Understanding the Binding Nature of Term Sheets and Letters of Intent: What you Should Know

Understanding the Binding Nature of Term Sheets and Letters of Intent: What you Should Know

Mar 31, 2025 | Blog

By: Gregory Prekupec and Rahul Gupta 

 

Introduction

When navigating commercial transactions, parties often use preliminary agreements like term sheets and letters of intent (LOIs) to outline key terms before drafting a formal contract. But how enforceable are they?

Understanding Term Sheets and LOIs

1. A term sheet is typically a short and informal document summarizing key deal points. It is usually unsigned and non-binding but serves as a reference for further negotiations.

2. A letter of intent, on the other hand, can be a more formalized agreement expressing the parties’ intention to proceed with a transaction. It may contain both binding and non-binding provisions, depending on its wording.

Binding Vs. Non-Binding Provisions

In most cases, LOIs and term sheets are drafted as non-binding documents, ensuring that parties are not legally required to complete the transaction. However, certain provisions can be binding, such as:

  1. Confidentiality: Protecting sensitive business information exchanged during negotiations.
  2. Exclusivity: Preventing one party from negotiating with third parties for a specified period.
  3. Governing Law and Dispute Resolution: Establishing which jurisdiction’s laws will apply.
  4. Expense Allocation: Determining how transaction-related costs will be divided.

If these provisions are clearly worded as binding, courts may enforce them, even if the rest of the document remains non-binding.

Legal Considerations and Court Interpretation

Courts assess whether an LOI or term sheet is binding based on several factors, including:

  1. Language Used: Explicit statements indicating whether the document (or certain provisions) is intended to be legally enforceable.
  2. Definitiveness of Terms: If essential deal terms are left open, a court is less likely to find a binding agreement.
  3. Parties’ Conduct: If both parties act as if they have a binding agreement (e.g., one party begins performing obligations), a court may enforce it.
  4. Intent to Create Legal Relations: Courts apply an objective test, asking whether a reasonable person would interpret the document as an enforceable contract. For instance, in Labatt Brewing Co. Ltd. v. NHL Enterprises Canada L.P. 2011 ONSC 3219, the court found that if an LOI specifically enumerates certain provisions as non-binding then a reasonable person would not expect to be bound by those sections. Conversely, the Court of Appeal for Ontario in Oshawa Group Ltd. v. Mason Homes Ltd., 2005 CanLII 36443 (ON CA) found the LOI to be binding as it contained all the essential terms of a contract.

Best Practices for Drafting Term Sheets and LOIs

To avoid unintended legal consequences, businesses should:

  1. Clearly State Intent: Specify whether the document is entirely non-binding or if certain provisions are binding as vague or incomplete terms will likely be non-binding.
  2. Identify Deal-Breakers Early: Use the document to pinpoint critical terms before investing significant time in negotiations.
  3. Ensure Clarity and Precision: Ambiguous language can lead to disputes over enforceability. For example, agreements to agree are likely unenforceable a court would be unable to determine the terms of the purported definitive agreement.
  4. Seek Legal Counsel: A corporate lawyer can help structure the document to align with business objectives while minimizing legal risks.

Final Thoughts

Term sheets and LOIs are valuable tools in business negotiations, providing structure while allowing flexibility. However, their enforceability depends on careful drafting and clear language. If you’re entering into a transaction and need guidance on structuring preliminary agreements, our firm is here to help. Contact us today to ensure your deal terms are properly protected.

    Understanding the Binding Nature of Term Sheets and Letters of Intent: What you Should Know

    A Legal Guide to Acquisition Finance: Structuring and Navigating Business Transactions

    Mar 24, 2025 | Blog

    By: Gregory Prekupec and Rahul Gupta 

     

    Key Takeaways

    Acquisition financing enables businesses to fund acquisitions through debt, equity, or a combination of both, each with distinct risks and benefits. The choice between asset acquisitions, share acquisitions, or amalgamations depends on factors like tax implications, liability risks, and regulatory requirements. Successful acquisition financing requires careful structuring, due diligence, and alignment of financing with business growth objectives.

