Term Sheets and Letters of Intent (LOIs): When Are They Binding?

10 Feb Term Sheets and Letters of Intent (LOIs): When Are They Binding?

When working on a deal, you will likely encounter two main types of documents in the early stages: term sheets and letters of intent (LOIs). These documents outline the key terms of a potential agreement between parties before moving to the formal contract stage.

But the big question is: when are these documents binding?

 What is a Term Sheet?

A term sheet is a preliminary document that outlines the general terms and conditions of an investment. Think of it as a “first draft” of what the final agreement might look like. It is commonly used in venture capital and other financing deals.

What is a Letter of Intent?

A letter of intent (LOI) is often used for mergers, acquisitions, or other significant transactions. Like a term sheet, it outlines the main points of a potential deal but may include specific commitments, such as confidentiality agreements or exclusivity periods.

Binding or Non-Binding?

While both term sheets and LOIs are typically non-binding—meaning the parties are not legally obligated to complete the deal—there can be exceptions. Here are a few key areas where binding commitments might come into play:

• Confidentiality: Even in a non-binding document, clauses requiring confidentiality (or “non-disclosure”) are usually enforceable. This means any shared information must be kept private.
• Exclusivity: Some LOIs include an exclusivity period, meaning one party cannot negotiate with others for a set amount of time. This clause is generally binding, requiring a commitment not to pursue other deals during that time.
• Costs and Expenses: Occasionally, there may be an agreement about who will cover costs or reimburse certain expenses, even if the deal does not go through. If this is specified in the document, it is typically binding.
• Good Faith: Some term sheets and LOIs include a “good faith” requirement, which means both parties agree to work sincerely toward the final agreement. While not legally enforceable in all situations, it can influence how a judge views the behaviour of both parties if the deal falls apart.

Why Have Non-Binding Agreements?

These documents are crucial because they allow both parties to test the waters before fully committing. They lay the groundwork, clarify intentions, and help prevent misunderstandings down the line. Additionally, they provide both sides a sense of security by outlining the main deal points before committing to a full contract.

Avoiding Surprises

To ensure clarity, both parties should clearly specify which parts are binding and which are not. Including language like “this document is non-binding and does not constitute a legal obligation” can help prevent unintentional commitments.

Takeaway

Not every part of a term sheet or LOI is binding, but certain clauses—like confidentiality and exclusivity—usually are. When entering early deal discussions, take the time to understand what each section means. If you have any doubts, consult legal advice. Clarity from the beginning will go a long way in creating a smooth deal-making process.

If you have any questions or would like to learn more about term sheets and letters of intent, feel free to reach out to us. We are here to simplify complex terms and help you make better decisions.

Warm Regards,

R&D