Private Equity

Private equity deal professionals frequently enter into indications of interest, term sheets, letters of intent, and other preliminary agreements as part of the process of getting to a “definitive” agreement to acquire or sell a business.  A previous post to Weil’s Global Private Equity Insights blog warned about the risk of accidentally contracting as a result of these preliminary agreements  “based on objective manifestations of intent [in those preliminary agreements] that do not in fact match one’s subjective intent.”^[1]  That post also advised that the most common way to “avoid  ‘surprise’ or ‘gotcha’ contracts” arising from these preliminary agreements is “to include language, in writings evidencing the preliminary stages of a deal, that specifically states that such writings are nonbinding,” and that “no binding legal relationship will be created unless and until the parties execute a fully negotiated, definitive contract.”^[2]  But, while we may all think we know a “definitive” agreement when we see one, do we?

A recent Texas Court of Appeals decision, Le Norman Operating LLC. v. Chalker Energy Partners III, LLC, No. 01-15-01099-CV, 2017 WL 4366265 (Tex. App.—Houston [1st Dist.] Oct. 3, 2017), suggests that a definitive agreement can exist by virtue of a series of emails between the parties confirming the essential terms of their deal, despite a confidentiality agreement signed at the beginning of an auction process by all potential bidders that specifically provided as follows:

No obligation.  The Parties hereto understand that unless and until a definitive agreement has been executed and delivered, no contract or agreement providing for a transaction between the Parties shall be deemed to exist and neither Party will be under any legal obligation of any kind whatsoever with respect to such transaction by virtue of this or any written or oral expression thereof, except, in the case of this Agreement, for the matters specially agreed to herein.  For purposes of this Agreement, the term “definitive agreement” does not include an executed letter of intent or any other preliminary written agreement or offer, unless specifically so designated in writing and executed by both Parties.

According to the court of appeals, while “[t]he Confidentiality Agreement provided that a letter of intent or other preliminary agreement was not a ‘definitive agreement,’ … it did not specify what constituted a ‘definitive agreement.’”  The sellers’ view was that only a signed Purchase and Sale Agreement, a form of which had been provided as part of the auction process, and which had been marked-up by the putative buyer as part of that process, could constitute a “definitive agreement.”  But the putative buyer’s view was that when they submitted their final offer, via email, the auction process had ended and their email offer was not made subject to the bid procedures that governed that process.  Indeed, the original auction process had essentially failed because the required percentage of the sellers had not accepted the winning bidder’s bid (and the putative buyer had actually been the winning bidder in the auction process).  The email offer was for a lower percentage of the oil and gas working interests being sold (as a result of the failed auction process) and was not made subject to the bid procedures in the same manner as the original bids had.   Indeed, the putative buyer specified that the sellers had 24 hours to “accept” the email offer.  After the sellers’ agent (Chalker) notified the sellers of the offer and obtained commitments to participate in the sale to the putative buyer from sellers holding the requisite percentage (67%) of the working interests based on the terms set forth in the email offer, the sellers’ agent responded to the putative buyer’s email offer, within the specified time, with an email stating that:

We have the group on board to deliver 67% subject to a mutually agreeable PSA. We are calling to discuss next steps and timing.  Chalker et al will be turning a PSA tonight to respond to your last draft.  Please give me a call to discuss schedule and timing.

The evening of the next day (the day before Thanksgiving) the sellers’ agent delivered an updated draft of the PSA to the putative buyer. But because it was now the night before Thanksgiving Day, the sellers’ agent told the putative buyer in the email delivering the updated PSA (as one would always hope going into the Thanksgiving weekend) that “our crew will largely be taking tomorrow and Friday off,” indicating that they did not expect any response to the PSA draft from the putative buyer until after the weekend.  But alas, during the ensuing two days, one of the other disappointed bidders (Jones Energy), informed of the new deal offered by the putative buyer (LNO), offered a new deal of its own.  And the sellers decided to accept the new deal, entered into a PSA with Jones Energy, and ultimately consummated the transaction.  LNO, of course, cried foul and sued the sellers for breach of contract, and Jones Energy for tortious interference.  While LNO and Jones Energy settled, the breach of contract action against the sellers proceeded.  But the trial court granted the sellers’ motion for summary judgment based in part on the trial judge’s view that “[t]here was no meeting of the minds because the Confidentiality Agreement, the Bid Instructions, and the Data Room Presentation preclude a binding contract without an executed, delivered purchase and sale agreement, or ‘PSA.’”

On appeal, the Texas First District Court of Appeals reversed the trial court’s summary judgment holding that a fact issue existed as to whether the sellers and LNO were bound by the pre-Thanksgiving email exchange despite the fact that no PSA was ever signed.  According to the court:

The November 19-20 e-mails and written elections of the Sellers constitute a writing that sets out the assets to be sold, the purchase price, a closing day, and other key provisions. Thus, a fact issue exists as to whether the November 19-20 e-mail chain and subsequent written elections were sufficient to constitute a “definitive agreement” for the sale of the Assets.

Because the common law of contract has long held that parties may be legally bound by a preliminary agreement that contemplates a further more formal agreement, as long as the preliminary agreement contains all of the essential or material terms, the appellate court thus determined that there was a fact issue as to whether “the parties agreed and had a meeting of the minds on the essential terms of the sale sufficient to create a contract, even if they left other provisions for later negotiation.”  Moreover, there was apparently some evidence that several drafts of the PSA had been exchanged between the sellers and LNO and there did not appear to be much substantive disagreement on LNO’s proposed modifications prior to the pre-Thanksgiving emails.  Accordingly, summary judgment was inappropriate and the case was remanded to the trial court for a jury determination as to whether a contract had been formed as a result of the pre-Thanksgiving Day emails, even though a more formal PSA was also contemplated and clearly had never been signed.

At first blush it may be tempting to dismiss this case as an aberration.  But as noted in the prior Weil Insights post,^[3]  simply stating that an offer or acceptance of specified terms is “subject to contract” has repeatedly proven to be a very ineffective means of avoiding the formation of a contract based on the otherwise agreed terms set forth in a preliminary agreement.  Indeed, the New York Court of Appeals recently said that “[l]ess ambiguous and more certain language is necessary to remove any doubt of the parties’ intent not to be bound.”^[4]  And the fact that earlier preliminary agreements contain language clearly disclaiming intent to be legally bound does not preclude later writings and conduct of the parties from becoming binding contracts.

Obviously the sellers’ agent could have stated unequivocally in its responsive email that there was no intent to be bound in the absence of a signed PSA, but LNO had made clear in their email offer that they did not want to be “jerked around anymore” and were insisting that the sellers’ agent “accept” their offer within 24 hours and that they had “recommended to [their] Board to pass if the timeline is not met or a counterproposal is sent.”  Another possibility of course was to define “definitive agreement” in the Confidentiality Agreement as being a purchase and sale agreement in a form similar to the form of the purchase and sale agreement provided to the bidders in the data room, and to clarify that entering into a signed PSA was a necessary condition precedent to the formation of any legally binding contract between the parties.  But even then there is always the possibility for the conduct of the parties to be deemed a waiver of any such agreed conditions—so diligence and caution remain the watch words for avoiding the formation of definitive agreements when you actually just want to move the process forward with the ultimate intent of only being bound by a finally executed purchase and sale agreement.^[5]