    Introduction

    1. Acquiring a business is a significant milestone, often requiring substantial financial investment. Acquisition financing is a crucial component of this process, providing businesses with the necessary funding to acquire another company.
    2. This guide explores the key aspects of acquisition finance, including types of acquisitions, financing methods, and the unique factors that businesses must consider when structuring such deals.

    Understanding Acquisition Finance

    1. Acquisition finance refers to the funding used to purchase a business. This financing can come from debt, equity, or a combination of both. Businesses seeking to acquire another company must carefully evaluate the financial structure that best aligns with their goals, risk tolerance, and long-term growth strategies.
    2. While debt financing typically allows businesses to leverage capital without diluting ownership, equity financing often provides long-term stability without immediate repayment obligations.

    Types of Acquisitions

    1. There are three primary methods of acquiring a business:

    • Asset Acquisition: The buyer purchases specific assets and liabilities of the target company. This method allows the buyer to select valuable assets while avoiding unwanted liabilities.
    • Share Acquisition: The buyer purchases all outstanding shares of the target company, effectively taking control of all assets and liabilities.
    • Amalgamation: Two companies merge to form a single entity, consolidating their operations, assets, and liabilities.

    2. Each method has its advantages and challenges. Asset acquisitions provide flexibility in selecting valuable assets, while share acquisitions ensure full control of the target company. Amalgamations, on the other hand, create synergy by combining resources and expertise.

    Choosing the Right Acquisition Method

    1. Several factors influence the selection of an acquisition method, including tax implications, liability issues, regulatory requirements, and the complexity of transferring ownership.
    2. Share acquisitions are generally simpler and require fewer contract assignments, whereas asset acquisitions minimize liability risks but involve additional documentation and third-party consents. Notwithstanding the foregoing, share transactions may require third-party consents to the change of beneficial ownership of the target.

    Methods of Financing Acquisitions

    Businesses can finance acquisitions through equity financing, debt financing, or a combination of both.

    1. Equity Financing: Involves raising capital by issuing shares or bringing in investors. This approach avoids debt obligations but dilutes ownership.
    2. Debt Financing: Involves borrowing funds from banks or financial institutions. Debt financing can be structured as senior debt, subordinated debt, or mezzanine financing, each with varying levels of risk and interest rates.
    3. Hybrid Financing: A combination of debt and equity, balancing financial leverage while maintaining some degree of ownership control.

    Types of Loans Used in Acquisition Financing 

    Several loan structures exist to finance acquisitions:

    1. Leveraged Loans: Used for high-risk acquisitions, often carrying higher interest rates.
    2. Asset-Based Loans (ABL): Secured against company assets, providing lenders with collateral.
    3. Investment-Grade Loans: Offered to highly-rated borrowers with lower risk profiles.
    4. Syndication//Bilateral Loans: Loans can be bilateral (single lender) or syndicated (multiple lenders), secured or unsecured, and structured to meet the specific needs of the transaction.

    Key Steps in Financing an Acquisition 

    Acquisition financing involves multiple steps, including:

    1. Private Sale or Auction: The target company may be acquired through a private negotiation or a competitive auction process.
    2. Loan Structuring: The buyer arranges financing through a lead lender, negotiating terms, interest rates, and repayment structures.
    3. Due Diligence: Buyers and lenders conduct thorough financial and legal assessments of the target company to mitigate risks. Lenders must be satisfied through their due diligence before funding.
    4. Purchase Agreement Execution: The final contract is signed, detailing the terms and conditions of the transaction. Lenders may require a signed purchase agreement in advance of the closing date to review, among other reasons, the material adverse change clause, to ensure the target is more-or-less the same as it was during the due diligence process.
    5. Closing and Fund Transfer: Once all conditions are met, funds are transferred, and the acquisition is completed.

