Date: May 29th, 2013

Term sheets serve several important functions in the early and intermediate stages of many business transactions. These documents—also called letters of intent and memoranda of understanding—enable parties to frame and negotiate the essential elements of a transaction, including determining if a meeting of the minds on a transaction is possible. By embodying in abbreviated form what the parties consider to be the key material terms of their proposed transaction, term sheets have become the shorthand language for negotiating terms and striking deals.

Armed with a signed term sheet, business people and their lawyers move forward to conduct due diligence and to draft and negotiate detailed definitive transaction agreements. With the term sheet signed, entrepreneurs and executives stop pursuing a range of options and work to finish the deal at hand. In short, the parties move forward with their deal on the strength of the term sheet. When a term sheet expresses the parties’ “meeting of the minds” and is supported by consideration in the form of the parties’ resource commitments and decisions to forego other opportunities, what keeps the term sheet from being a contract in its own right? Even if a term sheet is clear in expressing that it does not embody the final substantive agreement of the parties, a party may argue that the term sheet is an enforceable “contract to negotiate an agreement.”

In a significant California term-sheet case, Copeland v. Baskin Robbins, 96 Cal. App. 4th 1251, 117 Cal. Rptr. 2d 875 (2002), the California Court of Appeal distinguished between a mere “agreement to agree” in the future and a contract to negotiate an agreement. The underlying dispute involved Copeland’s proposed purchase of an ice cream manufacturing plant from Baskin Robbins and the critical related “co-packing agreement” between them that was to ensure that Baskin Robbins would buy the ice cream that the plant produced. The parties executed a letter of intent including a statement that they would enter into a co-packing agreement for specified quantities with other terms to be negotiated. After Baskin Robbins broke off negotiations on the co-packing agreement (citing a change in its larger business strategy), Copeland sued, asserting that Baskin Robbins had breached a contract to negotiate an agreement by refusing to continue negotiations and by failing to negotiate in good faith.

Although ultimately ruling against Copeland on other grounds, the appeals court supported the position that a term sheet or letter of intent could constitute a contract to negotiate an agreement, and that the implied covenant of good faith and fair dealing inherent in every contract could therefore attach to subsequent negotiations. On this theory, parties who sign a term sheet could find themselves bound to continue negotiating toward a definitive agreement and, if they broke off negotiations at any point, could be sued by the other party for breach of contract.

Other courts have criticized the notion that a term sheet can create an enforceable agreement to negotiate. In a case involving a proposed stock purchase that did not occur, a Virginia circuit court strongly criticized the approach taken in Copeland, finding no meaningful distinction between an “agreement to agree” and a contract to negotiate in good faith, whose breach, the court wrote “is an ill defined cause of action founded upon a nebulous agreement. It injects uncertain liability into contract negotiations; the jilted party can easily allege a failure to negotiate in good faith.” Marketplace Holdings, Inc. v. Camellia Food Stores, Inc., 64 Va. Cir. 144 (2004).

In Washington, “agreements to agree” are not enforceable and no court has directly addressed the enforceability of contracts to negotiate. P.E. Systems, LLC v. CPI Corp., 176 Wash. 2d 198, 208 289 P.3d 638, 644 (2012) (citing cases).

Since Washington courts have not offered meaningful guidance about whether term sheets might potentially be enforceable contracts to negotiate, we recommend adhering to the following “best practices” when preparing any term sheet, letter of intent, memorandum of understanding or similar preliminary statement of transaction terms.

• Specifically identify major contingencies and conditions precedent for completing the transaction. These may include obtaining needed financing, permits or consents, satisfactory completion of due diligence, and the negotiation of mutually satisfactory definitive transaction documents. Where a well identified “out” present in a term sheet is later credibly cited as the reason for breaking off negotiations, it will be very difficult for the other party to claim bad faith.

• State that nothing in the term-sheet document is intended to create a binding agreement, other than specifically-identified terms that are meant to be binding, such as “Confidentiality” and “Expenses.” For example:

“The paragraphs in this Term Sheet with the headings of ‘Expenses’ and ‘Confidentiality’ are intended to constitute a binding agreement of the parties in consideration of the parties’ efforts to undertake the Transaction, including the conduct of due diligence investigations and preparation of definitive documents. The other provisions of this Term Sheet are intended as the current intentions of the parties but are not intended to create legally binding obligations with respect to the Transaction and neither party shall be bound to the Transaction until each party has executed mutually acceptable definitive documents with respect thereto.”

• State that neither party is relying on, or is entitled to rely on, the term-sheet document for any purpose. This undermines the other party’s ability to claim damages based on the resources it expended or the opportunities it passed up in reliance on having a signed term sheet.

• Include general disclaimer language at the beginning or at the end of the term-sheet document to clarify that it is non-binding, subject to the negotiation of mutually satisfactory definitive agreements, and not a contract to negotiate an agreement. For example:

“This Term Sheet does not constitute a legally binding obligation of any party hereto or an agreement by any party to negotiate in any particular manner, or at all, or to consummate the transaction(s) described herein. The definitive terms for the transaction(s) described herein, if same should occur, will be set forth in a definitive agreement between the parties. Either party may, at any time prior to execution of a definitive agreement, unilaterally terminate all negotiations pursuant to this term sheet, for any reason or for no reason, without any liability whatsoever to the other party.”