Understanding Letters of Intent in Canadian M&A Transactions
Before the detailed negotiations that lead to a definitive purchase agreement, most mergers and acquisitions (M&A) transactions begin with a letter of intent. Commonly referred to as an LOI, this document sets out the key terms and conditions that the parties have agreed to in principle, creating a framework for the negotiations and due diligence process that follow.
While letters of intent are a standard feature of M&A transactions in Canada, they are often misunderstood. Business owners sometimes treat them as informal or non-binding in their entirety, which can lead to unexpected legal obligations and disputes. Understanding what a letter of intent in M&A does — and does not — commit you to is an important part of protecting your interests in any business acquisition or sale.
What Is a Letter of Intent in M&A?
A letter of intent is a preliminary document that outlines the principal terms of a proposed transaction between a buyer and a seller. It is typically signed after initial discussions have established mutual interest but before the parties commit the significant time and expense required for full due diligence and the drafting of a definitive agreement.
The LOI serves several practical purposes. It confirms that the parties are aligned on the fundamental terms of the deal, such as the purchase price, the structure of the transaction (asset or share purchase), and the anticipated timeline. It also provides the buyer with a degree of certainty that the seller will not engage with other potential buyers during the due diligence period.
In the Canadian M&A context, LOIs go by a number of names, including term sheets, memoranda of understanding (MOUs), and heads of agreement. While the terminology differs, the function is essentially the same.
Binding vs. Non-Binding Provisions
One of the most common misconceptions about letters of intent is that they are entirely non-binding. In practice, most LOIs contain a mix of binding and non-binding provisions, and the distinction between the two is critically important.
Non-Binding Provisions
The core commercial terms of the LOI — such as the purchase price, the proposed deal structure, the scope of assets or shares being acquired, and the anticipated closing date — are typically expressed as non-binding. This means that the parties are agreeing in principle to these terms as the basis for further negotiation, but neither party is legally obligated to complete the transaction on these terms.
The non-binding nature of these provisions gives both parties the flexibility to adjust terms as more information becomes available during due diligence, or to walk away from the deal if the negotiations do not reach a satisfactory conclusion.
Binding Provisions
Certain provisions in an LOI are typically expressed as binding, meaning they create enforceable legal obligations even if the transaction ultimately does not proceed. Common binding provisions include the following.
Exclusivity (No-Shop) Clauses. An exclusivity clause prevents the seller from soliciting or entertaining offers from other potential buyers for a specified period, usually ranging from 30 to 120 days. This gives the buyer the time and space to conduct due diligence and negotiate the definitive agreement without the risk of being outbid. Exclusivity clauses are one of the most significant binding commitments in an LOI.
Confidentiality Obligations. The parties typically agree to keep the existence and terms of the proposed transaction confidential. This protects commercially sensitive information that is shared during due diligence and prevents market disruption that could result from premature disclosure of the deal. In some cases, a separate non-disclosure agreement (NDA) is executed in advance of the LOI.
Expense Allocation. LOIs often specify that each party will bear its own costs in connection with the proposed transaction, regardless of whether the deal closes.
Governing Law and Dispute Resolution. The LOI will typically specify which province’s laws govern the document and how disputes will be resolved. For transactions involving Alberta businesses, Alberta law is the most common choice.
Key Terms to Negotiate Carefully
While the LOI is a preliminary document, the terms you agree to at this stage set the tone for the rest of the transaction. Several provisions deserve particular attention.
Purchase Price and Payment Terms
The LOI should clearly state the proposed purchase price and how it will be paid — whether entirely in cash at closing, or with a portion deferred through vendor take-back financing, earnout arrangements, or holdbacks. If the price is subject to adjustment based on working capital at closing, the LOI should describe the mechanism in general terms.
Due Diligence Scope and Timeline
The LOI should set out the scope and timeline of the buyer’s due diligence investigation. Buyers need provisions broad enough for a thorough investigation, while sellers benefit from reasonable parameters that prevent overly intrusive or prolonged reviews.
Conditions to Closing
While the definitive agreement will contain detailed conditions to closing, the LOI typically identifies the major conditions at a high level. These might include satisfactory completion of due diligence, receipt of any required regulatory approvals, execution of employment or non-competition agreements with key personnel, and receipt of any required third-party consents.
Identifying these conditions early helps avoid surprises later in the process and ensures that both parties are working toward the same milestones.
Break Fees and Termination Rights
Some LOIs include provisions for break fees — payments that one party must make to the other if the transaction does not proceed for specified reasons. Break fees are more common in larger transactions but can appear in deals of any size, particularly where the buyer is investing significant resources in due diligence.
The LOI should also address the circumstances under which either party can terminate the LOI, including the expiry of the exclusivity period, failure to reach agreement on the definitive purchase agreement, or failure of a condition to closing.
Recent Developments in Canadian Law
Canadian courts have continued to clarify the legal significance of LOIs and other preliminary deal documents. Recent decisions have reinforced that courts will look at the substance of the agreement — not just its title or the parties’ stated intentions — to determine which provisions are enforceable.
This means that imprecise language in an LOI can have unintended consequences. A provision that the parties intended to be non-binding may be found to create an enforceable obligation if the language does not clearly express that intention. Similarly, obligations around good faith dealing and the duty to negotiate honestly have been the subject of ongoing judicial consideration in Canada.
These developments underscore the importance of having your LOI drafted or reviewed by legal counsel who understand M&A practice and can ensure that the document accurately reflects your intentions and protects your interests.
Moving from LOI to Definitive Agreement
Once the LOI is signed, the focus shifts to due diligence and the negotiation of the definitive purchase agreement — whether a share purchase agreement (SPA) or an asset purchase agreement (APA). The LOI provides the roadmap, but it is not a substitute for the detailed provisions that will ultimately govern the transaction. This transition is often where the most intensive negotiations take place.
Protecting Your Interests
Whether you are a buyer or a seller, the letter of intent in an M&A transaction is your first opportunity to shape the transaction on terms that reflect your priorities. Taking the time to negotiate a well-drafted LOI — with clear distinctions between binding and non-binding provisions — sets the stage for a more efficient and predictable deal process.
If you are entering into M&A discussions and need guidance on structuring or reviewing a letter of intent, engaging legal counsel experienced in M&A transactions early in the process helps ensure that your LOI protects your interests and provides a solid foundation for the transaction ahead. You can begin by booking a consultation with our team.