When a non-binding term sheet becomes a binding contract
The use of term sheets, letters of intent and similar documents are common in business transactions to evidence the parties' preliminary negotiations and understandings. Term sheets are very useful in allowing the parties to focus on the key negotiating points while avoiding becoming mired in the transaction details that will be documented in a definitive contract. Depending on the type of transaction, most term sheets will contain binding provisions only with respect to a few items, e.g., confidentiality, exclusivity and payment of the parties respective expenses. The remaining provisions are typically understood as not representing binding contractual obligations of the parties. A recent Delaware court decision, however, should put businesses on alert to make sure that they understand the legal implications of a preliminary agreement prior to signing. In Siga Technologies v. PharmAthene, Inc., the parties began negotiations with the goal of entering into a license agreement to collaborate on drug development. During preliminary negotiations, PharmAthene proposed that the companies merge. As discussions progressed, the companies entered into a term sheet providing that in the event the merger did not close, the parties would "negotiate in good faith" with the intention of signing a definitive license agreement consistent with the provisions of the term sheet. Siga was later able to secure funding from a third party source and decided to terminate merger negotiations. PharmAthene then sent Siga a proposed license agreement consistent with the provisions of the term sheet. Siga rejected the license and attempted to negotiate more favorable terms that differed materially from the term sheet. Negotiations later broke down and PharmAthene sued Siga for breach of the term sheet based on an alleged failure to negotiate in good faith. The Delaware court held that an agreement to negotiate in good faith is legally binding and that Siga had in fact breached the parties' express agreement to negotiate in accordance with the term sheet. While the term sheet in this case contained an express requirement to negotiate in good faith, it is notable that courts in other States have found that a term sheet may contain an implied covenant of good faith and fair dealing even where that obligation is not expressly stated. The Siga term sheet contained what is commonly referred to as an "agreement to agree", which can be very problematic in contractual negotiation and enforcement. It is important that the parties understand the legal impact of any term sheet or letter of intent and that the instrument specifically identifies those provisions that are intended to be binding and those that are not. Again, binding provisions for confidentiality and exclusivity in negotiations are common, but the term sheet should expressly provide that other provisions do not create any legal obligation. Given the preliminary nature of most term sheet negotiations, this should also include an express statement that the parties are not obligating themselves to negotiate in good faith. The parties should also consider the impact of when a term sheet expires. Most instruments contain an expiration date by which the parties contemplate that a definitive agreement would be in place. If the parties continue to negotiate following the stated expiration date, but do not expressly extend that date, they create some risk that the previously stated binding and nonbinding nature of certain terms may not be respected. Expiration of a term sheet without language providing that the stated type of term (binding or non-binding) survives expiration may result in the parties losing the benefit of the protective non-binding provisions. One additional point to add protection in a business acquisition where the acquirer will be purchasing the stock of the target company. In those cases we recommend, for securities law purposes, that the term sheet contain a disclaimer that the document does not constitute an offer to purchase or sell securities. For example, a disclaimer like the following is often included in a term sheet when a sale of securities is contemplated: This term sheet does not constitute an offer, solicitation of an offer, or any contract for the purchase or sale of, any securities. This can help each party avoid inadvertently incurring liability under federal or state securities laws.
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