Introduction

When navigating commercial transactions, parties often use preliminary agreements like term sheets and letters of intent (LOIs) to outline key terms before drafting a formal contract. But how enforceable are they?

Understanding Term Sheets and LOIs

1. A term sheet is typically a short and informal document summarizing key deal points. It is usually unsigned and non-binding but serves as a reference for further negotiations.

2. A letter of intent, on the other hand, can be a more formalized agreement expressing the parties’ intention to proceed with a transaction. It may contain both binding and non-binding provisions, depending on its wording.

Binding Vs. Non-Binding Provisions

In most cases, LOIs and term sheets are drafted as non-binding documents, ensuring that parties are not legally required to complete the transaction. However, certain provisions can be binding, such as:

1. Confidentiality: Protecting sensitive business information exchanged during negotiations.
2. Exclusivity: Preventing one party from negotiating with third parties for a specified period.
3. Governing Law and Dispute Resolution: Establishing which jurisdiction’s laws will apply.
4. Expense Allocation: Determining how transaction-related costs will be divided.

If these provisions are clearly worded as binding, courts may enforce them, even if the rest of the document remains non-binding.

Legal Considerations and Court Interpretation

Courts assess whether an LOI or term sheet is binding based on several factors, including:

1. Language Used: Explicit statements indicating whether the document (or certain provisions) is intended to be legally enforceable.
2. Definitiveness of Terms: If essential deal terms are left open, a court is less likely to find a binding agreement.
3. Parties’ Conduct: If both parties act as if they have a binding agreement (e.g., one party begins performing obligations), a court may enforce it.
4. Intent to Create Legal Relations: Courts apply an objective test, asking whether a reasonable person would interpret the document as an enforceable contract. For instance, in Labatt Brewing Co. Ltd. v. NHL Enterprises Canada L.P. 2011 ONSC 3219, the court found that if an LOI specifically enumerates certain provisions as non-binding then a reasonable person would not expect to be bound by those sections. Conversely, the Court of Appeal for Ontario in Oshawa Group Ltd. v. Mason Homes Ltd., 2005 CanLII 36443 (ON CA) found the LOI to be binding as it contained all the essential terms of a contract.

Best Practices for Drafting Term Sheets and LOIs

To avoid unintended legal consequences, businesses should:

1. Clearly State Intent: Specify whether the document is entirely non-binding or if certain provisions are binding as vague or incomplete terms will likely be non-binding.
2. Identify Deal-Breakers Early: Use the document to pinpoint critical terms before investing significant time in negotiations.
3. Ensure Clarity and Precision: Ambiguous language can lead to disputes over enforceability. For example, agreements to agree are likely unenforceable a court would be unable to determine the terms of the purported definitive agreement.
4. Seek Legal Counsel: A corporate lawyer can help structure the document to align with business objectives while minimizing legal risks.

Final Thoughts

Term sheets and LOIs are valuable tools in business negotiations, providing structure while allowing flexibility. However, their enforceability depends on careful drafting and clear language. If you’re entering into a transaction and need guidance on structuring preliminary agreements, our firm is here to help. Contact us today to ensure your deal terms are properly protected.