What is a term sheet?

A term sheet (Term Sheet) is a document that sets out the basic terms and conditions on which parties intend to enter into a commercial agreement.  Term Sheets are generally not intended to create legal relations between the parties but rather to form the basis of further discussions, which may be exclusive for a period of time and on a strictly confidential basis.  Once parties reach consensus on the commercial terms of a Term Sheet, a legally binding contract is then drawn up.

Term Sheets are useful in a number of commercial negotiations, including investments, licensing, resellers agreements and joint ventures.  The benefit of a Term Sheet is that they ensure both parties understand the commercial terms of the resulting agreement.  They can also save legal costs associated with drafting a full binding agreement at the negotiations stage that may or may not be entered into.

Common things contained in Term Sheets for commercial contracts

The contents of a Term Sheet are very much dependent on the subject matter of the negotiations, however, the following clauses are common to most Term Sheets:

• binding or non-binding – is the intention of the Term Sheet to be legally binding on the parties or is it subject to the terms of a yet to be prepared contract;
• commencement – the date (and on occasion the time) on which the resulting agreement becomes enforceable;
• conditions precedent – any actions or events that must occur before the agreement commences;
• confidentiality – each party usually agrees not to disclose the contents of the Term Sheet for the period of negotiations;
• commercial terms – the precise rights and obligations of the parties – in other words who has to do what for who, when by and in exchange for what;
• payments – any amounts that one party must pay to the other party at a specified time under the resulting agreement. Fees are often further classified, for example, into upfront fees, royalties, commission, resale fees and marketing fees;
• intellectual property – which party will own the intellectual property created in the course of the agreement, and whether one party will assign or licence certain intellectual property to the other party;
• jurisdiction – the state or country whose laws will be applied in the case of a legal dispute;
• parties – this is straight forward in the case of natural persons, but becomes more complex where one or both of the parties is negotiating on behalf of a company or as trustee for a trust. In some instances it may even be desirable to state the relationship between the parties, for example, in a Term Sheet for a resellers agreement, it is common to state that the Reseller is not the agent of the Grantor;
• purpose – the purpose of the negotiations, for example, the goods or services to be provided and the generally understood overall objective to be achieved;
• term – how long the resulting agreement will remain in force, and can be renewed or extended; and
• territory – it is often desirable to limit the geographical area which the resulting agreement will apply to, for example, in a Term Sheet for a licence or distribution agreement, the territory could be limited to control where the goods or services could be promoted.

Note that the above list is not exhaustive as the items to be included will vary depending on the nature of the particular contract.

Common legal issues with Term Sheets – are the parties legally bound?

Depending on the circumstances a term sheet may reflect the final agreement between the parties or it may not.  The case of Masters v Cameron (1954) 91 CLR 353 outlined three categories:

• where the parties have agreed upon all the terms of the contract and intend to be immediately bound to the performance of those terms but at the same time propose to have the terms restated in a form which will be fuller or more precise but not different in effect;
• where the parties have agreed upon all the terms of their arrangement, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document; or
• where the intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract

Since this case, a fourth category was recognised by Baulkham Hills Private Hospital Pty Ltd v G R Securities Pty Ltd (1986) 40 NSWLR 622:

“In the absence of agreement as to further terms to be inserted in the formal contract, the obligation of each party would be to execute a formal contract in accordance with the terms of the agreement appearing from…[the informal contract]”.

Term sheets typically fall into the third category (except for provisions concerning confidentiality) of Masters v Cameron (1954) 91 CLR 353 – the intention of the parties is not to make a concluded bargain at all, unless and until they execute a formal contract. See our article here which discusses this case and the rules surrounding it.

That said, there are also circumstances where they can be legally binding in circumstances where there are sufficient detail contained in the document.  The answer is not always clear; a term sheet will need to be assessed on a case by case basis.

Practical issues with term sheets

If the resulting agreement is entered into on terms less favourable to one party, that party will generally be unable to enforce the more favourable terms contained in the Term Sheet.  Moreover, a large company will often bring a pre-prepared or “standard form” Term Sheet to a negotiation, and the other party may feel that they are not in a position to negotiate its terms.  Finally, as a Term Sheet is usually non-binding, either party can leave the negotiations at any time, meaning any time and money expended during the period of negotiation will be lost.

Takeaways

You should understand what your position is when you are negotiating an agreement with a term sheet. While this is unlikely to create a binding agreement, your intention and the other party’s intention may be different. It is important to understand the legal effect of using a term sheet and its consequences; one should not provide a term sheet intending it to be the full and final contract.

Links and further references

Cases

Baulkham Hills Private Hospital Pty Ltd v G R Securities Pty Ltd (1986) 40 NSWLR 622

Masters v Cameron (1954) 91 CLR 353

Further information about term sheets

If you’re looking for a proactive lawyer to advice you on using a Term Sheet as part of contract negotiations or drafting the resulting contract, contact us for a confidential and obligation-free discussion:

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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