When negotiating to buy a business, a buyer will often ask the seller to sign an exclusivity (or lock-out) agreement. This is designed to stop the seller dealing with other prospective purchasers for an agreed period.
The buyer can then carry out its due diligence investigation of the target, and negotiate the terms of the deal, safe in the knowledge that it is not wasting time and resources at the risk of the seller deciding to sell to someone else.
What are the key terms?
An exclusivity agreement will usually contain obligations on the seller:
- to terminate any existing negotiations with third parties;
- not to negotiate with, or invite offers from, any third parties; and
- not to pass sensitive information about the target to third parties.
Those obligations will typically apply for an agreed period (90 days is common) and will also generally bind the seller’s employees, representatives and agents.
Will it be enforceable?
One of the key things with an exclusivity agreement is that, to be enforceable, it has to be a “lock-out” agreement – that is, one that prevents the seller from negotiating with someone else – rather than a “lock-in” – that is, an agreement that requires the seller to negotiate with the buyer. Under English law, such a lock-in agreement is not enforceable as it is considered too uncertain.
In addition, to be enforceable, an exclusivity agreement must be:
- supported by consideration, which could simply be the buyer incurring significant costs and expenses in investigating the target; and
- for a fixed period, or at least terminable on reasonable notice.
What if the seller breaches the agreement?
Where a seller breaks the exclusivity agreement, the buyer’s usual remedy would be to claim damages for breach of contract to compensate the buyer for its losses (mainly, wasted costs) arising from the seller’s failure to honour the agreement. Unfortunately for the buyer, loss of potential profit cannot be recovered as there is no way of knowing if the negotiations between the parties would have been successful or on what terms.
Whilst the parties may want to specify a fixed amount which is payable if the seller breaches the agreement, they must be careful to ensure that this is a genuine pre-estimate of loss otherwise it may amount to an unenforceable penalty. As it is impossible to predict at what stage a breach may occur, it is generally preferable to state the categories of costs which the buyer will be able to recover, such as professional fees, due diligence costs and an agreed rate for management time.
As an alternative to damages the buyer may try to get an injunction to stop the seller from negotiating with a third party during the exclusivity period. But an injunction will only be granted if the court thinks damages would not be an adequate remedy for the buyer in all the circumstances.
On a practical note, buyers also need to remember that a seller cannot be forced to negotiate with a buyer and can always walk away from a deal at any time. Provided the seller waits until the exclusivity period has finished before dealing with an alternative purchaser, the buyer will be unable to recover its wasted costs.
For more information, email firstname.lastname@example.org.