This article is written by Shubham Bhatnagar a student of 2nd year-3 year LLB- Faculty of Law, DU pursuing a Diploma in M&A, Institutional Finance and Investment Laws. This article has been edited by Ojuswi (Associate Lawsikho). 

This article has been published by Sneha Mahawar.

Introduction 

A term sheet is also known as a memorandum of understanding, head of terms, or letter of intent. It is a document that outlines the key terms of transactions that have been agreed upon between the parties including the identity of the target company to be acquired, the purchase price to be paid, and the timeline for the transaction.

It is executed at the start of the transaction. It is a written confirmation of the main principal terms of a particular transaction that have been agreed upon. The most important reason it is executed is that it provides a framework for everybody else who’s involved other than in the preliminary discussions as to the understanding and principles which have been agreed in principle. The most important reason it is executed is that it provides the framework for everybody else who’s involved other than in the preliminary discussions as to the understanding and the principles which have been agreed upon and how the definitive documents can be executed going forward.

In simple words, it is a base document that guides what the parties are going to achieve word for word and at times it is also seen if it is a binding term sheet. It also forms a base for discussions with various third parties such as lenders and regulators.

A term sheet is usually expressed to be not legally binding but it will contain some provisions which are specifically expressed to be legally binding.

A term sheet typically will not bind the buyer to proceed with the transaction and will be expressed to be subject to the parties entering into full documentation to conclude the transaction, such as the Sale Purchase Agreement or SPA.

The term sheet does contain some non-legally binding terms, typically the terms that set out the commercial details which have been agreed upon, such as what is being sold or acquired, the price, the settlement mechanism, time frame, and the other agreed-to terms. Despite the non-legally binding nature of the commercial terms, they must be drafted carefully as these provide a framework for the SPA to follow.

A buyer will typically wish to insist on provisions dealing with exclusivity, restrictive covenants, payment of a deposit, governing law, and the dispute resolution mechanism to be legally binding. The exclusivity clause is important as it restricts the seller from participating in discussions relating to the transaction with other third parties for a specified period typically up to three months, or until the buyer indicates that it does not wish to proceed further with the transaction. Any breach of this clause will typically entitle the buyer to recover its costs and expenses from the seller. If a buyer is required to pay a deposit then the term sheet should contain a legally binding provision dealing with the payment mechanism of the deposit and its repayment or forfeiture in the event the transaction does not proceed.

On the other hand, a seller will insist on a legally binding confidentiality clause. This requires the buyer and its professional advisors to keep all information disclosed by the seller in respect of the transaction during the due diligence process strictly confidential. The confidentiality obligation may be subject to certain exceptions such as if the disclosed information is already in the public domain. A seller will also insist on including restrictive covenants to prevent the buyer from abusing information that it has received from the seller during the due diligence. An example of this would include restrictions on soliciting customers, clients, or key employees of the target in the event the transaction does not proceed.  

Term sheets are therefore important and it is always advisable to engage an experienced M&A lawyer to prepare and draft one. Well-drafted term sheets provide certainty and clarity to the parties concerning the transaction terms.

They also provide a level of comfort to the parties in committing resources and time in proceeding with the transaction, such as engaging professional advisors and commencing due diligence. They also assist the parties in preparing the formal transaction documents thereby saving time and expense and facilitating the completion of the transaction more efficiently. 

This article will focus on why a term sheet is used in a commercial, when can the term sheet be legally binding, which part of the term sheet is legally binding, and also discuss binding and non-binding term sheets, along with the downside of having a term sheet.

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Why do people always prefer to execute a term sheet

The biggest reason why people execute a term sheet is that it bridges the gap, if any, between verbal discussions and the final handshake between the parties. If the parties have executed, for instance, a term sheet in case of a pure fundraising transaction, and there is a new investor. He is excited about the company and he’s intending to invest in the company. Now, the parties can come to consent in the meeting but thereafter when it is put down on a sheet of paper it identifies the expectations upfront and if there are any key issues they can surface at a preliminary stage before the parties can expend additional time resources going forward. 

Nevertheless, the term sheet intends to form a morals commitment for both parties to observe this and also a big advantage is that it highlights which issue can pop up between the parties upfront and thereafter give confidence to both parties that largely the understanding is achieved thereafter both of them can commit to spending more time and resources on the particular transaction.

Why is a term sheet used in commercial deals

Term Sheets allow the parties to identify the deal breakers very early on in the process and that’s very useful because if the parties know that if there’s an issue that cannot be resolved they don’t have to go forward and can abort the transaction early on if there’s an insurmountable issue. However, if there are issues that are kind of tricky, parties can early on in the process find creative ways to resolve them that are very useful indeed.

It serves as a colossal tool for the lawyers to guide them as to how to go about drawing up the definitive documents. Without a well-crafted term sheet, it will be difficult for the lawyers to see how to proceed and when they will end up drawing lopsided or one-sided and which is not useful.

The comfort or confidence that it instils in the parties when they see a well-formed term sheet is enormous. It is also an indication to the parties that not everything is binding in a term sheet but there is a lot of moral commitment attached to it. Therefore, from a deal confidence standpoint, a term sheet also is an important tool.

Should an M&A term sheet be legally binding

A term sheet ordinarily except few provisions is non-binding and there are good reasons for it because a term sheet is a high-level document and in order to make the entire term sheet binding, there will be protracted negotiations that require getting into details and derails the whole momentum which the parties have to build up just after the initial deal. Therefore, that is best kept for definitive agreements and if the term sheet is made binding entirely it may trigger obligations to disclose the transaction to stock exchanges. This might trigger fillings under competition law if the relevant thresholds are met.

