Spotlight On: Letters of Intent and Non-Disclosure Agreements
January 13, 2023
Key documents to help get deal negotiations underway.
A transaction often starts out with two key priorities: getting on the same page about the basic terms of the deal, and protecting sensitive information that the parties plan to share.
Parties often outline deal terms by way of a term sheet, also known as a letter of intent (often shortened to “LOI”) or a memorandum of understanding (“MOU”). To protect their sensitive information, they may use a non-disclosure agreement, or “NDA”, also known as a confidentiality agreement.
Here’s what to focus on when working with these documents.
Term sheets can take all sorts of forms, from the “back of a napkin” to a formal structured document. They typically set out the structure of the transaction, together with the price, closing conditions, and other key terms of the deal, such as an expected timetable and the obligations of the parties during the negotiation phase.
It is a good idea for the parties to get tax advice at an early stage when preparing or reviewing a term sheet, as the structure of the transaction is often driven by tax planning.
Why Use a Term Sheet
Parties may choose to use a term sheet for a number of reasons, including:
- to confirm they are on the same page (quite literally) about the fundamental terms of a deal;
- to focus negotiations, reduce surprises, and set each party’s expectations at an early stage;
- to improve the chances of completing the transaction by identifying deal conditions early on;
- to improve efficiency and reduce costs when the definitive agreement is being prepared;
- to explain a transaction to those not directly involved in negotiations, such as a party’s board of directors or lenders;
- to enhance deal stability even if it is non-binding; and
- because it is common practice in the industry or by one of the parties.
On the other hand, parties may opt not to use a term sheet for the following reasons:
- while it may cut costs down the road, there are upfront costs to negotiating and putting a term sheet in place;
- having to negotiate a term sheet could slow down the progress of preparing definitive documents for a transaction (although in our experience, it usually makes things more efficient);
- there is a risk of a binding effect of a term sheet even if unintended by a party; and
- if a party is a reporting issuer, a term sheet might create disclosure obligations under securities law depending on how material it is.
Binding vs Non-Binding
Most term sheets signal the parties’ intention to implement a transaction, but are intended for discussion purposes only and do not bind the parties to complete the deal.
They do usually contain some binding provisions though, including provisions stating the governing law, providing for confidentiality (either a stand-alone confidentiality clause, or confirming that a separate NDA remains in effect), confirming that the parties will pay their own expenses, and providing for a period of exclusive negotiations. To be binding, the term sheet must be clear and signed.
Also known as a “no-shop” clause, an exclusivity provision typically requires the target to negotiate only with the would-be purchaser for a fixed period, which usually ranges from a few weeks to a few months. The target must typically refrain from negotiating with or soliciting any other party during that time.
The purchaser often seeks a period of exclusivity because transactions can involve complex due diligence work and negotiations which represent an up-front investment of its time and expense. Sometimes, the purchaser pays a deposit to help form part of the consideration for the exclusivity period.
Since an exclusivity clause ties up a target from talking with other potential deal partners, it is often a focal point for all parties. The duration of the exclusivity period and the scope of activities that are not permitted during that time are usually key factors. The purchaser will generally want to ensure that it has enough time to complete its due diligence and prepare definitive documents to close the deal.
NDAs are commonplace and are often presented at or near the beginning of negotiations. NDAs are designed to address the challenge of protecting information that one party discloses to another as they work towards a deal.
NDAs are sometimes seen as a relatively standardized document, to be completed quickly with a one-size-fits-all approach to drafting. However, some key considerations for any NDA that merit careful attention are:
- whether the NDA is unilateral or mutual;
- how “confidential information” is defined;
- the purpose for which the recipient of “confidential information” can use it; and
- the term for which information must be kept confidential.
We also discuss some practical and privacy law considerations for disclosing your confidential information.
Unilateral vs Mutual
Whether an NDA is unilateral or mutual determines who takes on the burden of protecting confidential information that they receive.
An NDA should only be mutual if both parties expect to share information with the other. Typically, a potential purchaser or investor is receiving information about the target company and accordingly is the only one subject to confidentiality obligations (so a one-way NDA may be more appropriate).
However, if there is a reason both parties are conducting due diligence on their counterparty – if for example the purchaser is paying for the acquisition using its own shares, or in a joint venture scenario – a mutual NDA may be more appropriate.
Definition of Confidential Information
Most NDAs use a defined term such as “Confidential Information” to capture a range of non-public information that could be disclosed in the course of negotiations.
Ideally, this definition should be broad enough to cover all types of information that the owner derives economic value from or that is personal information protected under privacy legislation, whether disclosed before or after the parties sign the NDA. However the definition should also be specific enough to help the recipient clearly identify what constitutes confidential information, and what does not.
“Confidential information” typically does not include information that is or becomes public through no fault of the recipient, or which has been independently obtained or developed by the recipient (without the use of any of the disclosing party’s confidential information).
An NDA should state the purpose for which the recipient may use the confidential information it receives. The purpose should identify the proposed transaction as specifically as possible at that time.
The narrower the scope of the purpose, the less of a possibility that the disclosing party’s confidential information can be used for any unexpected objective, either now or in the future.
NDAs often specify a length of time for which “confidential information” must be kept confidential. This period can be indefinite. The recipient party, which takes on the burden of maintaining the secrecy of such information, should be prepared to protect the information for that length of time.
Consider the following additional terms that can be contemplated directly in the NDA:
- setting out that disclosure of confidential information will be limited on a “need-to-know” basis;
- requesting the right to return or destroy any confidential information shared with the recipient at any time;
- providing for an injunction to stop the recipient from disclosing information, or from an anticipated disclosure; and
- setting out the right to be indemnified for all costs relating to enforcing the NDA.
Disclosing Confidential Information in Practice
Regardless of how carefully your NDA is drafted, enforcing the agreement and proving a breach can be a challenge. Moreover, any information leak can be difficult or impossible to contain or to be compensated for in money. Accordingly, it can be helpful to consider the practical options available for how to share your confidential information, such as:
- uploading more sensitive information to the datasite later in the deal negotiation process (and closer to closing);
- sending information only to specific people instead of uploading it to the datasite;
- sharing information only between lawyers;
- redacting or encoding certain information; and
- sharing information in person only, in hard copy.
Disclosing parties should also be aware of any confidentiality obligations of their own that they owe to third parties.
“Personal information” and Privacy Law Considerations
Privacy laws such as the Personal Information Protection and Electronic Documents Act (PIPEDA) define “personal information” as any information about an identifiable individual. A disclosing party should consider whether any information it proposes to disclose includes personal information – employee information is a common example.
PIPEDA restricts how personal information can be disclosed and usually requires the knowledge and consent of the individual to be obtained. However, there is an exception in PIPEDA for use and disclosure of personal information by parties to a prospective business transaction, so long as certain conditions are met.
PIPEDA is one of a variety of privacy-related statutes in force in Canada. Parties should consider if any other privacy considerations apply to their transaction.
- Get tax advice early on about the transaction structure, any timing considerations, and any other important details to mention in your term sheet.
- Clearly identify any binding provisions. Consider separating non-binding provisions from binding provisions in your term sheet – ideally, have a separate section for each one.
- Consider putting an NDA in place early in your negotiations to help set expectations about protecting confidential information, whether or not any such information has been shared yet. Consider the expected flow of information, and who should have the obligation of confidentiality.
- In your NDA, pay close attention to the “purpose” for which confidential information may be used, and the scope of information which will be considered confidential.
This blog post is not legal or financial advice. It is a blog which is made available by SkyLaw for informational purposes and should not be used as a substitute for professional advice from a lawyer.
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