    Factors Unique to Acquisition Financing 

    Acquisition financing presents unique challenges that businesses must address:

    1. Timing: The acquisition and financing transactions must close simultaneously to ensure a smooth transfer of ownership. Acquisition timing may become further complicated for practitioners if there are corresponding or simultaneous tax-deferred roll-over transaction(s), a franchise acquisition, or lease considerations, among others.
    2. Conditionality: Lenders may impose conditions such as financial covenants, due diligence requirements, and minimum equity contributions.
    3. Existing Debt Management: The target company’s existing debt must be reviewed, restructured, or repaid as part of the financing process.
    4. Security and Guarantees: Lenders often require collateral security, guarantees from the acquiring company, or pledges on the target’s assets.

    Conclusion

    1. Acquisition finance is a complex but essential tool for business growth and expansion. Understanding the available financing options, structuring the right deal, and managing the risks involved are critical to a successful acquisition.
    2. Whether through debt, equity, or a combination of both, businesses must carefully evaluate their financing strategy to ensure long-term sustainability and value creation.
    3. By strategically navigating the financing landscape, companies can successfully execute acquisitions and position themselves for future growth.
    Understanding the Binding Nature of Term Sheets and Letters of Intent: What you Should Know

    Asset vs. Share Deals – A Taxing Decision (But We’ll Make It Less Painful)

    Mar 10, 2025 | Blog

    By: Gregory Prekupec and Rahul Gupta 

    Understanding the Tax Implications of Asset Vs. Share Deals 

    When buying or selling a business, one of the most critical decisions is whether to structure the transaction as an asset sale or a share sale. Each approach has distinct tax consequences for both buyers and sellers. Understanding these implications can help businesses maximize tax efficiencies and avoid unexpected liabilities.

    Seller Considerations: Why Share Sales Are Often Preferred

    1. From a tax perspective, sellers typically prefer selling shares rather than assets. The reason is simple: capital gains taxation. Under Canada’s capital gains tax regime, only 50% of a capital gain is taxable. Additionally, individual sellers may be eligible for the Lifetime Capital Gains Exemption (LCGE), which allows them to shelter $1,250,000.00 of capital gains on the sale of shares in a qualified small business corporation.
    2. By contrast, selling assets can lead to a higher tax burden. Some proceeds may be fully included in income, and if the business distributes these proceeds to shareholders, further tax can apply. This results in double taxation: once at the corporate level and again when the funds are distributed to shareholders.
    3. Another challenge with asset sales is the potential recapture of previously claimed depreciation, which is fully taxable. This can result in a significantly higher tax liability for the seller than if they had sold shares instead.

    Buyer Considerations: Why Asset Purchases are Often Preferred

    1. Buyers typically prefer acquiring assets rather than shares because it provides them with greater tax benefits and flexibility. In an asset sale:
      • The buyer gets a stepped-up tax cost on the acquired assets, allowing for greater future tax deductions through capital cost allowance (depreciation).
      • The buyer can select which assets to acquire and avoid unwanted liabilities, which may not be possible in a share sale where all assets and liabilities transfer with the company.
      • However, buyers must consider additional costs such as sales tax and land transfer tax, which may apply to asset purchases but not share purchases.

    2. One scenario where a buyer may prefer a share purchase is when the company being acquired has favourable tax attributes, such as non-capital losses, that the buyer can use to reduce taxable income post-acquisition. Additionally, purchasing shares may allow a buyer to preserve valuable contracts, licenses, or regulatory approvals, which might not be easily transferable in an asset deal.

    Key Tax Considerations in Asset Purchases

    1. If a business is sold as an asset sale, different tax rules apply to various types of assets:

    • Accounts Receivable: If the buyer and seller elect under ITA Section 22, the seller can claim a loss for bad debts, and the buyer can deduct uncollected amounts as income losses.
    • Inventory: Gains on inventory are taxed as ordinary income, not capital gains, which is less favourable for the seller.
    • Capital Property (e.g., land, buildings, equipment): Capital gains apply, with only 50% of the gain being taxable. For depreciable assets, there may also be recaptured depreciation, which is fully taxable.
    • Intangible Assets (e.g., goodwill, trademarks, customer lists): These assets are now included under Class 14.1 for tax purposes, allowing for a capital cost allowance of 5% annually.

