Drawing up a letter of intent? First ask for advice!

Prior to a negotiation process, the parties often record the conditions for negotiation in a letter of intent. If one of the parties eventually withdraws from the negotiations, this often results in legal action. Last month the court of The Hague ruled on such a case. Corporate lawyer in The Netherlands Marco Guit explains.

Indicative, nonbinding bid

In the fall of 2012, company A, that invest and participates in other companies, was approached with a good opportunity: it was given the chance to invest in company B. Confidentiality agreements were signed and that same day company B gave an impressive company presentation. Company A made an indicative, nonbinding bid, subject to several resolutive clauses.

A letter of intent agreed

After the parties had progressed in the negotiation process, a letter of intent was agreed. This letter of intent included agreements on how to deal with the negotiations, the bidding conditions, confidentiality and rules on the so-called due diligence study.

To what extent is the letter binding?

It is sometimes hard to describe the legal qualification of a letter of intent. To what extent is this binding, for what reasons can a party withdraw and in which way are these conditions open to different interpretations?

Withdrawing from negotiations

In the letter of intent company A and company B agreed, among others, that the forecasts given were correct and that a due diligence study would be conducted. Rules were also included about when a party could withdraw from the negotiations if the transaction were to have a negative impact on the capital position of company A and who would bear the costs of this transaction.

Precarious financial situation

The due diligence study suddenly showed that company B was not doing so well at all. On the contrary, the study showed that company B was in a precarious financial situation, that the forecasts for the current year were incorrect and that the administration of company had to be improved. All in all much less positive than the company presentation had let on.

100,000 euro in costs, who’s to pay?

On 22 May 2013 company A therefore informed company B that there was a completely different picture from the due diligence study, that company A was withdrawing from the transaction and would recover the costs, of approximately 100,000 euro from company B. Company B refused to accept this and certainly would not bear the costs of company A. They then turned to the court of The Hague.

‘Withdrawal not allowed’

Company B defended its position with the statement that company A was not allowed to withdraw from the transaction at all and that this had to be based on an objective test. Also, company A could not recover the costs from company B, as these costs were unreasonable and that, under the given circumstances, this could not be expected from company B.

Many other hurdles

However, the court reached a different conclusion and considered that company A was free to determine on what information they based their decision to withdraw as funder. This leeway was left open in the letter of intent. The court also noted that many other hurdles would have to be taken, according to the letter of intent, such as approval by the supervisory board of company A to agree to the transaction. It was therefore quite likely that the transaction would not have gone through for other reasons.

Prospects suddenly less positive

Concerning the costs, company B defended its position with the statement that this was unreasonable. Nevertheless, the court ruled that the costs, based on the letter of intent, could also in fact be recovered from company B. After all, company B had held out too positive prospects, which meant that company A incurred costs. As these prospects were suddenly less positive, the costs based on the letter of intent had to be borne by company B. The court also noted that the company B was constantly kept informed of the costs, and approved of these, whilst if they wanted to object they should have done so at that time. Finally, the court concluded that company A was entitled to withdraw from the transaction and to recover the costs from company B.

Dutch lawyer to draw up a letter of intent

This case shows how important the approach of a letter of intent is, as well as the way in which the conditions are described. In this matter (apparently) a broad interpretation was possible that eventually resulted in these proceedings. It is therefore wise to think the conditions through and to record them properly, if necessary by a Dutch lawyer. This prevents high and unnecessary costs afterwards.