In this article we look at the non-binding aspect of a term sheet and why people prefer an agreement which may not be enforceable.
Term Sheets Not Legally Binding: A term sheet, as the name suggests is a document that contains the broad terms and conditions of an arrangement or a prospective agreement. From the definition, we can understand that the term sheet is a precursor to a prospective agreement and not the agreement itself. This means that it is not a binding instrument. It is meant to be an instrument of discussion. Only when the parties to a term sheet are fully satisfied with the terms of a sheet, will they proceed further to work out the finer details of the arrangement in order to make it legally binding.
Term sheets can be for any kind of arrangement. But the nomenclature of term sheets is most commonly used in the financial markets for arrangements that involve financial instruments such as equity and loans. It can be prepared by any one party for the other party to agree or it can be the result of discussions and negotiations between the two parties. But in financial markets, it is usually the person providing the finance that prepares a term sheet. The investor or lender usually maintains a general term sheet that contains details such as the funds that will be provided, the cost of providing the funds (interest or equity), the duration of the agreement, etc.
But why would someone enter into a non binding term sheet arrangement when they have the option of entering into a legally binding agreement? Why would a party make itself vulnerable in this manner? Let us take a look.
Why Term Sheets Are Not Conclusive
There are all kinds of arrangements as far as contracts and agreements are concerned. Some of them are simple give and take arrangements, like rent agreements, sale agreements etc. Some agreements are one time agreements, where the parties execute the obligations of the agreement and then dissolve the arrangement permanently. The agreements in the financial markets are usually long term agreements. And when long term commitments are involved along with large amounts of money, people want to be sure before they make a legal commitment. But how can one be sure about it?
This is where non-concluive agreements come into the picture. In non-financial market related arrangements a non-conclusive agreement is called a Memorandum of Understanding or an MoU. In financial market related arrangements it is called a term sheet.
The idea is for the parties to envision the working arrangements and the conditions necessary for the dynamic to work. This vision and the speculated terms and conditions are put on paper for each party to see in a broad manner to understand what the actual scenario will look like.
Besides, many operators in the financial market require a contract for every single one of their transactions. A money lender has to enter into a loan agreement for every person who comes in for a loan. An investor has to sign a shareholders’ agreement with every investment they make. They will not have the bandwidth to engage every party in a detailed discussion. So they create an overall set of terms and conditions they usually prefer working with. Any party willing to engage with the operators must first look at the term sheet and either agree to the terms or come up with their own terms along with a justified reason as to why the operator should modify his term sheet and what the operator gains out of the modification.
But this is the general idea as to why a term sheet is not binding. However, there are certain aspects of a term sheet that are legally binding, despite the rest of the agreement being non-conclusive. Let us take a look at these.
Legally Binding Aspects Of A Term Sheet
Confidentiality – Many times, the term sheet mentions that the terms mentioned in the term sheet are not to be shared or discussed with anyone while the negotiations are ongoing. This term is binding because the person making the offer may be making the offer to a party based on different assessments and perspectives. So the parties to a term sheet have a right to have their negotiations and their terms remain confidential and that would be binding. Besides, confidentiality has got nothing to do with the performance of the obligations of the term sheet. It is a general requirement that comes from a place of privacy rights.
Exclusivity – If a term sheet specifically states that the parties involved cannot engage with competing parties within the duration of negotiations of the term sheet, it is legally binding. Again, like confidentiality, exclusivity has got nothing to do with the terms and conditions for performing the obligations of a term sheet. It is a simple question of principle as to not engage with someone else who is offering the same thing as long as discussions on the term sheet are ongoing, or rather requesting the other party to engage exclusively with just one party at a time.
Validity period – Once a validity period has been entered into the term sheet, that becomes the lifetime of the term sheet. The term sheet will compulsorily expire on the date of validity. Of, course, the parties can renew the arrangement by signing a new term sheet.
Conclusion
The contracts act can be very speculative at times given that there is a lot of emphasis on ‘intent’ when it comes to judging the fairness of the agreement, which in turn decides whether an agreement can be legally binding. You may put something down on paper and get the other party to agree to the terms and sign. And the court may still strike down the agreement as a mala fide agreement if it feels that the intent of the agreement was to exploit or hoodwink. This is why you must consult a legal expert to draft your agreements so that the agreement is drafted in clear, unambiguous terms. Someone who can guide you on what can be considered legally binding and what cannot be considered legally binding. If you are looking for an expert to guide you in aspects of drafting a term sheet, get in touch with vakilsearch and we will connect you with our team of legal experts who can help you with your requirements.
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