Let’s face it – no one likes Term Sheets. Lawyers dislike the concept because of how haphazard and vague the first cut of the document can be and business clients do not like the idea of having to read, edit and sometimes even incorporate language into a Word document. Love it or hate it, should we be wary of this seemingly rough and preliminary document that is based on the premise of being non-binding? We explore a recent development in today’s piece.
For the uninitiated, a Term Sheet is a (supposedly simple) document, usually represented by way of a table (because lists with headings make everything clearer) – serving as a blueprint for a potential transaction, it includes data pertaining to everything relevant to such a hypothetical transaction, from the names of the parties to the important terms and conditions that need to be present when the parties eventually sign the final documents (many Term Sheets in fact go so far as to list out what the documents to be signed will be, assuming all parties to the transaction agree).
Why a Safe Space?
Term Sheets are unique in the sense that they are drafted on the premise that all parties to a transaction can read and understand the content in it. Unlike a typical legal agreement that contains everything from boilerplate clauses to statutory references in a lengthy format, Term Sheets lay out the focal points and modalities of a proposed transaction in a way (usually) understandable to all individuals forming a part of each party’s respective teams. For programmers out there, it’s the lawyer’s equivalent of a flowchart prior to coding; for artists, it’s the legal equivalent of a rough sketch or a trace prior to drawing.
Now when we say ‘safe’, we mean safe from lawyers, judges and interpretation, because a Term Sheet never claims to be a final, specific or definitive contract that binds parties – it’s also a safe space for non-lawyers that just need a reference document to plan and negotiate a potential deal that will eventually require definitive legal documentation. At the very most, it denotes an intention to enter into a contract eventually, which may or may not happen.
Contract laws account for this, including provisions that account for oral contracts and contracts entered into merely by way of the conduct of parties, to name a few; however, Term Sheets have always, not only by market practice but also by way of explicit mention in the documents themselves, been deemed to be legally unenforceable documents that aren’t binding in the sense that no party to a Term Sheet can be forced to specifically perform an obligation merely because of a mention in the document (which isn’t specific enough to transcribe into a legal agreement either) – however, this safe space to negotiate and iron out deal terms may not exist anymore in the way that we understand it.
At the very most, it denotes an intention to enter into a contract eventually, which may or may not happen.
Term Sheets Sound Useful – What Changed?
Well, to say that ‘jurisprudence’ on Term Sheets has changed would be a bit of a stretch – our case at hand involves the outcome of a sole arbitrator’s understanding of what Term Sheets are (or rather, what they are not, as some will argue) and the level of contractual binding they create between parties negotiating and acting upon one; the decision was the outcome of an arbitration arising out of a dispute between two companies engaged in the hospitality business, with one seeking to acquire the business of the other. The rationale dictating the outcome of the arbitration can however be extended to any scenario involving a proposed transaction between two or more parties and a Term Sheet prepared for such a transaction, even if labelled as ‘non-binding’ or the like.
Here are the relevant facts and conditions of the case at hand along with the arbitrator’s understanding of what such actions meant (and would also mean):
- The Term Sheet’s preamble set out the document as being non-binding on the parties, however, to ascertain the true intent of the parties, it is imperative to read the complete document as a whole and not just the preamble; ignoring the clauses which form the main subject matter of the Term Sheet would be incorrect;
- The presence of a clause and annexure in the Term Sheet titled ‘Closing’ and ‘Closing Obligations’ respectively, and a partial compliance with the aforesaid conditions (such actions being uncontested by the party receiving the information and the benefits) indicates that the Term Sheet was not merely an exploratory document;
- An ‘execution’ of the Term Sheet would lead to a right by one of the parties to conduct a due diligence on the counterparty – such a due diligence was carried out, with information shared by the relevant party – this contractual obligation would not have arisen if the Term Sheet was ‘non-binding’;
- The Term Sheet specified that ‘definitive documents’ would need to be entered into towards closing the transaction, but such definitive documentation only formed one aspect of the conditions to be fulfilled – there were several obligations specified in the Term Sheet that needed to be complied with in addition and separate from the definitive documents – therefore, The Term Sheet was not merely exploratory; furthermore, the execution of the definitive documents was to be ‘subject to the conditions set forth in the Term Sheet’, indicating that the execution of final documentation was not independent of execution of the Term Sheet;
- While the Term Sheet did contain a basic framework for the proposed transaction subject to which definitive documents were to be executed and while this may have been the intent originally, the parties by conduct waived the non-binding preamble of the Term Sheet and created a binding and enforceable contract;
- Had the Term Sheet been non-binding and meaningless, there was no reason for the parties to have entertained or shown interest in any communication in respect of the abovementioned closing conditions; and
- The parties were acting upon the Term Sheet and the Term Sheet is a binding document.
