When is a Term Sheet Legally Binding?

As a business owner, you will likely engage in contractual negotiations with other organisations. These negotiations take place to assist you in performing your daily business functions. For instance, you may use contracts when acquiring goods or providing services to other agencies. In the performance of these contracts, you will need to agree on a set of terms with another business to form a legally binding contract. Many businesses set out such terms on what is known as a term sheet. This document dictates the basic terms of a contract and is only legally binding in certain circumstances. This article will explain the situations where a term sheet is legally binding and how you could enforce its provisions. 

What is a Term Sheet?

A term sheet is an agreement made before a formal agreement to document the basic contract terms for an investment. You may also hear it referred to as a:

• head of agreement;
• letter of intent; or
• memorandum of understanding.

Common use cases include financial transactions, such as mergers and acquisitions.

Is a Term Sheet Legally Binding? 

On its own, a term sheet is not legally enforceable. Therefore, you cannot use a term sheet as a replacement for a legally binding contract. This will be the case even if both parties have signed and have agreed to its provisions. Indeed, for a contract to be legally binding and enforceable, there must be an offer and acceptance of the contract’s terms. Additionally, there must be payment for the services provided and clarity of the contract’s terms. Finally, there must be an intention to create legal relationships. 

However, while a term sheet is not usually considered a legally enforceable document, it is useful for establishing a parties’ intent to create an enforceable agreement. By setting out the main obligations of an agreement in a term sheet, you can prove that both parties agreed to form legal relationships. However, there are some circumstances where the provisions of a term sheet may impose legally binding obligations on a contracting party. 

When Can the Provisions of a Term Sheet be Legally Binding? 

Term sheets can include specific provisions that might bestow obligations on parties to fulfil certain duties relating to that contract. It is always wise to look out for the wording in a term sheet to establish when or if it might be legally binding. For example, if the letter starts with the phrase ‘subject to contract and without prejudice’ or ‘subject to contract’, that will typically mean that the term sheet is not legally binding. 

As a business, you will come across the following four legally enforceable provisions in a term sheet that you must adhere to. Those include: 

• provisions on exclusivity;
• provisions on confidentiality;
• negotiation terms; and
• closing costs. 

Provisions on Exclusivity

Exclusivity is an important part of most business dealings. It essentially means that you will contract solely with the other entity included in the agreement that is being formed. Exclusivity prevents you from, for example, looking to transact with other agencies who might buy your products. Additionally, exclusivity may prevent you from transacting with businesses that may become competitors with the party you have originally agreed to do dealings with.

If you breach an exclusivity clause, the other party can take legal action against you. For example, you may be bound by an exclusivity clause in a term sheet to only trade with party Y when it comes to selling apples. So, if you sell apples to party X, you may be in breach of the exclusivity term in your term sheet and could become open to legal action.

Confidentiality Provisions

Disclosing commercially sensitive business information can come with big ramifications. Especially when negotiating a contract, a term sheet may include provisions that prevent you from disclosing the nature of the agreement you are working on to a third party. Moreover, the term sheet may also prohibit the disclosure of any the financials relating to that business transaction. This is particularly important in financial transactions that occur on the stock market. Indeed, this is because possessing certain confidential information can allow you to take advantage of a market. 

Closing Costs 

Terms relating to the closing costs can allow one party to enforce another to pay specific fees. For example, a term sheet might mandate that one party pays the legal fees and administration fees associated with a financial transaction. These terms are binding, and a contract will be invalid if one party does not pay the closing costs outlined in a term sheet. 

Negotiation Terms 

A negotiation term requires parties to negotiate in good faith. This means that any entity negotiating on the terms of the transaction must at least attempt to negotiate with other parties before they walk away from the negotiation table. 

Key Takeaways  

Before a business enters into a legally binding contract, it is important to set out a term sheet that will detail the main terms to be included in that contract. Term sheets are not legally binding but may include specific provisions that impose legally enforceable obligations on parties to that agreement. Those terms can include: 

• provisions on exclusivity;
• provisions on confidentiality;
• negotiation terms; and
• closing costs. 

It is also advisable to get a lawyer’s advice if you’re looking to draft a term sheet. If you need more advice on whether your term sheet is legally binding, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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