negotiation of the definitive agreement, it might be advisable for the parties to first enter into a letter of intent (LOI) or term sheet (note that these terms are commonly used interchangeably). Negotiating and signing an LOI can save both you and your counterparty time, money, and frustration in a number of ways (see Contract Negotiation: Strategies for Closing the Deal for further discussion). For example, if the parties can't agree on the fundamental deal points to be included in the term sheet (which are discussed below), then it's safe to say that the deal won't move forward in any meaningful way, and the parties can simply walk away from the transaction.

On the other hand, a signed LOI can serve as a valuable roadmap for the first draft of the main agreement. Just remember one thing: both parties fully anticipate that the terms of the final definitive agreement will mirror those already reflected in the LOI. As such, you should negotiate the LOI with the mindset that its terms will be subject to little or no modification from that point forward.

This article will discuss the basic content of a standard LOI and walk you through the thought process behind its preparation.

Description of the Transaction

Although not required, parties often like to begin a term sheet with a description of the transaction. This is useful because it gives an overview of the broader intent and objectives of the transaction, which frames the parties' understanding of the remainder of the document. It also ensures that the parties are on the same page with respect to their expectations.

Consideration and Purchase Price

All contracts require that each party receives something of value (often referred to as consideration) in order to be enforceable (see Consideration: Every Contract Needs It). When negotiating a significant commercial contract, the parties are usually most focused on how the deal benefits them. That's why one of the first items addressed in most term sheets is a description of each party's consideration. While consideration can take many forms (for example, the receipt of goods, services, assets, equity, debt, deeds, titles, licenses, intellectual property rights, and so forth), more often than not, at least one of the parties is accepting some sort of cash payment in connection with the deal (the purchase price). The LOI should explicitly state the purchase price (if applicable), as well as any other consideration to be exchanged between the parties.

Prohibited Actions

Any time you sign a term sheet, there will inevitably be a subsequent time period during which you negotiate and finalize the definitive agreement, resulting in the consummation of the underlying transaction (the closing). This interim period can lasts days, weeks, or months. As such, depending on the nature of your transaction, one party (the requesting party) might insist that the other party (the enjoined party) refrain from significantly changing the way it conducts business during the interim period. For example, buyers and lenders often require these assurances in the context of acquisitions and business loans, respectively; however, these concerns can also arise in other circumstances.

In these situations, the requesting party can add a section in the term sheet specifying certain actions and events that will be prohibited prior to the closing (the pre-closing covenants). The following is a list of items that are commonly included in the pre-closing covenants. The occurrence of any of these events during the interim period — with respect to the enjoined party's business — would give the requesting party the right to terminate the deal:

• the conduct of business outside the ordinary course
• any material adverse change in its business, financial condition, or prospects
• the sale of any assets, other than in the ordinary course of business
• any major capital expenditures outside the ordinary course of business
• any changes in ownership
• any changes to the senior management
• any distributions to equityholders or employees, other than in the ordinary course of business, consistent with past practices
• any other significant transaction inconsistent with past practices, or
• the initiation of a bankruptcy filing or other similar proceeding.

Proposed Timing and Closing Date

Because of the interim period described above, the LOI should also include a proposed date for either signing the definitive agreement or effectuating the closing, both of which could possibly be on the same date, depending on your transaction structure. Here is a standard provision that you can include in the LOI regarding the proposed timing of the transaction:

"The Parties shall use all commercially reasonable efforts to complete and sign the Definitive Agreement within [__] calendar days of the date hereof and to close the transaction as promptly as practicable thereafter."

Note that you will have to modify the clause above to reflect the specific agreement between you and the other party.

Conditions to Closing the Proposed Transaction

In addition to the pre-closing covenants discussed above, the term sheet can also specify certain events that must occur before the parties can consummate the transaction (closing conditions). Standard closing conditions might include the following:

• the receipt of all necessary third-party consents
• the receipt of all required approvals from each entity's owners, directors, or managers regarding the transaction
• confirmation that the parties have satisfactorily completed any necessary due diligence investigations of each other
• the receipt of all required regulatory approvals, and
• any other closing conditions mutually agreed-upon by the parties.

