Common use of Bargaining Power Clause in Contracts

Bargaining Power. Even the briefest of XXXx typically includes the pricing. But there are many other terms besides pricing that are important. If a party agrees in the LOI to the pricing but leaves the other terms to be negotiated later, the party has given up the ability to use its agreement to a price as bargaining power in negotiating the other terms. The seller is usually much more disadvantaged by this. With some exceptions, these other terms mainly are for the buyer’s benefit. If the pricing is already agreed, the seller has less opportunity to gain anything meaningful in the negotiation of the other terms. If the pricing is not already agreed, the seller can require the buyer to pay more if the buyer wants these other terms to be more buyer favorable. This adverse impact on the seller’s bargaining power is compounded by a very common LOI term – a “no shop” or “exclusivity” provision. As discussed below, in this provision the seller agrees not to negotiate for the sale of the business with any third party for some specified period of time during which the parties expect to negotiate and execute a “definitive” binding purchase agreement. The “no shop” is a matter of fairness to the buyer. Before expending all the time and money needed to pursue the transaction, including investigating the business and negotiating the purchase agreement, the buyer wants assurance that the seller is committed for some limited time period to pursue a deal exclusively with the buyer and not negotiate with someone else. But by taking the business off the market for the agreed period, the seller has given up bargaining power in negotiating the other important terms of the sale -- the “threat” of the seller going with a different buyer if the buyer asks for too favorable terms. Combined with an agreement on the pricing, the “no shop” places the seller at a distinct bargaining disadvantage in negotiating the other terms of the sale. The seller can avoid this by insisting that key terms of the sale besides the pricing be negotiated in the LOI – as part of the agreement on price and before the seller agrees to take the business of the market. This preservation of the seller’s bargaining power means less advantage for the buyer. For this reason, and because negotiation of the other terms takes more time during which another buyer potentially could arrive to “steal” the deal, a buyer may resist negotiation of the other terms in the LOI. A potential compromise is for the parties to agree on a preliminary short (e.g., a week or ten days) “no shop” period during which the parties negotiate the other key terms for inclusion in the LOI. This preserves more of the seller’s bargaining power while providing the buyer assurance that the seller is negotiating exclusively with the buyer. If the negotiations are successful, the LOI can include another “no shop” period during which the purchase agreement is negotiated. This second “no shop” period can be relatively short because the parties have already negotiated the terms that are to be reflected in the purchase agreement, shortening the period needed to produce the purchase agreement. Efficiency. From a time and cost-saving standpoint, both parties can greatly benefit from negotiating not only the price but also the other key terms in the LOI. If only the price is agreed, what typically happens is counsel for the buyer proceeds to prepare a draft of the purchase agreement, which as noted earlier is often very long and densely worded. This draft will reflect the purchaser’s wants for the other key terms. After review by the buyer, the draft is sent to the seller and its counsel. The seller’s counsel analyzes the draft and summarizes for the seller what the buyer has proposed in the draft for the other terms. The parties then proceed to negotiate those terms, sometimes by exchanging drafts of the purchase agreement. Compared to negotiating the key terms in the LOI, this process is very inefficient in both time and money spent. When the key terms are negotiated in the LOI, the terms are stated in simple, brief language that the buyer and seller can easily understand. When the key terms are instead negotiated through drafts of a purchase agreement, the key terms are buried in dense wording, making it difficult for the clients to understand, greatly complicating and slowing down the process. Furthermore, if the key terms are negotiated in the LOI, it saves a great deal of time and expense in preparing the purchase agreement. The LOI serves as a road map for the purchase agreement. There is an understanding of what the purchase agreement should provide, greatly narrowing the scope for argument. Counsel for the parties can be left to handle the details of the drafting to make sure the drafting reflects what has been agreed. Time is not wasted in drafting and reviewing long provisions that end up not being part of the deal. Finally, negotiating the key terms in the LOI will accelerate uncovering any impasse between the parties over terms – again saving both parties time and expense. If the parties are not going to be able to reach agreement on a key term so that the deal does not happen, the sooner this occurs, the better. "It usually is much better -- especially for the seller -- to negotiate as much of the key terms of the sale as possible in the letter of intent."