Beware the Unintended Binding Term Sheet

September 12, 2016

Term sheets and letters of intent are often used by parties to set out the key terms agreed to in principle prior to entering into negotiations of a more formal and final agreement. Although rarely used as the final all-inclusive agreement, a term sheet evidences the serious intent of the parties to consummate a transaction. Notwithstanding this serious intent, in most cases term sheets are not intended to be binding agreements, and parties usually assume that they are non-binding. This shall serve to caution practitioners and contracting parties alike that under certain circumstances, and often to the surprise, and sometimes detriment, of one of the parties, term sheets, or certain provisions therein, can in fact be binding even if not intentionally so.

To be clear, as a general principle term sheets are non-binding; however this general principle does not always hold true. So the question becomes what makes a term sheet, or certain provisions therein, binding? On the one hand, parties may intentionally make certain provisions binding, for example parties may include terms for exclusivity, confidentiality, or payment of costs and expenses. On the other hand, parties may inadvertently create a binding term sheet based on how the term sheet is drafted or the circumstances surrounding the term sheet.

Likely the most common unintentionally binding “provision” of term sheets is a duty to negotiate in good faith. Courts have found that even when there is no expressly stated duty of good faith, a duty of good faith may still exist and be imposed on the negotiating parties. Such a finding by a court will be based on the circumstances, and will likely be based on a finding that the parties “intended” to be bound by an agreement to negotiate in good faith. Such a duty may prohibit the parties from renouncing a deal, abandoning the negotiations, insisting on conditions that do not conform with the initial agreement of the parties, or negotiating with other parties, even if a better offer arises prior to the execution of the formal agreement.

Beyond a duty of good faith, under certain circumstances the term sheet itself may be interpreted as a formal binding contract. Such an interpretation may arise if the parties indicated their agreement on the essential terms to the transaction, and the subject matter thereof, in the term sheet. In these circumstances, when determining whether an obligation is binding or not, courts look to the parties’ intent by examining factors such as: (i) the language used in the term sheet; (ii) the context of the negotiations between the parties; (iii) whether the terms are sufficiently definite to be enforceable or there are material terms still left to be negotiated; (iv) partial performance of the obligations by one of the parties; and (v) whether the subject matter of the discussion concern complex issues which are normally address in a formal contract. The more definitive a term sheet, the greater the likelihood that a court may find that the terms are sufficiently definite to be enforceable.

So how do you avoid an unintentionally binding term sheet? Unfortunately there is no iron clad solution. With that said, the most important step is to ensure that the term sheet properly and clearly reflects the parties’ intentions. If parties wish certain terms to be binding then they must clearly articulate this intent. At the same time, if parties do not intend a term sheet, or certain provisions therein, to be binding they likewise must clearly and unequivocally articulate this intent. Further, parties should consider: (i) having an unsigned term sheet (only if binding exclusivity or confidentiality clauses are not desired); (ii) specifically stating that the term sheet is non-binding, or alternatively specifically stating which provisions are binding and which are non-binding; (iii) leaving out some of the essential terms to the agreement; and (iv) including damages limitations in order to limit risk in the event the term sheet is determined to be binding.

It is important to consult with your attorney while negotiating term sheets and letters of intent as some important issues being addressed may be difficult to change or renegotiate in the definitive agreement. SMGG can help you navigate the term sheet process, as well as the process all the way through closing of the transaction. If you have a question about the term sheet process or any business services matter, please contact Amelia R. Brett of Strassburger McKenna Gutnick & Gefsky in Pittsburgh at abrett@smgglaw.com or (412) 281-5423, or any other member of our Business Services team.