          Key Tax Considerations in Share Purchases

          1. When a company is sold as a share sale, tax planning strategies can optimize the seller’s position, including:
          • Utilizing the Lifetime Capital Gains Exemption (LCGE) to shelter up to $1,250,000.00 of capital gains.
          • Safe Income Planning, where dividends are structured to reduce taxable capital gains.
          • Capital Dividends, which can be paid tax-free to shareholders in certain cases.

              Purchase Price Allocation: A Critical Favour

              1. One often overlooked aspect of business transactions is how the purchase price is allocated among the various assets being acquired. This allocation has major tax implications for both buyers and sellers. Sellers typically prefer to allocate more value to capital property to take advantage of lower capital gains tax rates, while buyers favour allocations that maximize future deductions (e.g., depreciable assets with high capital cost allowance rates).
              2. The Canada Revenue Agency (CRA) requires that the allocation be reasonable, so careful planning is necessary to avoid disputes.

                Other Important Tax Considerations

                1. Beyond the primary tax issues, several additional considerations can impact business transactions:
                • GST/HST Implications: While share sales are generally not subject to GST/HST, asset sales can be. However, an election under Excise Tax Act Section 167 can often eliminate GST/HST on the sale of a business’s assets.
                • Earn-Out Arrangements: If part of the purchase price is based on future business performance, the seller may need to carefully structure the agreement to avoid unexpected income tax consequences.
                • Non-Resident Sellers: If a non-resident is selling taxable Canadian property, the buyer may be required to withhold and remit tax to the CRA unless the seller obtains a clearance certificate under ITA Section 116.

                  Final Thoughts

                  1. Structuring a business sale as an asset or share deal requires careful tax planning. Sellers typically prefer share sales due to capital gains advantages, while buyers often favour asset purchases for tax efficiency and liability control. However, there are exceptions where share purchases can be advantageous for buyers, such as when acquiring valuable tax attributes.
                  2. Given the complexity of tax laws and the financial implications involved, seeking professional legal and tax advice is essential. Our firm specializes in guiding businesses through corporate transactions, ensuring the best outcomes for all parties involved. Contact us today to discuss your business transition strategy and how we can help you navigate these important decisions.
                    Understanding the Binding Nature of Term Sheets and Letters of Intent: What you Should Know

                    A Quick Guide for Managing Transactional Risk

                    Mar 3, 2025 | Blog

                    By: Gregory Prekupec and Rahul Gupta 

                    Introduction

                    When drafting commercial agreements, it’s crucial to consider how risk is allocated between the parties to ensure your client’s interests are protected and that they don’t fall victim to outdated or unexamined precedents. A strong understanding of risk allocation allows lawyers to clearly articulate their clients’ post-closing obligations and potential liabilities.

                    Key Methods of Risk Allocation

                    Risk allocation in commercial contracts can take many forms. Below is a non-exhaustive list of common mechanisms:

                    • Indemnification
                    • Limitations on Liability
                    • Termination Rights
                    • Force Majeure
                    • Contractual Remedies
                    • Product Conditions & Warranties
                    • Insurance Coverage
                    • Payment Terms
                    • Guarantees

                    Now, let’s break down these risk allocation tools in more detail.

                    Indemnification

                    Definition: An indemnity clause requires one party to compensate the other for specific costs or liabilities, such as lawsuits, damages, or legal fees. This is often paired with a duty to defend and a hold-harmless obligation.

                    Purpose: A well-drafted indemnity clause can:

                    • Shift financial burdens onto the indemnifying party.
                    • Cover expenses not protected under common law (e.g., legal fees).
                    • Minimize uncertainty regarding future liabilities.
                    • Reduce litigation risks.
                    • Handle third-party claims effectively.

