Letters of Intent: Traps for the Unwary
A recent ruling made by the Delaware Court of Chancery serves as a reminder to exercise caution in drafting letters of intent.
In Global Asset Capital, LLC ("Global") v. Rubicon US Reit, Inc. ("Rubicon"), C.A. No. 5071-VCL (Del. Ch. Nov. 16, 2009), the Delaware Court of Chancery ordered Rubicon to stop engaging in activities that the court ruled constituted a breach of Rubicon's obligations under its letter of intent (LOI) with Global.
Background
A summary of the facts as alleged in the case: Facing possible bankruptcy, Rubicon decided to enter into an LOI with Global that contemplated that Rubicon would file for bankruptcy in conjunction with signing a final agreement with Global. Under that agreement, Global would act as a stalking horse bidder in a court-supervised auction of Rubicon's assets.
The LOI also prohibited Rubicon from disclosing the terms of the LOI to third parties and prohibited Rubicon from soliciting other offers during the term of the LOI. In addition, the LOI included a provision that the parties would work toward negotiating a final agreement.
Soon after signing the LOI, Rubicon disclosed the terms of the LOI to its creditors to gain leverage in an effort to relieve its liquidity problems. Rubicon then failed to respond to Global's initial draft of a final agreement and instead proceeded to solicit alternative offers.
Not surprisingly, Global filed suit against Rubicon asking the Court to enjoin Rubicon from further disclosing the terms of the LOI and entertaining alternative offers. Global also asked the court to compel Rubicon to move forward with a finalizing an agreement and filing for bankruptcy.
Rubicon argued that since it no longer had an urgent liquidity crisis, the LOI had essentially expired. Alternatively, Rubicon argued that even if it was obligated under the LOI, the fiduciary duties of its directors to keep the company out of bankruptcy conflicted with the LOI, and therefore, its performance under the LOI was excused.
The Court granted Global's motion and ordered Rubicon to stop disclosing the terms of the LOI and soliciting other offers. In its analysis, the Court emphasized several key points.
First, sufficiently clear LOI's do create enforceable obligations. If the parties don't intend to create enforceable obligations, then they should expressly say so in the LOI.
Second, an agreement to negotiate in an LOI represents a concrete obligation to do so and failure to meet this obligation may constitute a breach of the agreement.
Finally, the Court pointed out that Delaware courts don't recognize an inherent fiduciary-out where the obligations in a contract conflict with the fiduciary duties of the company's directors - if contracting parties want to have a fiduciary out, they must include express language allowing for it.
Practical Take-Aways
The Global case serves as an important reminder:
- Always indicate in an LOI which provisions are intended to be binding and which are not.
- Do not include a covenant to work toward a final agreement unless you intend to do just that.
- Include express language allowing for fiduciary or other outs if that is the intent is that one or more of the parties are to have such an out.
