TOPIC 4: PRE-TRANSACTION DOCUMENTS

What are we going to cover today?

- Letter of Intent
- Confidentiality Agreement

(taking into account that the order is

LOI/NDA (non-disclosure agreement) -> DD -> Signing -> Closing)
The order represents the normal steps of the transaction: first there will be an offer and contra
offers to decide if it is possible to make a deal. Once major points of the transaction have been
agreed, it is decided to formalize the process, and the due diligence comes, by which they agree in
some concepts that will guide the transaction until the signing. After the signing, there is a period in
which it will be necessary to satisfy certain conditions, and both will have to work together to get to
that closing phase.

In this topic we are going to focus on the pre-transaction documents, which are the letter of intent
and the non-disclosure agreement.

Letter of intent

The letter of intent is the confidence that the other person is going to move this us and no go for
another buyer or seller, so even if specific terms cannot be agreed, they agree on the process.
It is also known as Heads of Terms / Offer Letter / Term Sheet/ MoU

It is always signed at the start of the transaction, prior to the due diligence and the negotiation of
the transaction document.

The purposes of the letter of intent are:

1- Summarizing main commercial terms of the transaction. Why is it important to establish the
commercial terms in the pre-transaction documents?
- There are a lot of players in transaction; financing banks (they will have a role
somewhere between DD and signing), insurance companies, external players. If you
establish commercial terms, your professional advisers will have a clear document
with them, and that document will direct to the DD phase.

2- Setting a time table for the transaction: buyers might want to be a lot of time between the
NDA and the DD. Why?
- They need to get money and to find investors.
- That way they have more time to make a decision.
- They can wait for a moment in which price foes down.
- Flexibility
- They might want to gather information and break the information asymmetry so that
they know what they are buying.

That is why usually an exclusivity period is agreed, so that this is not limited. In fact, the seller
wants to establish that exclusivity because while in that transaction he cannot get engaged
with other potential buyer, he is taking the asset of the market. The seller is interested in the
short NDA-due diligence period, also because he wants to keep the asymmetry of
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 information, and also because that way he can know if he has a deal with us or if he should go
back to the market.

3- Regulating the obligations of the parties during DD and negotiations

There is no standard form – some are short and informal, some are long and detailed.
Usually, moreover, it is legaly non-binding, you can’t enforce it in front of a court. However, there
are some specific clauses which are binding, such as confidentiality of exclusivity.

Finally, if the intent is to tie the other party down on certain points before detailed negotiations,
then it will be fairly detailed.

There are some advantages of having a letter of intent:

A. They confirm a moral commitment – it is more difficult for a party to withdraw from the
transaction or to change fundamental terms
B. Provide focus – where the transaction is complex the letter of intent helps to focus
negotiations, highlight major issues at an early stage. That way, it prevents parties from
wasting money. It is therefore an excellence source of information for transaction teams and
outside advicers.
C. Framework for binding commitments: confidentiality, exclusivity, standstill, break fee
D. Third parties: the letter provides a useful summary of the main commercial terms that help
“selling” the transaction to the board of directors, shareholders, financing banks and
prospective investors
E. Basis for clearance submission – it can be submitted to the relevant authorities for
competition law or tax clearance.

However, there are also some disadvantages:

A. Limited room for maneuvers (moves): even though they have moral force, a party’s
negotiating position may be weakened if it seeks to depart from the agreed terms.
B. Inadvertent creation of legal relations – most EU jurisdictions impose a duty to negotiate in
good faith – entering into a letter of intent may crystallize such duty and make it easier to
enforce. Depending on jurisdiction, parties cannot freely walk away from negotiation if the
other party was rightly in good faith, relying on the agreement
C. Adverse tax consequences: if later on there is a change in the transaction structure tax
authorities may argue that the change was made in order to avoid tax payment
D. Protracted negotiations: if too much detail is negotiated at the LoI stage then negotiations
might take a lot of time

As we were watching before, the letter of intent is useful to establish the commercial terms of the
transaction, but what are exactly those commercial terms? The commercial terms might incorporate
- the transaction structure (asset deal vs. share deal)
- the purchase price and assumptions (for example, no unpaid tenant incentives, triple
net leases, etc.) and qualifications (e.g.price is subject to adjustments on account of
DD findings)
- Payment of the purchase price – down payment
- Representation and warranties
- Construction guarantees, IP rights
- Property management and facility management
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 - Costs
- Term of the letter of intent

Now we are going to talk about the exclusivity, concept that prevents the seller form actively
seeking or negotiating with other prospective purchasers for a specified period, giving the purchaser
a period of exclusivity in which to do the DD and negotiate the acquisition agreement.
In order to draft a good exclusivity clause, the steps are:
1- Define the obligation of the seller precisely: not to actively solicit any other potential buyer,
not to respond to any third-party enquiry
2- Fixed and reasonable period

The breach of an exclusivity will give rise to an action in damages. Parties may agree on a fix breach
penalty due to the difficulty of calculating the damages suffered by the purchaser. Are those wasted
costs? Or the loss of potential profit?

The break fee is to be paid by one party to another if a specified event occurs which prevents the
acquisition from signing/completing. Typical trigger events are:
- Breach of an exclusivity
- Purchaser’s due diligence shows a material liability of material adverse change
- Failure to obtain board/shareholder or regulatory approval
- Failure by the purchaser to secure third-party financing
- Right of first refusal being exercised
The break fee can be a fixed fee or a reimbursement of sunk costs.
Parties may agree on a fix breach penalty. If there is a break fee, we don’t have to go to court, that’s
why parties would be interested in it.

