As I write this article for publication in the fall of 2017, I realize daily that every wildfire in the province involves friends and clients of mine, more or less helpless in the face of the overwhelming power of the elements. Everyone in the Interior is on tenderhooks—a bad feeling, with little relief in sight.
For any of you who are waiting for the final article on how public and private rights of access can be established, I will have that ready for the next issue of Beef in BC.
For this issue, I want to explain the significance of letters of intent, as I often encounter mis-perceptions about them. First, I list the steps in a sale transaction, below, then discuss the critical importance of the letter of intent and getting it right.
A letter of intent describes the key business elements of a deal to sell or buy assets or shares. It is the result of negotiations between intended seller and intended buyer. It may be binding, or non-binding.
The information below is written from the viewpoint of the seller, but it applies to a buyer as well.
Pre-Sale Planning – Shares or Assets? You want to sell your ranch. You’ve talked with your family and your tax advisor. If your ranch is incorporated and you (and possibly other family members) own the shares in the ranch company, your tax advisor may recommend that the ranch company shareholders should sell their shares, if the shareholders are entitled to all or part of the lifetime capital gains exemption on the sale of their shares.
If the ranch is owned by individuals, not by a ranch company, then the ranch owners can only sell the assets of the ranch. Occasionally a ranch company will elect to sell some or all of its assets.
Through the pre-sale planning process you will have decided whether you are selling shares or assets. You also have a target price in mind, and key deal terms that will make a sale work for you. The price should be based on the net “in your jeans” after tax proceeds. The price of assets is rarely the same as the price for shares of the company owning the assets, so the calculations that your tax advisor does to assess your after-tax position are key in establishing a price for assets or for shares.
You Offer the Ranch for Sale. You put the shares or assets up for sale. You might list the ranch with a realtor, or approach someone directly who might be interested in buying the ranch, or a buyer may approach you to express interest in buying the ranch.
You start to market the ranch. One or more persons interested in buying the shares or assets arrive. You start negotiations, often using the realtor or another agent, your accountant or tax advisor, and your lawyer, to reach a deal on the sale price and terms of the deal.
The Letter of Intent. This is the point where the deal terms are negotiated and recorded in the letter of intent, which goes back and forth between seller and buyer until it accurately reflects the key business elements of the deal to sell and buy.
The letter of intent normally includes subject conditions, limiting the obligation of the buyer to buy, or the seller to sell, unless certain conditions are met
Further discussion of the content and significance of the letter of intent follows later in this article.
Due Diligence. Once a letter of intent has been completed and signed by buyer and seller, the buyer’s representatives move into the due diligence process, where they check out everything they can about the title to the property that the buyer intends to buy, and its legal, financial, and physical condition and attributes. The due diligence list is lengthy and varies from client to client and ranch to ranch.
The objective of the due diligence process is for the buyer to make sure that he or she has the desired information about the ranch and can make an informed decision about either buying the ranch, or exiting from the deal.
I have seen due diligence periods as short as two days, and as long as several months. One to two months due diligence is the norm. A long due diligence period of three to six months tends to be a drag on the deal, prevents the seller from exploring other opportunities for sale, and should be avoided except in the most unusual circumstances.
Satisfying Subject Conditions. While the due diligence process is on-going, the buyer will be working to clear subject conditions.
Subject conditions can be many and varied. The buyer usually has subjects to satisfy, occasionally the seller also sets subject conditions. Buyer due diligence and financing are common conditions. But there can be many others, unique to the deal—nearly any requirement can be incorporated into the deal if agreed by buyer and seller.
Formal Agreement. When due diligence has been completed and subject conditions have been satisfied, the seller and buyer, through their lawyers and accountants, enter into a formal sale agreement.
These are lengthy agreements with many attached schedules. The agreement spells out the deal at length and in detail: the closing arrangements, representations and warranties of the seller about the description, title and condition of the underlying assets, the financial condition of the ranch company and the ranch business, and other attributes of the ranch business. The pre- and post-closing obligations of buyer and seller are included. The agreement also addresses the obligations and processes to be followed if the representations and warranties are later found not to be factual.
