Prospective Buyer Had No Duty to Negotiate in Good Faith with Seller

Introduction

Selling a business is an involved process. A prospective buyer first usually wants to see some basic financial information about the business. But before that happens, the seller often asks the prospective buyer to sign a confidentiality agreement.

The seller and the prospective buyer may then agree upon a purchase price and payment terms; all subject to the results of due diligence. At that point the prospective buyer and seller often negotiate and sign another preliminary document often called a letter of intent. It summarizes the major deal points: structure (stock or asset sale-and if asset sale what assets and liabilities), purchase price and payment terms.

The letter of intent usually says that the description of the major deal points in the letter of intent does not bind either prospective buyer or seller; and that an agreement to sell is only binding when the parties sign a definitive acquisition agreement. There usually are some binding terms in the letter of intent, such as whether the seller must exclusively deal with the prospective buyer for a term, for example, of 60 days.

After that, the prospective buyer usually conducts more due diligence; and the parties negotiate an acquisition agreement. However, many of the deals that reach letter of intent stage never close; for a variety of reasons.

A seller may feel that it has been damaged if the prospective buyer terminates negotiations; maybe because word has gotten out on the street of the failed deal; and the seller may think that other suitors, employees, customers, or suppliers may view the seller as damaged goods.  In those circumstances a seller is tempted to sue the prospective buyer for breaching a duty to negotiate in good faith.

The deal

This case involved the seller of a tech company and a prospective buyer that signed a confidentiality agreement on September 7, 2016. The confidentiality agreement made clear that neither party was committing to a transaction, or even to continued negotiations.

Due diligence followed and the tech company and prospective buyer signed a letter of intent (which was referred to as an “Indication of Interest”) on January 29, 2017. The deal on the table was a purchase of the tech company’s assets for $24 million, payable at closing, with an earnout potential of $10 million. However, the letter of intent said that those terms are not binding on either the prospective buyer or seller; and only the signing of a definitive acquisition agreement by both prospective buyer and seller would create a binding agreement to do a deal.

The deal continued with due diligence and negotiations over the draft asset purchase agreement. The prospective buyer produced a draft asset purchase agreement that was in line with the financial terms described in the letter of intent. Then, on April 5, 2017, the prospective buyer told the seller that it wanted to buy the tech company’s stock from its owner, instead of buying the company’s assets. Five days later, the prospective buyer notified the tech company that it was not going to buy the company’s business.

The lawsuit

Not surprisingly, the seller was upset. It had stopped talking to other suitors (even though it had not promised to do so) and some word of the pending deal had leaked out to the market. Seller sued the prospective buyer in a Pennsylvania federal district court for damages; claiming that the prospective buyer breached its duty to negotiate in good faith. The prospective buyer moved to dismiss this claim arguing that as a matter of law, the prospective buyer had no duty to negotiate in good faith.

The court agreed with the prospective buyer. Why? Because there was no duty to negotiate in good faith in either the confidentiality agreement or the letter of intent. In fact, those documents permitted the prospective buyer to pull the plug on the deal at any time and with no reason.

This case is referred to CKSJB Holdings, LLC v. EPAM Systems, Inc., Civil Action No. 18-217, United States District Court, E.D. Pennsylvania, (March 29, 2019)

Comment

The court understood why the seller was upset with the prospective buyer. But their legal relationship was defined by the confidentiality agreement and letter of intent. The seller could have insisted on inserting a prospective buyer duty to negotiate in good faith in the letter of intent. It did not and so it must bear the consequences.

The seller’s claim might have survived this preliminary legal skirmish under California law (the court applied Pennsylvania law). California implies in every contract a duty to negotiate in good faith; meaning that the duty does not have to be stated in the contract. Pennsylvania does not.

By John McCauley: I help businesses minimize risk when buying or selling a company.

Email: jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291

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