A term sheet, heads of terms or letter of intent (“LOI”) is a document which provides an overview of the key commercial and other terms of a transaction. A well-drafted term sheet or LOI provides a clear pathway for a transaction invariably expediting the time to completion and reducing transaction costs. By contrast, a vague or incomplete LOI which does not set out the key issues from the outset or is not clear on how these points are to be dealt with, can often result in long and frustrating negotiations and a loss of leverage at the documentation stage.
It should be noted, however, that there may in certain circumstances be reasons not to enter into a term sheet/LOI. For example, it limits maneuverability in negotiations, there is a risk of inadvertently creating legally binding commitments, merger/competition issues may be triggered and a formal term sheet or LOI may be evidence of an arrangement which can affect certain tax relief open to the parties.
The phrases term sheet, heads of terms or LOI are often used interchangeably. They are essentially the same although the format of a term sheet/heads of term will differ slightly to an LOI. An LOI is generally written in letter form and focuses on the parties’ intentions whereas a term sheet lists deal terms in bullet-point or similar format and can be signed to formalise the document. The industry meaning given to the terms “Letter of Intent” or “Heads of Terms” can also change. For example, in the construction industry, “Letters of Intent” are often used as a pre-contractual means of commencing the construction works and have a fairly specific meaning. However, quite often in the past, there has been some confusion as to their contractual status leading to a whole raft of case law dealing with the issue as to whether or not a LOI created an enforceable contract between the parties. In nearly all of these cases, the LOI was meant to be replaced at a later stage of the project with fully drafted contractual provisions, however, for one reason or another (either because the parties simply forgot or because negotiations between them broke down), this next step was not taken and an almighty mess ensued as arbitrators and courts were left to determine the issues!
As term sheets or LOI’s are often negotiated and signed before involving legal advisers, we have set out some key points to note when drafting these documents.
There is no standard form term sheet or LOI. As noted above these documents can take several forms and this often depends on the context, type of deal, and size of and relations between the parties and the industry in which they operate. An LOI letter format generally allows for a less formal approach (which is often appreciated in early stages of a transaction) although it is certainly not incorrect to set out the terms of a deal in a term sheet. In either case, informal or otherwise, you should be careful to ensure that the LOI or term sheet is not legally binding if that is not what is intended (or vice versa).
Term sheets and LOIs are usually non-binding although there may be certain provisions which the parties intend to be legally binding. The LOI or term sheet should clearly state what aspects of the document are intended to be binding or not. If you do not wish the document to be binding it should be clearly expressed as being “not legally binding”, “subject to formal contract” and “for discussion purposes only”. Provisions which are commonly intended to be binding (and which should be expressed to be so) include exclusivity during the negotiation phase, a requirement to continue with good faith negotiations, confidentiality and costs incurred during the negotiation phase. If it is intended that the term sheet/LOI be binding, there are formalities which need to be considered in order to achieve this. For example, the terms must be sufficiently certain to be enforceable and “consideration” (used as a technical legal term) must move between the parties. In either case, legal advice should be sought if you are unsure.
Seek advice where necessary
Some issues such as the governing law of the formal documents can have a significant impact on costs and your rights. Another key issue is tax. It is advisable to seek advice on these matters before formalizing the term sheets or, at the very least, to reserve your position on these matters.
It is helpful to set out in the term sheet/LOI who will be responsible for the next procedural steps in the transaction. For example, whose advisers will be preparing which documents? What is the timetable for due diligence and how will this be carried out? Who will be responsible for co-ordinating third party consents?
Assumptions may be necessary
It is often necessary to set out the assumptions on which certain issues have been agreed. This is usually where there are additional steps that need to be carried out or examined before a conclusion can be reached, such as due diligence and assessing any third party consents that are necessary.
It is important to use consistent terminology throughout the LOI/term sheet. Although the formal documents will obviously set out the provisions in greater detail, it is helpful during detailed negotiations and for advisors who need to prepare formal contracts for terms to be consistent. It is important to note that certain words have a specific legal meaning and if you’re intending provisions to be legally binding, it is prudent to ask your adviser – words such as “partner”, "best efforts", “reasonable efforts” and even “including” have particular meanings in law.
It is certainly not uncommon for all parties to sign the LOI/term sheet (generally by counterparties returning a signed copy of the letter or document). If the document is intended to be legally binding then obviously it should be signed. If the document is not intended to be legally binding then clearly this is not required. However, there are certain strategic benefits to have a party sign a document as it shows a level of commitment and that the counterparty has likely followed an internal process to sign the document. Remember that, even if a document is not signed, but parties proceed to act in accordance with its terms, it could still be held to constitute an enforceable contract, so being clear as to whether this is the intent is crucial.
Parties often circulate draft LOIs and term sheets before formalizing a signature version. This is a useful way to flesh out the key points of a transaction. As such, if it is necessary to circulate a draft with blanks and brackets to elicit a response then this is acceptable. It may be, however, that in doing so you lose some leverage. There is quite often a benefit in providing a first proposal.
Although it may seem obvious, a well-formatted document is a key part in making your document clear and understandable. Numbering is helpful for referencing but bullet points and a table format are equally acceptable. Headings are obviously helpful and if a logical order can be followed (for example, by following the chronology of a deal), this will assist subsequent negotiations and the formalising of the documents. Again, it should be noted that if the document is not intended to be legally binding, mark throughout the document (in the footer and in headers) that the document is “for discussion purposes only” and not intended to be legally binding. You should also note that it is confidential.