Volume 7 Issue 14, July 21, 2020
by Jonathan E. Sterling and Tom A. Knapp, Brown & Fortunato, P.C.
"Have you signed an LOI yet?" This may be one of the most important questions at the outset of a healthcare transaction. Many times, the parties believe a handshake agreement can be magically transformed into a comprehensive and binding contract without change or disagreement. Inevitably, however, the terms of the handshake agreements shift—and continue to shift—until one party surrenders. That is, unless a letter of intent, or LOI, is entered into by the parties.
LOIs include mostly non-binding terms that are contingent upon the parties' execution of legally binding, or definitive, agreements in the future. The primary contingency is the buyer's due diligence investigation into the seller's enterprise. However, before this occurs, each party must understand its respective benefit of the bargain before it can justify the time and expense of pursuing the transaction. In other words, LOIs are a non-binding "meeting of the minds" between the parties that serves as the basis for the definitive document, otherwise known as the purchase agreement.
What's the point? Why enter into a non-binding agreement? While buyers and sellers typically agree on basic terms, such as purchase price and deal structure, they often overlook other fundamental deal points that, if agreed upon early, could save a significant amount of time, expense, and conflict. The more the parties agree to at the outset, the less they have to negotiate in the future.
Moreover, LOIs typically forestall parties from changing approved terms without providing a valid justification for doing so. If the change is unjustified or unsatisfactory to the other party, the LOI specifies what happens if one or both parties refuse to move forward. This typically results in a termination of the LOI without any further obligations among the parties (except those that are typically binding, such as confidentiality, exclusivity, and expense obligations).
Buyers and sellers have different perspectives and preferences concerning what should be included in an LOI. Buyers tend to emphasize flexibility whereas sellers tend to prefer more details. At a minimum, buyers and sellers should consider including the following in each LOI contemplating the purchase and sale of a healthcare company.
The LOI should describe (i) the structure of the transaction (e.g., asset or equity sale/purchase), (ii) the consideration being exchanged, (iii) how and when the consideration will be paid to the seller, and (iv) whether anything will be excluded from the sale. The structure will almost always have an impact on the transaction's regulatory requirements.
In addition to the scope of the transaction, it is a good idea to establish the scope of buyer's due diligence. This creates a timeline by establishing a cutoff date for the buyer to complete diligence and sets expectations for the types of documents and information the seller will need to provide. Due to the critical impact that diligence has on a healthcare transaction, buyers should consult with regulatory attorneys and advisors to determine which documents and information to request and review prior to closing a transaction.
Parties often argue over the scope of representations and warranties, which are statements (or promises) that certain facts are true at closing and will remain true after closing. "Ordinary" representations and warranties typically have a finite survival after closing, but "fundamental" representations and warranties (i.e., those that are considered imperative to the buyer) can survive longer and, in some cases, indefinitely. Buyers want as many "fundamental" representations and warranties as possible, but sellers want very few. In the healthcare space, where non-compliance with regulatory laws, rules, and regulations can lead to devastating penalties, the parties will debate whether representations and warranties related to compliance should be considered fundamental.
Sellers argue that they should not be responsible for non-compliance with obscure laws, rules, or regulations. Buyers, on the other hand, believe sellers should remain responsible regardless of knowledge of compliance; either you're in compliance or you're not. Therefore, to the extent possible, the parties should determine the scope (and survival) of key representations and warranties as early as possible to prevent unnecessary debates while drafting and negotiating the definitive agreement.
Sellers almost always require buyers to agree to confidentiality obligations to prevent the unauthorized use or disclosure of a seller's confidential and/or proprietary information. Not only do sellers want to prevent diligence materials from being used by their competitors, they also want to ensure that diligence is conducted in accordance with HIPAA and other data security/privacy laws. The LOI can include these obligations directly or include a reference to a standalone confidentiality or non-disclosure agreement that the parties executed. These obligations are also typically binding on the parties.
Indemnification obligations are among the most heavily negotiated terms in a transaction. This is because they affect the risk allocation among the parties and primarily provide the buyer with a mechanism to pursue the seller for certain issues that may arise after closing. In the healthcare industry, this is especially important to both parties since certain regulatory authorities can perform investigations and audits of claims submitted numerous years ago. Sellers prefer to know the extent of their post-closing exposure. Buyers want as much protection as possible.
To resolve this tension, the parties should attempt to agree on the scope of seller's indemnification obligations and any limitations thereon, such as whether the seller's total liability will be "capped" and whether the buyer's claims must reach a minimum threshold before seller's indemnification obligations are triggered.
Since the LOI will contain mostly non-binding provisions, it should specify that its terms do not obligate either party to pursue the transaction. If there are other conditions to closing the transaction, these conditions should also be identified. Due to the many regulatory risks in a healthcare transaction, buyers typically require sellers to obtain all necessary consents and file all mandatory notices with governmental authorities, Medicare, Medicaid, and third-party contractors (if any). Buyers also prefer not to close the transaction until due diligence is completed to their satisfaction.
If the buyer will require the seller(s) to agree to various restrictive covenants (such as non-competition and non-solicitation arrangements), these can be identified in the LOI. The geographical and temporal scope of these restrictions should be set forth. However, certain jurisdictions have specific rules regarding such restrictive covenants and their enforceability against medical professionals.
What happens if the LOI is terminated? Usually nothing. However, the parties should be careful to specify what obligations, if any, will continue after the LOI is terminated. LOIs typically specify that the terms have no force and effect after termination except for those that are expressly identified as binding. For example, the parties will typically be responsible for paying their own expenses and be bound by certain confidentiality and exclusivity obligations but otherwise be free of any further obligations or liabilities.
LOIs can be extremely useful if drafted properly. The parties should consider things other than the purchase price and closing date when deciding to pursue a potential transaction. The more thoughtful the parties, the more thoroughly they can craft an LOI that will create value by resolving key issues early.
Jonathan E. Sterling (JSterling@bf-law.com) is a member of Brown & Fortunato’s Corporate Group. Jon serves both public and private clients in a variety of business transactions including mergers, acquisitions, divestitures, restructurings, venture capital, entity formation, and corporate governance.
Tom A. Knapp (TKnapp@bf-law.com) is is a member of Brown & Fortunato’s Corporate Group, where he is a shareholder. Tom serves as the lead advisor to buyers and sellers in numerous health law transactions involving the sales and acquisitions of durable medical equipment companies, pharmacies, medical groups, home health agencies, hospices, and other healthcare-related entities.
For over 20 years, Brad has held a number of significant executive positions including founding Lone Star Scooters, which offered medical equipment and franchise opportunities across the country, Lone Star Bio Medical, a diversified DME, pharmacy, health IT, and home health care company, and BMS Consulting, where he has provided strategic analysis and M+A intermediary services to executives in the healthcare industry. In addition, he is a regular columnist for HomeCare magazine and HME News, where he focuses on healthcare marketplace trends and innovative business strategies for the principals of healthcare companies. At VERTESS, Brad is a Managing Director and Partner with considerable expertise in HME/DME, home health care, hospice, pharmacy, medical devices, health IT, and related healthcare verticals in the US and internationally.