For example the seller may remove certain assets from the ranch company being sold, because of the requirements of the deal, or according to tax advice given to the seller. If the ranch company is being sold and has cash or investments in it, these often need to be removed as a buyer is not likely to want to pay for money inside the ranch company as part of the sale price.
Closing. This is the day when the deal is closed. Ownership of the shares (or assets) is transferred to the buyer and the purchase price is paid to the seller. This exchange of shares or assets for money, is made safe for seller and buyer by the pre-arranged closing process of the lawyers for seller, buyer, and buyer’s lender.
So, back to the Letter of Intent, commonly referred to by its initials, LOI.
Clients frequently do not appreciate the significance of the LOI—a big mistake. Because the LOI is only a few pages and most of the language is informal, clients do not realize that the LOI is the key document in the entire deal.
A LOI may say that it is binding or non-binding. Clients sometimes expect that, because of the non-binding provision, they can easily review or renegotiate parts of the transaction later, when the formal purchase agreements are in process, but this is a misconception. A client may sign a LOI without getting tax, accounting, and legal advice, being seduced by the informality and non-binding provision of the LOI. When this happens, it is never good news for the client.
The fact is that whether binding or not, the LOI is universally treated in business circles as at least morally binding, and virtually legally binding, by the seller, buyer, and their professionals.
Yes, a seller or buyer can, if they choose, exit the deal if the LOI allows. But this only takes place in the most unusual and unanticipated circumstances.
Negotiation of the LOI is the most important part of the sale and purchase transaction. If you have a professional sale team working for you, they will appreciate that negotiation of the LOI is the key step in the transaction.
Make sure that the LOI is accurate and that it reflects every aspect of the deal. Do not expect to sign a LOI and then casually expect to renegotiate components of it.
The law around interpretation of contracts has changed a lot since the “good old days”—which in my case was when I went to law school in the 1970s. Back then, you could look at the contract itself and see what if any legal issues existed, based only on the wording of the contract. The lines were clear and the contract was sound if it was within those lines, and unenforceable or void if it wasn’t.
The Supreme Court of Canada said in Sattva Capital Corp. v. Creston Moly Corp. in 2015, that there must be a practical common-sense approach to contractual interpretation, and that all of the surrounding circumstances, called the “factual matrix”, must be examined. Consideration of the factual matrix is not to overwhelm the wording of the contract, which remains of primary importance in interpretation, but the circumstances apart from the wording of the contract are always to be considered.
After the Sattva case, lawyers wondered if the factual matrix is only to be looked at for help in resolving ambiguities in the wording of the contract, or if the factual matrix is to be looked at to interpret the contract even if there is no ambiguity in the wording.
A 2017 Alberta Court of Appeal decision, IFP Technologies (Canada) Inc. v. EnCana Midstream and Marketing recently decided that a judge interpreting a contract is to consider the factual matrix whether or not any ambiguity exists in the contract, and that includes a contract with an “entire agreement” clause—a clause that says something like “This contract constitutes the entire agreement between the parties and supersedes all prior agreements and understandings, oral or written, by and between any of the parties with respect to the subject matter of this contract”.
It is possible that the IFP case could be appealed to the Supreme Court of Canada. The Alberta Court of Appeal decision may not be the final word on this issue. It is, however, likely to be followed by other courts in Canada pending any Supreme Court of Canada review of the decision.
The significance of the decision in the context of letters of intent, is that a court which is interpreting a contract will now look at the historical relationship between the parties, the customs of the industry, any previous or related agreements, and the negotiating process. This will naturally include the succession of drafts of the letter of intent, as well as other documents created or referenced in the negotiating process.
I am indebted for the analysis of the IFP case to Michael Styczen, P.Eng., and Laura Easton of DLA Piper who published a case comment on July 21, 2017 through the DLA Piper website. Their concluding comment is “It should be considered a dangerous practice to sign a letter of intent which does not correctly reflect the details of the transaction while planning to get the details correct in the definitive [i.e. the formal] agreements”. Very good advice.
If you intend to sell your ranch, appreciate the critical importance of two parts of the process.
First is the pre-sale planning you should do with your sale team of professionals, before the ranch is offered for sale. This pre-sale planning can have a huge effect on how much money you actually receive from the sale.
And second is the absolutely critical importance of a complete and accurate letter of intent.