09/30/2009 03:43:26 PM EST
Patrick Santel, Liz Bassett and Rachel A. Miles on Texaco, Inc. v. Pennzoil, Co.: When Letters of Intent Are Binding and Drafting Guidance
Letters of intent in merger and acquisition transactions may give rise to unintended legal consequences, such as being bound when parties did not intend to be so bound or third parties may be liable for tortious interference. The Texaco v. Pennzoil case forced boards of directors and legal practitioners to reexamine how they view letters of intent and provides guidance as to steps parties can take to reach the desired results when drafting them.
In this commentary, three authors discuss the striking illustration of the risk that letters of intent pose to third parties as set forth in Texaco, Inc. v. Pennzoil, Co. Patrick Santel, Liz Bassett, and Rachel A. Miles provide a summary and an analysis of Texaco v. Pennzoil, 1987 Tex. App. LEXIS 6484, as well as extensive background facts leading up to the filing of the lawsuit for tortious interference with a contract.
The authors write:
Parties use letters of intent in M&A transactions for various reasons. For example, a letter of intent can be useful to guide parties' expectations as to certain terms of a potential transaction, to "test the waters" before incurring the costs of negotiation and investigation of a transaction, or to help the buyer secure financing for a transaction. Also, signing a letter of intent allows parties to file a premerger notification report under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, which will start the clock running on the waiting period. Letters of intent, however, may give rise to certain legal consequences. For example, a party may find itself bound by the letter of intent, or a term therein, when that party did not intend to be bound until the execution of the final definitive written agreement. Therefore, that party may not be able to walk away from the transaction, or term, without becoming vulnerable to a claim for breach of contract. Along the same line, the letter of intent can expose third parties to the risk of claims such as tortious interference with a contract if the letter of intent was found to bind the original parties to an agreement.
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The events forming the basis of Pennzoil's claim began on December 28, 1983, when Pennzoil made an unsolicited public tender offer at $100 per share for 16 million shares of Getty Oil. Pennzoil then began discussions with Gordon Getty, a director of Getty Oil and trustee for the Trust which owned 40.2% of Getty Oil's outstanding shares, and a representative of the Museum, which owned 11.8% of Getty Oil's outstanding shares. In early January 1984, Pennzoil, the Trust, and the Museum drafted a document entitled "Memorandum of Agreement" to reflect terms which had been reached during their discussions.
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The court used this four-factor framework to evaluate Texaco's arguments that the evidence was insufficient to support the jury's findings.
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By rejecting Texaco's various arguments with respect to a lack of sufficient evidence to support the jury's findings, the court affirmed the jury's decision in Texaco v. Pennzoil. The decision in this case forced boards of directors and legal practitioners nationwide to reexamine how they view letters of intent. Although some argue that Texaco v. Pennzoil was wrongly decided, the case provides guidance as to steps parties can take when drafting a letter of intent. These drafting techniques have become common practice amongst attorneys when preparing letters of intent. First, parties should consider including language which indicates which items in the letter of intent are binding and which are not. If the letter of intent is ever examined in a court case, as was the Memorandum of Agreement in Texaco v. Pennzoil, this language may prevent the court from having to look at extrinsic evidence to determine whether the document was intended to be binding.