Letters of intent for buying a BC business: which parts bind you

You and the other side have agreed on a price in principle, and someone has suggested putting it in a letter of intent. It feels like a formality before the real negotiation starts.

In practice, parts of a letter of intent can be enforceable contracts the moment it is signed. Knowing which parts bind you, and drafting them deliberately, avoids disputes before the deal has even been checked.

What a letter of intent is meant to do

A letter of intent (LOI), sometimes called a term sheet or memorandum of understanding, records the main points a buyer and seller have agreed in principle: what is being sold, the price and how it will be paid, the expected closing date and the conditions the buyer needs satisfied. It usually comes after a confidentiality agreement and before due diligence and the formal purchase agreement. Our overview of the legal steps in buying a business in BC shows where it sits in the sequence.

The point of an LOI is to make sure the two sides are close enough to justify the cost of lawyers, accountants and lenders. It is not usually meant to commit either side to close. The trouble is that "usually" is doing a lot of work. Whether any particular part of an LOI is a binding contract depends on what the document says and how a court would read the parties' intentions, not on the title the document is given.

How a court decides whether an LOI is binding

There is no BC statute that decides whether a letter of intent binds you. The question is answered by ordinary contract law, which asks two things.

• Did the parties intend to be legally bound? Courts look at the words used and the surrounding circumstances. Clear wording that the document is not binding until a formal agreement is signed points strongly against a contract.
• Are the essential terms settled? A contract needs enough certainty to be enforced. If key terms are left to be agreed later, the document may be no more than an agreement to agree.

A decision often cited on this point is the Ontario Court of Appeal's ruling in Bawitko Investments Ltd. v. Kernels Popcorn Ltd. In that case the court found that an oral deal to grant a franchise was not an enforceable contract, because the parties intended to sign a formal written agreement and had not agreed on essential terms. The reverse can also happen: a detailed LOI that settles every important term, and says nothing about needing a further document, can be treated as a binding deal even if one side did not mean it to be.

The clauses that usually do bind

Most LOIs are drafted as a mix. The business terms (price, structure, closing date) are expressed as non-binding, while a short list of clauses is expressly made binding from the moment of signing. Those binding clauses are where buyers and sellers get caught.

Exclusivity or "no-shop"

The seller agrees not to market the business or negotiate with anyone else for a set period while the buyer does due diligence. For a buyer this protects the time and money spent investigating. For a seller it takes the business off the market. Look closely at the length of the period, whether it can be extended, and what happens if the buyer goes quiet.

Confidentiality

If a separate confidentiality agreement has not already been signed, the LOI often contains one. It typically limits how the buyer may use the seller's financial statements, customer lists and supplier terms, and it usually survives even if the deal dies.

Deposits

Some LOIs require a deposit. Whether it is refundable, and on what conditions, should be spelled out. A deposit described loosely can lead to a dispute about whether the seller may keep it when the buyer walks away after due diligence.

Costs, termination and governing law

Clauses saying each side pays its own costs, setting out when the LOI ends, and choosing BC law are commonly made binding. A break fee or expense reimbursement, if there is one, needs particular care.

Common traps for buyers and sellers

• No clear statement about what binds. If the LOI does not say which paragraphs are binding and which are not, you leave the question to be argued later.
• Too much detail. A long LOI that reads like a finished agreement can be mistaken for one. Detail belongs in the purchase agreement.
• Exclusivity with no exit. A seller can be locked out of other offers while a buyer delays. A buyer can face a claim if it negotiates in a way that breaches the binding terms.
• Conditions left vague. If financing, landlord consent or satisfactory due diligence are conditions, say so plainly so that walking away on those grounds is not disputed.
• Assuming you can change your mind on anything. Even where the business terms are not binding, the binding clauses are contracts. The Supreme Court of Canada held in Bhasin v. Hrynew that every contract carries a duty to perform it honestly, which means not lying to or knowingly misleading the other side about matters directly linked to performance.

What to settle before you sign

Before signing, both sides should be able to answer a few questions in one sentence each:

• Which paragraphs bind us now, and which are only a statement of intent?
• How long does exclusivity last, and how does it end?
• Is there a deposit, and when is it refundable?
• What conditions must be met before either side is committed to close?
• Is the deal a purchase of shares or of assets? See our guide to share purchase or asset purchase.

Once the LOI is signed, the work moves to due diligence and then to the key terms of the purchase agreement. Points left open in the LOI tend to become harder to negotiate later, so it is worth getting them right at the start.

Before you sign a letter of intent, have it read clause by clause

Our business purchase and sale lawyers can review a letter of intent before you sign, mark which terms will bind you, and carry the agreed points into the purchase agreement that follows.

Call 604-259-2844 or send us a message to arrange a consultation at our Vancouver office.