The main legal document in any sale process is the Sale & Purchase Agreement (or “SPA”). However, before the SPA is created and negotiated, it is the legal documents of confidentiality agreements and Heads of Agreement that are all important to vendors.
But what is the purpose of these two legal documents and why are they important to sellers in a sale process?
Confidentiality agreements (also called “non-disclosure agreements” or “NDAs”) are undertakings signed by bidders in the initial stages of exploring a potential deal. Their purpose is to protect the confidentiality of any commercially sensitive information about a company being sold that is disclosed to bidders during deal negotiations.
The main features of confidentiality agreements typically include:
- A definition of the confidential information to be protected, normally covering commercially sensitive business information released (whether in writing or by mouth) about the company as well as the fact that the sale itself is taking place
- An obligation on the buyer to keep the confidential information secret and to use it only in assessing whether to do the deal
- Exceptions when the buyer is allowed to disclose the information (for example to their appointed professional advisors)
- A promise that neither party will try to poach the other party’s employees for a defined period after the confidentiality agreement has been signed
- An obligation on the bidder to return or destroy the received information upon request
Limitations of confidentiality agreements
Confidentiality agreements offer protection of a seller’s information but with some limitations. For example, the main remedy for breach of a confidentiality agreement is an injunction prohibiting disclosure, which will be of little use if the confidential information has already been leaked, the horse having already bolted. Furthermore, damages for loss suffered may not provide adequate compensation since the damage done may be irreparable.
In practice, proving that there has been a breach of a confidentiality agreement can often be very difficult. Therefore, even where a confidentiality agreement is signed, every practical step should be taken in a sale process by a seller and their advisors to safeguard valuable information, for example by withholding the release of sensitive information until the later stages of the deal when it is more certain that the bidder will complete the acquisition.
Heads of Agreement
Heads of Agreement (also known as “Heads of Terms”, “Memorandum of Understanding”, “Term Sheet” or “Letter of Intent”) is a document signed around the mid-point of a sale process by the seller and the preferred buyer to capture the agreed terms of the deal. The signing of Heads of Agreement is then followed by the buyer’s due diligence investigations and the creation of the SPA.
Heads of Agreement are useful to both sides as they:
- Encourage timely agreement before due diligence begins, thereby helping to avoid negotiation and renegotiation midway through due diligence
- Establish a reasonable timetable for the final stages of the deal (being due diligence and the SPA)
- Offer a framework for binding commitments (such as exclusivity and confidentiality)
- Provide an agreed set of terms to be converted into the fuller length SPA by the lawyers
Care should be taken to avoid spending too much time on negotiating the Heads of Agreement as this may lead to a loss in deal momentum. Discussion should be limited to agreeing the principal terms of the commercial deal, and debate over the finer detail should be saved for the negotiation of the SPA itself.
Typical contents of Heads of Agreement
The contents of Heads of Agreement depend largely on the individual transaction but will usually
include agreement on the:
- Price and structure of the deal
- Conditions required for exchange and completion (such as due diligence, relevant board and shareholder approvals etc)
- Confidentiality provisions
- Apportionment of cost (it is normal for each side to bear their own costs with regards to the proposed deal)
- Jurisdiction and governing law
- Timetable to completion
Heads of Agreement also often include an exclusivity clause (or “lock out”) to prevent the seller from negotiating with rival bidders once the preferred buyer has been selected to sign Heads of Agreement. This quite reasonably gives the preferred buyer comfort that it can invest time and expense in due diligence and legal work without other bidders intervening.
Certain provisions of the Heads of Agreement – confidentiality, exclusivity and costs – are usually identified as legally binding, with the rest being “subject to contract” and therefore non-binding. It is always important to make it clear which provisions are intended to be legally binding and which are not.
Heads of Agreement are in many ways also “morally binding” and a party wishing subsequently to diverge from an agreed position in the Heads of Agreement can find themselves with little room for manoeuvre without introducing bad faith into proceedings, which is always to be avoided when seeking to complete a deal.
Confidentiality Agreements and Heads of Agreement are not long or onerous legal documents like the Sale & Purchase Agreement (see the Reading Room’s article “The Sale & Purchase Agreement”) but they are important documents to get right as they help to prevent problems arising further down the line as a deal progresses.
Written by Charles Russell LLP for Boxington
This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions.
Copyright © Boxington Corporate Finance Limited
The copyright in this article is owned by us and may not be adapted, copied, published, distributed or redistributed in any form or media without our prior written permission unless full and clear credit is given to Boxington with appropriate and specific direction to the original content.