The rationale dictating the outcome of the arbitration can be extended to any scenario involving a proposed transaction between two or more parties and a Term Sheet prepared for such a transaction, even if labelled as ‘non-binding’ or the like.
As we mentioned earlier, the decision is an outcome of an arbitration, so it’s safe to say that we need to take it with a mound of salt – it does, however, give us a glimpse into the potential thinking of judges when adjudicating cases involving Term Sheets, documents not typically considered to be ‘legal’ documents in the corporate world.
The concept of the Term Sheet itself has evolved, becoming more intricate and having clauses drafted very similarly to those in final agreements – the reason for this is that a well drafted Term Sheet translates into a better drafted final agreement that all parties to a transaction have lesser qualms over. This, clearly, can be a double-edged sword of sorts.
An Analysis of the Decision and Key Takeaways
Disclaimer: These views are personal and should not be construed as legal advice (unless you ask us for a signed opinion based on clear facts and circumstances).
- Merely stating that a Term Sheet is non-binding will not preclude an adjudication to the effect that a Term Sheet is, in fact, binding. This is consistent with India’s approach to prioritising the substance over form of contract and agreements. We recommend, however, that such preambles to Term Sheets set out in detail as to why the content of the document should not be binding, primary reasons being that Term Sheets’ provisions are rudimentary and merely meant to provide a blueprint for business and legal teams;
- Headings such as ‘Closing’ and ‘Closing Obligations’ in Term Sheets can be construed / interpreted to be conditions that are to be complied with even prior to definitive documentation, and once fulfilled and accepted, can be held to legitimise the legal nature of a Term Sheet. This is problematic, since Term Sheets typically set out conditions precedent and subsequent that need to be fulfilled by way of final and definitive documentation; we do not believe such sections in a Term Sheet can be avoided, but it can be ensured that no actions flowing from such conditions be carried out or accepted (even by way of communications and correspondences) by parties to a Term Sheet.
- Due diligence exercises and the receipt of sensitive data personal to parties need to be clearly specified and called out as being exercises independent of proposed transactions and only for the purposes of analysing the viability of such proposed transactions – if the ability to carry out due diligences automatically counted towards the consummation of a proposed transaction, there wouldn’t be a need for due diligences in the first place (the award doesn’t mention or understand this, unfortunately). We see this aspect of the decision as being problematic as well and in need of correction.
- Definitive documentation is typically based on the blueprint of a Term Sheet’s facets, but the arbitrator seems to have considered the need for definitive documentation to be in addition to compliance with the Term Sheet’s content – we can only suggest that Term Sheets be clear that proposed transactions would only be effective on the completion and execution of definitive documents, and that the content of the Term Sheet serves only an illustrative purpose, at best. Language to the effect of making definitive documentation subject to conditions set forth in a Term Sheet are to be avoided as well.
- Labelling Term Sheets as being ‘executed’ is to be firmly avoided – Term Sheets are at best to be signed and accepted by parties to the extent of setting out a preliminary understanding of a transaction that may or may not be completed and consummated – clarifying this is key.
- Enthusiastic conduct by a party to a Term Sheet to act upon the contours of a Term Sheet is to be red flagged and potentially rejected, even in correspondences, by the counterparty. The arbitrator based his finding on the ‘conduct’ of the parties – we do not know whether this was the primary determining factor since this rationale of ‘conduct’ towards the decision in the award is sprinkled all over other arguments, but it seems to be the appetiser as well as dessert in this multi-course meal of a decision holding the Term Sheet as being a binding and enforceable document.
The Way Forward
The biggest takeaway from the case at hand is the fact that relying on a Term Sheet beyond its understood purpose and carrying out (or even accepting) actions subsequently without the establishment of definitive documentation is risky, to say the least. While it is beyond our comprehension as to how an award to specifically perform execution of definitive documentation will work (we expect a lot of appellate movement in this case given how ambiguous it is), the risk exists and it is time for lawyers and business teams alike to recognise the dangers of negotiating and acting upon Term Sheets under the misconception that such documentation is unenforceable (even if it says it is so). The best lawyers also draft in a manner and style that precludes potential misinterpretation, so there are no doubt lessons to be learnt from this award and its rationale.
Lastly, lawyers are not always necessarily involved at the stage of drafting and negotiating the business elements of Term Sheets, and this needs to change as well, with all parties to a transaction recognising the importance of sound legal counsel even in the preliminary stages of a transaction – the pros outweigh the cons more so because lawyers involved in the Term Sheet process typically translate the intent of parties into definitive documentation a lot more efficiently and with a lot more fidelity, while also providing advice on communications as well as all the moves on the figurative chess board behaviourally conducted by clients.