However, there are some situations indeed where a binding term sheet may work if it’s an uncomplicated, straightforward transaction without not too many complex safeties either in structure or deal terms or no warranties, and then it is expected that a binding term sheet may also serve the purpose of the parties are not willing to incur substantial time and expenses in a definitive agreement.

When can a term sheet be legally enforceable

A document including a term sheet whether it’s binding or not and enforceable or not hinges on the fact whether it satisfies the tenets, the key ingredients under the Indian Contract Act 1872. Broadly if a document is entered into, the parties who are competent to enter into a contract with free consent for a lawful object and a lawful consideration and with the intent to create legal relations that documents will be enforceable. 

Now in the context of term sheets, a term sheet circuits all these conditions that are also enforceable. Therefore, more often than not since the parties want to make a term sheet ordinarily non-binding, they need to clearly spell out which provisions are binding and meant to be enforceable and which are not binding and therefore not be enforceable. If it is not done then there is a lot of ambiguity and leaves enough room for courts to interpret whether the part is conducted in a manner that they demonstrate they always intended to create legal relationships and that can have unwanted ramifications. 

A term sheet is not a stage where any party wants to make too many commitments and if it is not properly worded that can have undesirable consequences.

Which part of a term sheet needs to be legally binding

There is no hard and fast rule as to which part should be binding and non-binding in a term sheet conventionally only the terms which really matter while the parties are still exploring the transaction that is made binding, which is mostly the confidentiality obligations.

The seller obviously does not want the buyer to exploit the confidential data and its sharing during a due diligence exercise just in case a deal doesn’t go through likewise the buyer would want the protection of exclusivity obligations of the seller so that the seller does not really offer which the buyer makes and really goes around to shop for a better offer and uses the buyer as a stalking horse.

If there are costs and expenses, break-free reverse break fee-related provisions, they should also be made binding. Ultimately, to really give teeth to all of these provisions, i.e, in order to enforce, naturally, governing law and a dispute resolution mechanism are required which should be binding as well just in case parties need to take refuge under the judicial forum to enforce a particular binding provision of a term sheet.

Binding vs non-binding term sheet

Non-Binding term sheet

It may be a misnomer to call it fully non-binding, the parties intend to set out very clearly what are the key commercial principles that form the basis for negotiating the transaction documents going forward. 

Nevertheless, a limited set of provisions would bear binding so a non-binding term sheet would constitute 2 parts the majority portion of the non-binding term sheet would be non-binding while very specific provisions in the document would be binding and a non-binding term sheet is usually in a short-form document will set out the principle underlying the issue however there are exceptions to this especially in case of a complex transaction.

Binding term sheet

Are usually executed where the parties have a certain intention to make it binding and it can vary from using it strategically to submit to regulators at a particular point in time or the parties have a time crunch and they will not be in a position to execute entire documentation within a short time frame so they execute a slightly longer form binding agreement which would be enforceable at a later point in time.

While executing or working on a binding term sheet it should be kept in mind, that if it is made vague it would not be enforceable and also not advisable to enter into then, so a binding term sheet should be in a long form with more or less all the details well set out between the parties and very clearly the intention of the parties to make it binding should be set out. 

Lastly, the terms of making a valid contract should be followed, meaning offer, acceptance, consideration, capacity, and the uncertainty of the contract should be well set out and it should not appear that it is not a full contract by itself.

The key difference between a binding and non-binding term sheet would be as such depending upon the intention of the parties whether to make it binding or not binding but if one is working on a binding or non-binding term sheet it should be clearly and explicitly set out as to what is the intention of the parties. Whether the intent is for all clauses to be binding or the intent is except for some provisions of the agreement all other provisions of the term sheet are not binding and will not obligate the party to contract and maybe consider using some terminology like subjunctive to contract or subject to approval.

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Downside 

The term sheet is a very important document that should not lead to prolonged negotiations due to unnecessary detailing of the documentation. It may limit the flexibility of a party to negotiate further or change your position.

The buyer, the acquirer, or the investor would have limited information compared to the seller or the target company in place so the sellers are at a significant advantage over the buyer at this particular stage so the buyer should be careful at this point if agreeing on certain terms it’s always better to set out certain assumptions. It might limit room for manoeuvring over at a later stage although it will continue to remain a moral obligation as such.

It should not increase the workload of the parties at the time of doing the term sheet itself. The term sheet intends to cut down the cost and if at all there are key issues that are not solvable at this point of time but making it unnecessarily long leading to as prolonged negotiation will not seek the benefit of having a term sheet, where the intent was always to bridge the gap and move on to the next things in the transaction space as such.

Conclusion

It is advised to have a term sheet, it is a critical tool in terms of identifying deal-breakers, instilling confidence in the parties, and guiding the lawyers to move forward with their diligence and direction on how to draw the definitive agreements.

Spill out very clearly which terms are binding and not binding and act in consistency with the terms of the term sheet. Involve lawyers and advisors involved early on in drawing the term sheet because the last thing a party wants is to agree to something and to, later on, realise that this is not something that will not fly under applicable tax laws or legal provisions or is suboptimal and that’s not a way to start the relationship isn’t it to renege upon your good fit promises made early on.

The intent of the term sheet should be beneficial to the cost involved and the time involved and one should be mindful that timing is always key when working on a term sheet. It should not be the case again that documents are being negotiated twice over once at the time of the term sheet and again repeating the entire procedure for a long period at the time of doing a definitive document.

References


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