No Solicitation of Other Offers

You should include a non-solicitation provision that prohibits the parties from soliciting or negotiating with third parties to engage in any transaction that is similar to, or would compete with, the matters described in the LOI.

Expenses

The term sheet should clearly describe how expenses will be allocated between the parties. It's common for the parties to stipulate that they will each bear responsibility for their own expenses. However, note that this section of the term sheet should also include any exceptions to that general rule (for instance, reimbursements of attorney's fees, remuneration for travel or accommodations, or indemnities).

Public Announcements

Particularly if you're negotiating a sensitive transaction that must be kept secret until the deal is finally completed, you should manage how your business developments are revealed to the public. Your LOI should require that both parties mutually agree upon the content, procedure, timing, and medium for any public announcements regarding the transaction.

Brokers, Agents, or Finders

Include a representation that none of the parties have utilized any brokers, agents, or finders to facilitate the transaction. This is important because brokers typically expect a fee for their services, and neither party wants to be blindsided with a future claim for unpaid commissions. This oversight could result in either an unexpected payment or a burdensome litigation proceeding. For further information on broker commissions and expectations, see Fee Protection and Commission Agreements With Brokers: What You Need to Know.

Confidentiality

Ideally, before negotiating the LOI, you and the other party have already signed a confidentiality agreement covering all of the non-public information to be exchanged between the parties in connection with the proposed agreement. If there is no such agreement, then you can include a separate confidentiality provision in the term sheet to cover this vital concern. See Nolo's article, Sample Confidentiality Agreement (NDA), for further information on confidentiality agreements and provisions.

Due Diligence Review

If applicable, you can also include an optional provision in your term sheet regarding due diligence matters. Due diligence is the research that one party conducts on another before entering into a significant transaction. The due diligence process is meant to protect the interests of the investigating party by uncovering any potential liabilities or other problems that might emanate from the transaction. For example, due diligence investigations are common in connection with business acquisitions or financing arrangements. If the nature of your transaction motivates one or more of the parties to conduct due diligence on the other, then your term sheet should provide that the parties, their companies, and their management will cooperate in good faith with all due diligence efforts.

Miscellaneous Terms

Towards the end of the document, the letter of intent should also include any miscellaneous terms that the parties would like to have reflected in the definitive agreement. These are boilerplate provisions that appear in most contracts regarding governing law, amendments, assignments, and so forth. For more information on these miscellaneous provisions, see Common Boilerplate Provisions in Contracts.

No Binding Agreement or Obligation

Conclude the term sheet with a bold declaration from the parties that they intend to memorialize the final deal terms in a separate definitive agreement and only be bound by the terms of that document. Here is a sample provision:

"Except for Sections [__], [__], and [__], THIS [LETTER OF INTENT/TERM sheet] DOES NOT CONSTITUTE OR CREATE, AND SHALL NOT BE DEEMED TO CONSTITUTE OR CREATE, ANY LEGALLY-BINDING OR ENFORCEABLE OBLIGATION ON THE PART OF EITHER PARTY TO THIS [LETTER OF INTENT/TERM sheet]. NO SUCH OBLIGATION SHALL BE CREATED, EXCEPT BY THE EXECUTION AND DELIVERY OF THE DEFINITIVE AGREEMENT CONTAINING SUCH TERMS AND CONDITIONS OF THE PROPOSED TRANSACTION AS SHALL BE AGREED UPON BY THE PARTIES, AND THEN ONLY IN ACCORDANCE WITH THE TERMS AND CONDITIONS OF SUCH DEFINITIVE AGREEMENT. This [LETTER OF INTENT/TERM sheet] shall be DEEMED TO HAVE BEEN NEGOTIATED AND PREPARED EQUALLY BY BOTH PARTIES AND SHALL BE construed according to its fair meaning and not strictly for or against either Party."

Note that you should fill in the blanks in the above clause with any sections that should survive the signing of the definitive agreement (for example, confidentiality and expenses).