Mergers and Acquisitions description Article
Buying or selling companies usually involves a complex and long negotiation process so that the parties can reach an agreement. The many and diverse factors of a going concern mean that, before signing a sales and purchase agreement, there is a need to review and negotiate the company’s physical, legal and accounting situation. To do this, it is usual and recommended for the parties to reach prior agreements to regulate their rights and obligations during the negotiations.
Such prior agreements are not regulated in Spanish law. Their use and content have been shaped by commercial usage. The most common agreements before buying or selling companies are non-disclosure agreements, memoranda of understanding and letters of intent. Choosing any of them depends on the circumstances of the specific transaction and what the parties aim to regulate.
Non-disclosure agreement (NDA)
A non-disclosure agreement is a contract whereby the signatories agree to share the documentation or information required for the negotiation process, which may be sensitive (e.g. accounting documentation, industrial property rights, etc.), which is why the obligation is imposed to not disclose the information to third parties or use it for purposes other than for the negotiation itself with which the parties may obtain a competitive advantage.
The obligations can include a penalty clause which envisages a specific penalty in the event of a breach.
Memorandum of understanding (MOU)
A memorandum of understanding is a document in which two or more parties who hold negotiations include the main terms of the transaction. Although the content is not mandatory for the parties, the representations have a strong ethical value linked to the good faith required in the pre-contractual phase. It is usually used as an open document during the negotiations so that any progress made is included in it.
Letter of intente LOI
A letter of intent is a document that expresses the intention of conducting a negotiation to reach a purchase agreement, whose main terms are outlined. Therefore, it is the agreement to reach an agreement.
It can be unilateral or bilateral. It is usually in the form of a letter, although the issuer can request the recipient to sign and accept it. If the letter requires the recipient’s acceptance, the binding commitments that may be included are not mandatory for the issuer until the recipient accepts it. This can be an express or tacit acceptance.
Usual content of a letter of intent
A letter of intent can include statements that are not binding for the parties and/or mandatory pacts that do have legal effects. The first type of statement defines the purpose of the negotiations while the second type regulate the parties’ obligations in the negotiations.
In the non-binding statements, the purpose of the negotiations is usually delimited, although only in a relative way. This is not a trivial statement. The delimitation may be very easy when the aim is to buy all or part of a company’s shares but this may be complex when the purpose is to acquire specific assets. Therefore, not specifying the purpose of the negotiations may thwart the transaction. It may also include the price or pricing method, the liabilities assumed by the buyer regarding the assets and third parties, the warranties and indemnities assumed by the seller, etc.
The existence of non-binding statements does not prevent the parties from including pacts which are binding.
The first clause in a letter of intent which will necessarily produce legal effects is the “non-binding” one. Its main purpose is to classify which representations are not mandatory for the parties. Therefore, it is not a pact in itself; it is a rule that interprets the statements to which it refers.
To mitigate any risks caused by a thwarted negotiation, a “risk and cost sharing” clause tends to be included whereby each party assumes its own risks and costs, thus delimiting the possibility of passing them on to the other if the negotiations break down. In any case, regulating cost sharing through a contract does not limit or exclude the liability in the event of a breach of good faith.
Other binding pacts usually included in a letter of intent are a non-disclosure agreement, an exclusivity period to reach an agreement, or deadlines for arranging the negotiation process and closing the transaction.
Effects of a letter of intent
The main function of a letter of intent is to limit any risks arising from a complex and long negotiation whereby the parties are not conventionally bound.
Therefore, the buyer obtains legal certainty when investing resources in an uncertain negotiation, while the seller gains certainty before sharing sensitive information and documentation. The letter of intent pursues two main purposes: a reinforcement in the culpa in contrahendo and a non-mandatory pact.
Regardless of whether the parties sign a prior agreement to regulate the negotiation process, article 7 of the Spanish Civil Code imposes upon them the duty to negotiate in good faith. The scope of the liability in the event of a breach of this obligation in the pre-contractual phase has been set out in case law as culpa in contrahendo. The letter of intent reinforces this obligation in two ways: firstly, it asserts that the negotiation exists whereby the duty of due diligence can be regulated and extended in the areas that require this (e.g. it determines the information that needs to be known by the buyer to form its wish in view of the acquisition); and secondly, it proves that there is an obligation (in a potential lawsuit based on this obligation).
Furthermore, the parties involved in a negotiation process run the risk of their conduct being classified as a tacit agreement. That risk may not be completely mitigated by the conduct itself since it will always be subject to interpretation. Therefore, the letter of intent contains the pact whereby the negotiation process does not require the final signature of the contract. That is the main function of a letter of intent: the parties’ conduct and representations in the negotiation process are not considered to be a true contract until the final agreement is signed.
Consequently, we can state that the lack of legal regulations in the pre-contractual phase means that it is especially necessary for the parties to sign an agreement prior to a purchase or sale so that their prospects are aligned before starting negotiations and any contingencies arising from a thwarted transaction can be mitigated.
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