Legal Enforceability of Term Sheet

Published on 30 Mar 2016 by Team

Any initial planning process of a business starts with an agreement upon the terms of business which is what the 'term sheet' is responsible for. The term sheet is an announcement of what organisations or businesses plan to achieve by the understanding agreed between them, irrespective of what they what they agree for in the future.

What is a 'Term Sheet'

The term sheet is a document outlining the material terms and conditions of a business agreement between a startup and a potential investor. The arrangement of a business exchange, for the most part, begins with agreement upon the terms of business in the form of a term sheet. The term sheet is a declaration of what parties intend to accomplish upon by the agreement, instead of what they eventually concur upon.

With respect to how detailed a term sheet is generally, it is generally a relatively short document that an investor prepares for presentation to the company in which the investor states the investment that he is willing to make in the company. This is at the transaction stage and aides in getting down to business the last term of the agreement. You can consult the best startup lawyers in India to get your term sheet drafted as per the requirements of your startup.

Term sheet covers the following terms 

A term sheet may address some or all of the following issues:  

  • the proposed structure of the transaction (for example, an asset purchase, stock purchase or merger), including, to the extent applicable, the specific assets that will be purchased and not purchased, any liabilities of the seller to be assumed by the buyer, the class or classes of seller’s stock to be acquired, the parties to the merger and the identity of the survivor
  • the purchase price and any purchase price adjustments, including whether any portion of the purchase price will be held in escrow
  • the nature of the consideration to be paid by the buyer (for example, cash, a note, shares of stock or a combination of the foregoing)
  • the due diligence process to be undertaken by the parties, including what information the seller will make available to the buyer and what access the buyer will have to the seller’s employees, records and facilities
  • any conditions that must be satisfied prior to closing the transaction (for example, obtaining financing or third party, stockholder or government approvals)
  • any confidentiality provisions that may prevent the parties from disclosing information they obtain during the due diligence process, even if a separate confidentiality agreement has already been entered into by the parties
  • any non-solicitation provisions (“no shop” or exclusivity provisions) that may prohibit the seller from negotiating with other potential buyers
  • any non-compete provisions that may prohibit the seller from competing with the buyer in a defined geographic area for a specified period of time

Term Sheet Whether created with Intention to create legal obligations

There can broadly be 2 types of Term sheets with respect to the intention of creation behind these documents-

(1) The parties did intend to create legal relations; and

(2) The Term Sheet was more than an agreement to agree, and hence, enforceable.

Enforceability of a Term Sheet - India

The following broad conditions must be satisfied in India as per the Contracts Act broadly:

  1. There exists a clear intention to create legal relations.
  2. That it is not an agreement to agree to an agreement.
  3. The terms are clear and unambiguous.
  4. The subject matter is certain.
  5. There is a flow of consideration.

Whether Term Sheets can be binding on the parties

Term sheets represent the preliminary understanding of the parties regarding a proposed sale and, as such, may be either binding or non-binding. In some cases, the parties may want a letter of intent or term sheet to be binding in its entirety. In most cases, however, either the buyer or the seller, or both, do not want to be obligated to consummate a proposed sale before the parties have actually entered into a definitive written agreement. The parties, therefore, may want only certain provisions of a letter of intent or term sheet to be binding immediately (for example, the confidentiality, non-disclosure or non-solicitation provisions and/or the provisions relating to the payment of expenses).

Letters of intent and term sheets should expressly state which provisions of the document are binding on the parties. If the intent of the parties to be bound, or not to be bound, is clearly stated in the letter or term sheet, such intent presumably should be given effect by a court in most cases; however, potential buyers and sellers should be aware that a court could conceivably infer the contrary intent if the document is silent, or less than clear, on the matter. Top startup lawyers in India can draft customised term sheet for your startup.

Where Term Sheet can be enforceable legally- Importance

The term sheet has no actual enforceability however it does have certain binding clauses mainly the confidentiality clause and exclusivity clause. The confidentiality clause, as is self-explanatory is a clause that forbids parties or either party from disclosing the terms of negotiation to a third party. Exclusivity clause is also known as “no shop clause”. They prevent the company from looking for other investors for a certain period while the term sheet is negotiated.

A term sheet acts as a ready reference in later stages of negotiation between a company and the investor. The basis of any negotiation will stem from the term sheet executed between the parties. Explained above were the standard terms used in most term sheets. However, no two term sheets are ever the same. They are tailored to fit the businesses and investors they represent, to their mutual advantage. It is better to hire a startup advocate in India to get your term sheet drafted.

It would, therefore, appear that the chances of enforcing a non-binding agreement/letter of intent are ordinarily low. However, judicial determination of letters of intent/ term sheets remains subject to the specific facts of each case and the provisions of the respective letters.

Parties often consider a letter of intent which sets out the crux of the transaction, a practical and easy to enter document to assess upfront, the broad pros and cons of the transaction and arrive at broad commercial understanding agreeable to all. So, in cases where a letter of intent is being entered into and is intended to be non-binding, care should be taken that the letter of intent clearly states that it does not constitute any contractually binding relationship between them. The parties also should not act upon the letter of intent (or initiate any work pursuant to it) as if they had a legally binding agreement, to avoid possible disputes in future.

It is therefore advisable for executing parties to protect their interest by entering into a definitive agreement prior to initiation of contract work to avoid long protracted litigation to prove the very legality of their contractual arrangements.

Generally, term sheets are non- binding in nature, but they can become legally binding if executed on a stamp paper. The provision for its nature being non-binding can be inserted in the term sheet itself or the intention of creating a binding contract can be inserted as well to consider the term sheet as a starting point of evidence in any future litigation with respect to any dispute. Parties should be careful while drafting these documents at the negotiation stage.

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Tags: Fund Raising 
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