We are also going to talk about the non-solicitation. It is an undertaking from the buyer that he will
not make offers of key employers of whatever employer by the parent company. Therefore, by this
figure, the letter of intent may include restrictive covenants to the effect that the parties will not
solicit each other’s customers, suppliers or employees.
However, overly onerous restrictive covenants may be unenforceable as being an unreasonable
restraint on trade or may infringe competition laws.
Consideration should be given therefore to the extent, duration and geographic area of such
covenants. For example:
- Covenants should be limited to competing business lines
- Restrictions may be limited to senior employees.

Other legal terms that may appear on the letter of intent are:
- The governing law
- The jurisdiction – courts vs. arbitration
- Security for payment obligations
- Enforceability
o As we have already seen, non-binding terms do not create contractual
obligations -> therefore it is used clear and unambiguous language

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 o The clauses which are intended to be legally binding are actually legally
binding and will survive the termination of the letter of intent
o Local legal advice needs to be sought to ensure that signing an letter of intent
will not inadvertently create legally binding obligations.
o It is therefore different when we talk about the letter of intent and when we
talk about the preliminary contract or the agreement to agree

Confidentiality agreement

The purpose of NDA or confidential agreement is am undertaking of both not disclosuring

information to third parties. Therefore, it imposes a duty of confidentiality on the purchaser and its
advisers in respect of any confidential information to be disclosed to the purchaser prior to entering
into a binding agreement. However, confidentiality undertakings might be mutual.
The confidentiality agreement is also called confidentiality undertaking, or non-disclosure
agreement (NDA).
This was done because, because of the transaction, one party might know some internal business
stuff of the other. If at the end of the process you did not agree, you have already shown everything
to the buyer.
Confidentiality undertakings may be included in the LoIs, and they will make sure that these clauses
are binding.
In most jurisdiction confidentiality undertakings may only be enforced against a party to the
confidentiality agreement.

The undertaking is therefore not to disclose or use the confidential information except for
specified purposes (e.g. the transaction).
- However, “use” can give rise to difficulties: once a recipient knows confidential
information, it is impossible for it not to take it into accutn when forming a view on an
issue to which that information might be relevant.
- The possible solution to this could be:
“The (recipient) shall be deemed not to have used the (confidential information) in
connection with any action taken or decision made if the (recipient) can show tht it
would have done what it did or would have taken the decision which it took even if it
had not had the (confidential information)…

The term of the undertaking is between 2 to 5 years.

There are however some exclusions to this undertaking:

- Information that is already in or enters the public domain
- Information disclosed on a non-confidential basis
- Information that was lawfully in the possession of the recipient prior to disclosure
- Information that is subsequently received by the recipient without obligations of
confidentiality.

Now we are going to talk about the permitted disclosure, that is, certain cases in which it is allowed
to disclose information. I will have to do so, information of the asset, especially when talking with
banks.

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So the recipient of the information will commonly which to involve others in the process of
reviewing and evaluating the information, such as professional advisers. There are indeed some
conflicts of interests here:
o The buyer is interested in involving third parties and get all the information
o The seller wants to restrict the circle of people to whom information is disclosed and to
ensure that all third party recipients keep that information confidential.

The solutions for this problem might be:

A. Obliging the recipient to procure compliance by permitted third party recipients;

B. The recipient being asked to give the confidentiality undertakings contained in the
confidentiality agreement on behalf of such third party recipients; this might the the
preferred by the seller, so that it does not sign so many contracts. If the confidentialty break
is coming from thirds, the seller can go against the buyer and make him responsible. , and if
third parties don’t have funds, the buyer will have to face those obligations.

C. Second layer of NDA:Requiring such third parties to enter into a confidentiality undertaking
directly with party providing the information. Direct contracts of seller and third parties.
Seller won’t like that the rest have a different agreement with him, the seller does not want
to sign directly with the advicers of the buyer. However, this is what the buyer wants,
because that way the seller cannot go against it if thirds don’t do things right.

But also it might be the case in which there is a forced disclosure (cases in which there is a breach of
non-disclosure agreement, and it is not liable for that). The recipient may have to disclose
information if required by law or so ordered by a court. In fact, the party providing the information
cannot prevent this,
The party providing the information will require the recipient:
1. To inform it of the circumstances of the disclosure
2. To discuss in advance how the disclosure should take place and how the potential impact of
such disclosure on it might be minimized.

However, a delay for discussions might not be practicable in certain situations (e.g., the recipient’s
share price has moved in response to rumors about the transaction and an announcement is
necessary to calm the markets).
The recipient may be precluded by law from “tipping off” the party providing the information (e.g.
suspicion of money laundering).

The final remark to be done is about the return of confidential information.

If the acquisition does not proceed, the recipient is required to return any information provided and
any copies, notes or records made from the information and to delete it from any computer or other
electronic system upon which it has been stored.
However this is very difficult to police these obligations in practice. Instead, the recipient can offer to
keep all information confidential until the expiry of the term of NDA.

The remedies for breach of the disclosure are damages (which are usually very hard to quantify). It
is therefore useful if a quantity is established before, so that if the time comes experts do not have
to come to calculate the quantity.

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There is sometimes the option for the information provider to seek injunctive relief (medidas
cautelares) so that we make sure that the buyer wont disclose any further confidential information,
but the court may be reluctant to grant it.