It’s common in many different kinds of cannabis contract negotiations for the parties to execute a document early in the stages of negotiations that is often called a letter of intent (or LOI), but can also be called a term sheet. LOIs are used in most real estate and M&A transactions, but can be used for any kind of contract negotiation. In this post, I’ll look at some of the reasons why people execute LOIs as well as some of the legal issues surrounding them.
LOIs are typically executed to early on in a transaction once the parties have settled on big-picture terms like purchase price and payment terms. Unless they are completely binding (more on that below), they don’t contain a ton of the terms that will eventually go into the final agreement (commonly referred to as the “definitive agreement”). In very complex deals, you may see longer LOIs that include complex provisions, but even those are much more abbreviated versions of the definitive.
The reason for LOIs is basically to hold a deal open and to make sure the parties have the basic terms summarized and agreed upon. LOIs are usually not binding and parties are free to walk away from the deal or propose modifications based on the results of an initial diligence (if any precedes the drafting of the definitive) or during negotiations for the definitive. But they serve as a good faith effort to keep the parties involved.
Some LOIs go a step further and have confidentiality and exclusivity clauses that actually are binding and require one or both parties to not disclose the deal terms to outsiders or shop the deal around (usually these obligations are put on the seller in a real estate sale or M&A transaction or lessor in a lease LOI). From the buyer/lessee’s point of view, these can be critical–most buyers would not want to spend the time inking an LOI only for the seller to take it to competitors and shop around for a better purchase price.
As I noted, there is a difference between binding and non-binding provisions of LOIs. Many LOIs include mostly or all non-binding provisions. It’s certainly possible to have a binding LOI but it’s less common. It can be very risky to execute a binding LOI because it by definition would not contain many of the terms the definitive would have (including even material terms). There is always a risk that one side could simply stop negotiating towards the execution a definitive agreement if they already had a binding LOI and it benefitted them to not have all the constraints of a definitive.
Most of the time when binding LOIs are used, they are much, much more comprehensive than a typical non-binding LOI for just this reason. And when there are LOIs that have hybrid setups (for example, non-binding general terms but binding exclusivity/confidentiality clauses), they will be very explicit about what is and is not binding. The rationale here is that courts in the past have found LOIs to be binding where parties have disagreed on whether they were intended to be binding, so a lot of this is an exercise in caution.
Some of the more common problems we see with LOIs are as follows:
- Sloppiness. Some companies will try to save on legal costs and repurpose old LOIs, and the result is a contract that may contain terms that don’t match the current deal or are inconsistent with what the parties thought they were signing. I don’t need to explain further why this is a problem.
- Binding v. Non-Binding Issues. This is exactly what I described above and can come back to haunt companies later.
- Failing to Address Regulatory Concerns. Most transactions in the cannabis industry raise at least a few regulatory issues. Some deals are completely prohibited under various states’ cannabis regs. Nevertheless, we’ve seen a lot of LOIs that contemplate transactions that need to be completely modified in order to square with the regs. Nobody wants to ink an LOI only to have to propose material changes to the deal.
- Failing to Include Material Terms. Even bad LOIs typically address the most pressing issues like purchase price and how/when it is paid. But there may be a host of other terms that are critical to the party issuing the LOI that are left out and that can cause headaches later. While LOIs shouldn’t be tomes, a half-page LOI can be equally problematic.
Cannabis companies who use LOIs should consider working with attorneys who can put together simple yet sufficient LOIs. Having a good LOI can save a lot of time, legal fees, and headaches later down the road.