                    Enforcement: Courts generally enforce indemnity clauses unless they are deemed unreasonable or unconscionable (e.g., due to vague language, significant bargaining power disparities, or absurd results).

                    However, practical issues such as jurisdictional enforcement (i.e., enforcing a judgment in a foreign jurisdiction) and prolonged litigation can affect their utility.

                    Best Practices:

                    • Scope: Who is indemnified? (e.g., shareholders, employees, affiliates, capital providers)
                    • Nexus Language: What events trigger indemnification? (e.g., are the events “related to,” “caused by,” or “solely resulting from”?)
                    • Recoverable Damages: Define whether indemnification includes only incurred costs or also future/unpaid expenses.
                    • Exceptions: Consider excluding indemnification for gross negligence, willful misconduct, or failure to mitigate damages.
                    • Limitations: Use minimal thresholds, upward caps, and time limits to control exposure.
                    • Procedures: Specify the notice period, control the indemnifying party has over the litigation, and required cooperation of the indemnified party.

                    Limitations on Liability (“LL”) Clauses

                    Definition: LL clauses define and limit a party’s exposure under a contract.

                    Purpose:

                    • Capping damages (e.g., a multiple of fees paid under the contract).
                    • Excluding liability for indirect, consequential, or punitive damages.
                    • Avoiding application of tort-based remedies.

                    Enforcement: Courts generally uphold LL clauses if they are:

                    • Clear and specific (ambiguous language can be interpreted against the obligor).
                    • Explicit about covered and excluded liabilities (e.g., negligence).

                    Best Practices:

                    • Ensure the LL clause aligns with the indemnification provisions.
                    • Consider carve-outs for fraud, gross negligence, or intentional misconduct.
                    • Avoid conflicts with any “cumulative remedies” provisions.

                    Termination Rights

                    Definition and Categories: Termination Rights allow a party to end a commercial agreement. There are two types of termination rights:

                    1. Termination for Cause: Allows a party to end the contract due to specific breaches (e.g., non-payment, insolvency).
                    2. Termination for Convenience: Enables a party to exit the contract without cause (often requires notice, transition cooperation, or termination fees).

                    Considerations:

                    • Negotiation Power: Unilateral termination rights create leverage for a party and increases pressure on the counterparty.
                    • Consequences of Termination: Define penalties, required transition periods, and other obligations upon exit.

                    Force Majeure (“FM”)

                    Definition: “Superior force” in French.

                    Purpose: Allows a party to be excused from their contractual obligations if certain events occur which are negotiated to be beyond that party’s control (e.g., COVID-19, health emergencies, natural disasters, wars, civil unrest).

                    Best Practices:

                    • Events not covered by the FM clause will not be deemed as such. Specificity and intentionally are key to drafting effective FM clauses.
                    • A party should be able to terminate the agreement of disruptions over an FM event continue over a certain period of time.
                    • Prescribe which obligations remain despite any such termination (e.g., confidentiality)

                    Contractual Remedies

                    Definition and Categories: A list of contractually available reliefs to a party in a commercial agreement. There are four types:

                    • Equitable Remedies: Courts may order specific performance, injunctions, or rectification.
                    • Cumulative Remedies: Allows parties to pursue all available remedies beyond the contract.
                    • Exclusive Remedies: Limits remedies to those explicitly listed in the contract.
                    • Liquidated Damages: Pre-determined penalties for breaches. They are useful when damages are difficult to quantify.

                    Purpose: To create greater certainty by either expanding or minimizing the level of liability as a result of a breach of the agreement.

                    Best Practices:

                    • Ensure cumulative and exclusive remedies provisions don’t conflict.
                    • Confirm liquidated damages are compensatory and not punitive.
                    • Consider prohibiting or permitting equitable relief based on the circumstances of all parties.

                    Product Conditions & Warranties

                    Definition: Provincial laws provide for implied warranties on the sale of goods within the actual agreement. Parties to such agreements can manage risk by subscribing to or contracting out of these implied warranties.

