Are Term Sheets Really Nonbinding?
AJ Febles was the author of this post.
You’re in the thick of week two of negotiations on a with a potential investor and you can’t help but wonder why you’re spending so much time on a document that has “nonbinding” written all over it. While it is true that term sheets summarize essential terms to be reflected later in binding legal documents, most
Investor Favored Terms
So, it is important to know that while term sheets are typically labeled as “nonbinding,” certain specific terms will create legally binding obligations. There are two legally binding commitments an investor will expect for any transaction: Confidentiality and Exclusivity.
Confidentiality refers to the request by venture capitalists (VCs) or potential investors to keep the term sheet and its specific terms confidential, in part to protect the VC’s ability to evaluate companies and propose winning terms. But given that both parties will disclose detailed information to each other in order to consider the transaction, confidentiality in a
Exclusivity, or “no shop”, refers to the set period of time during which a company and its founders agree not to shop for other potential offers. This period should more or less align with the deal timeline, typically around 30 days. Having an exclusivity provision in a
One example of a confidentiality and exclusivity provision can be found in the National Venture Capital Association model term sheet, which combines both concepts. It’s drafted as follows:
The Company and the Investors agree to work in good faith expeditiously towards the Closing. The Company and the founders agree that they will not, for a period of [______] days from the date these terms are accepted, take any action to solicit, initiate, encourage or assist the submission of any proposal, negotiation or from any person or entity other than the Investors relating to the sale or issuance, of any of the capital of the Company [or the acquisition, sale, lease, license or other disposition of the Company or any material part of the stock or assets of the Company] and shall notify the Investors promptly of any inquiries by any third parties in regards to the foregoing. The Company will not disclose the terms of this
Duty to Negotiate In Good Faith
Have you also noticed that your term sheet includes a provision requiring the parties to negotiate in good faith? Whether or not this is a binding duty is up for debate and may depend on your jurisdiction.
In some jurisdictions, like Texas and Virginia, even explicit agreements to negotiate in good faith included in a term sheet are not enforceable as a matter of law. But such is not the case everywhere. In Delaware, for instance, a signed
And the Delaware Supreme Court does not take a breach of good faith lightly. In 2013 it held that if the parties would have reached a definitive agreement but for the bad faith of the breaching party, the non-breaching party could recover contract expectation damages in an amount equal to the value that it could have reasonably expected to receive under a definitive agreement having those terms set forth in the term sheet. (Siga Techs., Inc. v. PharmAthene, Inc., 67 A.3d 330 (Del. 2013)).
That’s why we always emphasize that deliberation and care are paramount when negotiating a term sheet. If the parties want to be able to walk away without any liability while drafting the definitive agreement, the
It’s always best to say what you mean and mean what you say in a term sheet. We always advise our clients to be as clear as possible with regard to which provisions in a
- whether the language of the term sheet reveals an intent by the parties to be bound by its terms;
- the context of the negotiations;
- the existence of open terms;
- whether the parties have partially performed with regard to the obligations at issue; and
- the necessity of putting the agreement in final form, in a manner customary for such transactions
We also counsel our clients to include language explicitly stating that the parties are not bound to consummate the contemplated transaction unless and until a definitive agreement is signed.
Calling term sheets “nonbinding” is a misnomer. VC investors will want to feel assured in their potential investment by seeing exclusivity and confidentiality provisions in any