In many different types of cannabis contract negotiations, it is common for the parties to begin negotiations with a document that is often referred to as a letter of intent (LOI), but which can also be referred to as a term sheet. LOIs are used in most real estate and M&A transactions, but can be used for any type of contract negotiation. In this post, I’ll examine some of the reasons people run LOIs, as well as some of the legal issues that affect them.
LOIs are usually executed too early in a transaction as soon as the parties have agreed on general terms such as the purchase price and payment terms. Unless they are fully binding (more on that below), they don’t contain a ton of the terms that will ultimately go into the definitive agreement (commonly referred to as the “definitive agreement”). In very complex deals, you may see longer LOIs that contain complex terms, but even these are much abbreviated versions of the final deal.
The reason for LOIs is essentially to keep a deal open and to ensure that the parties have summarized and agreed the basic terms. LOIs are usually non-binding and the parties are free to withdraw from the agreement or to propose changes based on the results of an initial diligence (if preceded prior to the drafting of the final commercial) or during negotiations on the final outcome. However, they serve as good faith to keep the parties involved.
Some LOIs go a step further and have confidentiality and exclusivity clauses that are in fact binding and require one or both parties not to disclose the terms and conditions to outsiders or to buy the business (usually these obligations are imposed on the seller in a property sale, or M. & A transaction or lessor in a leasing LOI). From a buyer / lessee perspective, these can be critical – most buyers don’t want to spend the time creating an LOI just for the seller to get them to compete with and look for a better purchase price.
As already mentioned, there is a difference between binding and non-binding provisions of LOIs. Many LOIs contain most or all of the non-binding provisions. It is certainly possible to have a mandatory LOI, but it is less common. It can be very risky to run a Mandatory LOI because, by definition, it would not contain many of the terms that the final would have (including even essential terms). There is always a risk that one side will simply stop negotiating the execution of a definitive agreement when it already has a binding LOI and it benefits them not to have all of the limitations of a definitive agreement.
Most binding LOIs are much, much more comprehensive than a typical non-binding LOI for this reason. And if there are LOIs that have hybrid setups (e.g. non-binding general conditions, but binding exclusivity / confidentiality clauses), they will state very explicitly what is mandatory and what is not. This is because courts have found in the past that LOIs are binding when the parties disagree on whether they should be binding. So much of it is careful exercise.
Some of the most common problems we see at LOIs are the following:
- Sloppiness. Some companies will try to save legal costs and reuse old LOIs. The result is a contract that may contain terms that are inconsistent with the current deal or inconsistent with what the parties believed to be signed. I don’t need to explain why this is a problem.
- Bond v. Non-binding problems. This is exactly what I described above and can come back later to keep track of business.
- Failure to address regulatory concerns. Most transactions in the cannabis industry pose at least some regulatory problems. Some businesses are completely banned under various states’ cannabis regulations. Even so, we’ve seen a lot of LOIs considering transactions that need to be completely changed to match the regs. Nobody wants to colorize an LOI just to have to propose significant changes to the business.
- Contains no essential terms. Even bad LOIs usually deal with the most pressing issues like the purchase price and how / when it is paid. However, there may be a number of other terms that are critical to the party issuing the LOI that are left out and can cause headaches later on. While LOIs shouldn’t be books, a half-page LOI can be just as problematic.
Cannabis companies using LOIs should consider working with lawyers who can put together simple but sufficient LOIs. A good LOI can save a lot of time, legal fees and headaches later.