                    Best Practices:

                    • Clearly state whether implied warranties apply or are excluded.
                    • Define the scope of express warranties to avoid unintended liabilities.

                    Insurance

                    Definition and Purpose: Parties can manage risk by negotiating for certain insurance requirements to ensure either party has the monetary capability to comply with its commercial obligations under an agreement.

                    Best Practices:

                    • Assess the need for additional insurance before mandating coverage. Do internal resources provide enough protection for ensuring contractual compliance?
                    • Ensure insurance aligns with indemnification obligations.

                    Payment Terms

                    Definition and Categories: The timing of when payment is required for the goods or services being contracted for can help to manage risk. There are two types:

                    • Deferred Payments: Favourable to buyers but risky for sellers.
                    • Advance Payments: Reduce seller risk but may require concessions to the buyer.

                    Best Practices:

                    • Define triggers for payment acceleration or deferral.
                    • Include late-payment penalties or early-payment discounts.

                    Guarantee

                    Definition: Guarantees are used to ensure payment or performance will be made on time by requiring a separate entity (e.g., the directors of a party, the parent corporation, etc.) guarantee or ensure the same.

                    Purpose: The inclusion of a third-party increases the chances that the counterparty will receive payment on time or performance.

                    Best Practices:

                    • Scope of Guarantee: Define if it is full or limited.
                    • Enforceability: Ensure the guarantor has the means to fulfill obligations.
                    • Exclusions & Expiry: Define conditions for termination of the guarantee.
                    Understanding the Binding Nature of Term Sheets and Letters of Intent: What you Should Know

                    Fundamental Changes under the Ontario Business Corporation Act: A Brief Summary

                    Oct 18, 2024 | Blog

                    Gregory M. Prekupec, Rutendo Muchinguri

                    The Ontario Business Corporations Act (OBCA), RSO 1990, cB.16, governs how corporations in Ontario should operate. Understanding the key provisions of the OBCA is essential for corporate governance and for those drafting documents related to commercial transactions. One of the most critical sections for Ontario corporations to be aware of is Section 168, which addresses Fundamental Changes.

                    What are the Fundamental Changes Under the OBCA?

                    Section 168 of the OBCA outlines specific actions that require more than a simple majority of shareholder approval—these actions are known as Fundamental Changes. These decisions significantly impact the corporation and must be authorized through a special resolution, requiring at least a two-thirds majority of shareholder votes during a specially called meeting.

                    Examples of Fundamental Changes in Ontario Corporations

                    The following actions are considered Fundamental Changes under the OBCA, and thus require special shareholder approval:

                    1. Changing the company’s name
                    2. Adding or removing business restrictions
                    3. Modifying the maximum number of authorized shares
                    4. Creating new classes of shares
                    5. Changing the designation, rights, or privileges of shares
                    6. Altering issued or unissued shares
                    7. Dividing a class of shares
                    8. Authorizing directors to divide unissued shares
                    9. Changing the minimum or maximum number of directors
                    10. Amending the issue, transfer, or ownership rights of shares

                    Special Resolutions for Fundamental Changes

                    For any of the above fundamental changes to be validly implemented, the corporation’s Articles of Incorporation must be amended. According to Section 168(5) of the OBCA, these amendments require a special resolution—a vote that must pass with at least two-thirds of shareholder approval during a special meeting called specifically to address the proposed changes.

                    Why Understanding Fundamental Changes is Crucial

                    Corporations in Ontario must ensure that any action classified as a fundamental change is properly authorized by their shareholders. Failure to follow the proper procedure, including securing a special resolution, can lead to legal complications and invalidate the proposed amendments.

                    After the special resolution is passed, the corporation can proceed with the process of amending its Articles to reflect the approved changes.

                    Conclusion

                    Understanding the requirements for fundamental changes under the OBCA is vital for any corporation operating in Ontario. Ensuring compliance with these regulations protects the corporation’s legal standing and ensures that significant decisions are made with the appropriate level of shareholder approval.

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