On the way to a deal: Term Sheet or preliminary agreement?

A Term Sheet is a standard document that is concluded by the parties in almost every transaction, regardless of whether it is venture capital financing or the sale of an existing project. However, many founders (and sometimes even business angels) believe that Term Sheet and preliminary agreement are similar and interchangeable. In this article we will tell you why it is not so, what are the features of Term Sheet and what are its main differences from the preliminary agreement.

But first, let's define the term. 

The concept of Term Sheet

Term Sheet may be called in different ways, for example, Letter of Intent, Memorandum of Understanding, Heads of Agreement, etc. In essence, they all represent the same thing - a non-binding document reflecting the basic terms of the transaction and are so-called "gentlemen's agreements". The convenience of this type of documents is that they are prototypes of further agreements (e.g. Stock Purchase Agreement, Shareholders' Agreement), i.e. provisions from it can be used in further binding documents.

Term Sheet is a document that contains the key terms and parameters of a proposed transaction between two parties. As a rule, it includes the following conditions:

  • company’s valuation;
  • the amount of the investment;
  • the percentage of the shares that the investor acquires;
  • the structure of the transaction;
  • conditions under which the transaction will not proceed (e.g., negative due diligence results);
  • whether the investor has voting rights;
  • confidentiality provisions;
  • the anticipated timeframe for signing the agreements (closing date);
  • conditions to be fulfilled by the parties before signing the contracts (e.g., obtaining authorization from a governmental body);
  • anti-dilution and liquidation preference provisions;
  • composition of the company's governing bodies;
  • applicable law.

Term Sheet covers the essential aspects of the transaction without detailing every minor contingency and is most often in tabular form. An important feature of the Term Sheet is that it is not legally binding and is not an agreement, but is informative in nature. A Term Sheet is merely an indication of a potential commercial transaction between the parties and is not a legally binding agreement. This has some advantages, for example, the parties can be free in terms and wording, do not have to fight over every comma and describe in simple words what is important to them. Until the parties sign definitive agreements, neither party is bound by the transaction. You could say that the Term Sheet is an interim document that bridges the gap between the informal conversations between the investor and the founders and the 100-page legal documents that spell out every detail of the investment.

Regulation in Belarus

The concept of Term Sheet is alien to Belarusian law, but there is a similar concept – preliminary agreement. Many people mistakenly believe that these concepts are synonymous, but Term Sheet and preliminary agreement are not the same thing. The key difference lies in the legal consequences: a Term Sheet is a non-binding document that serves to outline the key parameters of the transaction and create a basis for further negotiations, but does not oblige the parties to conclude an agreement, while a preliminary agreement, on the contrary, is a legally binding document that entails the obligation of the parties to conclude a final agreement in the future (for example, a share purchase agreement). Belarusian legislation sets out a number of other requirements for a preliminary contract, such as that it must:

  • be concluded in the form established by law for the main agreement, and if the form of the main agreement is not established, then in writing (in this case, failure to comply with the rules on the form of the preliminary agreement entails its nullity);
     
  • contain conditions allowing to establish the subject matter, as well as other essential terms of the main agreement;
     
  • contain a term in which the parties undertake to conclude the main agreement. If the term is not specified in the preliminary agreement, the main agreement must be concluded within one year from the date of conclusion of the preliminary agreement.
  Term Sheet Pre-contract
Legal status Not a legally binding document Is a legally binding document
Obligation to conclude a main agreement Does not arise Arise. It must specify the time period in which the main agreement must be concluded
Level of detail Usually less detailed and contains general principles of the transaction Usually more detailed and may include more specific terms and obligations of the parties
Conditions that must be included  Absent. Contains key terms, but the parties themselves determine what to include in the content Conditions allowing to establish the subject of the agreement as well as other essential terms of the main agreement
Form Not established, but usually in writing The same as that established by law for the main agreement. If the form of the main agreement is not established, a written form is required.

International practice 

At the same time, it is important to take into account that the Civil Code of Belarus (as well as practically all the codes of other countries) enshrines the freedom of contract, i.e. the parties are entitled to conclude agreements not named by the Civil Code (this is Term Sheet), but the very name of the agreement is not an essential condition of it, i.e. in case of a dispute the court will analyze the content of the agreement, the actual will of the parties, the preceding circumstances (correspondence, negotiations), but not its name. This may lead to the fact that despite the fact that the parties named the document Term Sheet, the court may qualify it as a preliminary agreement and, accordingly, force the other party to conclude the main agreement. 

Thus, for example, this occurred in the case in New Media Holding LLC v. Kuznetsov [2016], which was decided by the High Court of London. In this dispute, two individuals, citizen Kuznetsov and citizen Gusinsky, signed a document called a Term Sheet relating to the management of SIA Energokom, a Latvian company in which they were both investors. The Term Sheet contained a condition that Mr. Gusinsky had the right to require Mr. Kuznetsov to buy out a certain percentage of the company's shares. In 2012, Mr. Gusinsky gave notice to Mr. Kuznetsov that he was exercising his right to demand the purchase of shares, but Mr. Kuznetsov failed to comply with this obligation and did not purchase the shares. He argued that the Term Sheet had no legal force because it was not intended to be a legally binding document or, at most, there was no consideration. The court rejected both of these arguments. Regarding the intent to create a legal relationship, the court noted that while often the name Term Sheet describes a framework document, there is no absolute rule that Term Sheets are solely framework documents and cannot be binding. 

The court also found that the Term Sheet contained detailed terms regarding the notice to purchase the shares, and that although the preamble to the document contained the phrase "basic terms", this did not mean that the document was not in the nature of an agreement.  On the issue of the consideration, the court found that the fact that the Term Sheet did not provide for Mr. Kuznetsov to receive any compensation for granting Mr. Gusinsky his right to demand the purchase of the shares was not decisive. It is clear from the surrounding facts that the Term Sheet was compensation to Mr. Gusinsky for agreeing to provide additional financing to Energokom.

That said, similar decisions have been made by courts not only in common law jurisdictions, but also in CIS jurisdictions. For example, the parties entered into the letter of intent, under the terms of which the parties undertook to enter into a future real estate purchase agreement no later than 3 months after the seller received the documents certifying title to all the objects, but no later than 7 months after the letter was entered into. In the decision of March 12, 2010 № KG-A40/14547-09 the Federal Arbitration Court of the Moscow District concluded that, as correctly noted by the court of first instance, the letter of intent concluded between the parties, meets all the features of a preliminary agreement and is concluded, as it defines the subject of the agreement, terms, price and other essential conditions.

In order to prevent this from happening, the parties usually include a clause in the Term Sheet stating that the document is not legally binding. At the same time, sometimes there are certain aspects that the parties want to make binding, such as the subject matter of the transaction, confidentiality, exclusive right (a provision under which the party to the contract that provides it must refrain from negotiating and concluding similar agreements with others for a certain period), applicable law. In general, the parties can make any Term Sheet clause legally binding.

Example: "This Term Sheet is not legally binding (except for confidentiality provisions), is not an offer, and is not a preliminary agreement or other form of liabilities."

Thus, the Term Sheet is a fairly useful source document. It establishes a clearer framework for the parties and makes easier to negotiate the signing of binding documents and hence ultimately to the finalization of the transaction. It is generally non-binding in nature, but a court may characterize it as a preliminary agreement. To avoid such consequences, the parties should be very careful about the contents of the Term Sheet and the wording it uses.


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