In the event of any corporate action, including but not limited to business transfer, joint venture, acquisition and merger, is occurring in between two parties, Term Sheet is one of the vital documents that shall be executed by both the Parties to capture the important provisions and the basic framework of the proposed transaction to be undertaken by the Parties. The Term Sheet is a very useful preliminary document. It lays down a broader framework for the parties to have meaningful commercial discussions towards the execution of definitive agreements and eventually, the consummation of a transaction. Usually, it is non-binding in nature. However, at times, it can be construed as a binding document. This article examines the binding nature of such Term Sheets.
Initial rulings on Enforceability of a Term Sheet
A Term Sheet, also known as ‘letter of intent’ or ‘side letter’, contains all vital clauses which are proposed to be incorporated in the definitive agreements, on the terms agreed in the Term Sheet. The enforceability of a Term Sheet was discussed at a very nascent stage, in a British case, “Barbudev v. Eurocom Cable Management Bulgaria EOOD and Ors.”1. The said case provided for a distinction between a) the intention behind creating legal relations and b) the intention behind creating enforceable obligations, while determining whether terms in a letter of intent were enforceable legally. The Hon’ble Court opined that even though the Term Sheet is written in a legal language, and may be held to be creating an obligation for such reason, the contents of a letter of intent can only be considered as an agreement to agree and hence should not be legally enforceable and it should be merely treated as an instrument to capture the intent of the Parties by which they have initiated negotiations to get into a valid agreement of agreed terms and in good faith. In India, in a similar case, Kollipara Sriramulu v. T. Awashtha Narayan2, the Hon’ble Supreme Court held that, when a document is treated as an instrument which is executed to constitute a further valid contract in between the Parties and the terms of such contract is captured in the instrument, then such an instrument can only be considered as a condition or bargain to the proposed contract and shall not be legally enforceable. Similarly, in the case of Rajasthan Co-op Dairy Federation Ltd. v. Maha Laxmi Mingrate Marketing Service Pvt. Ltd.3, held that any letter of intent cannot be considered legally enforceable as it just captures the intention to enter into a contract between the parties and that does not create any legal obligations for any of the parties to such letter of intent. In Gostho Behari Sirkar v. Surs’ Estates Ltd.4 it was held that ancillary agreement for the purpose of effecting a plan of sale, is not fundamental to the contract to sell, therefore the manner and mode in which it is carried out will not necessarily amount to a contract of sale.
Changes brought in the perception of enforceability of certain provisions of a Term Sheet by the arbitral award passed in the arbitration of Oyo and Zostel5
Factual Background
Zostel Hospitality Private Limited, or Zostel, is a startup which is involved inter alia in the business of providing backpacker’s hostel rooms in India through its electronic platform and Oravel Stays Private Limited, or Oyo, is a unicorn which operates the business of providing hotel rooms to its users through its electronic platform.
Oyo planned on expanding its business in the existing sphere and offered to acquire the business of Zostel. The parties signed a Term Sheet wherein Zostel agreed to, transfer its entire business, assets, customer data, certain key employees, software, and IP Rights to Oyo in exchange of 7% of the existing shareholding in Oyo.
The preamble of the Term Sheet expressly stated that it was non-binding in nature. Further the Term Sheet provided that the proposed merger was conditional upon the successful completion of the due diligence by Oyo; Zostel obtaining all necessary corporate, governmental, management, and third-party approvals; Zostel transferring its assets, IPs, software, consumer data, key employees, etc. to Oyo; parties simultaneously withdrawing all pending cases filed by them against each other in various courts; and parties signing the definitive agreements on mutually agreeable terms.
Dispute
Zostel alleged that despite meeting all its obligation as per the Term Sheet, Oyo abstained and failed in formalising the proposed acquisition. Oyo claimed that after a due diligence was conducted by it, all the undisclosed liabilities and unpaid dues came to light which commercially restrained Oyo from formalising the transactions vis-s-vis a definitive agreement, and the terms of the executed Term Sheet shall not be enforceable as the Term Sheet was non binding in nature as no definitive agreements were executed in furtherance of the same. Thus, the issue before the Arbitral Tribunal was deciding whether Oyo has wrongly restrained Zostel from encashing the benefits envisioned under the Term Sheet and whether Zostel would be entitled to claim for specific performance.
Observation of the Arbitral Tribunal
A vital factor that has to be considered in this case is despite the clear statement of the ‘non-binding nature’ of the term-sheet mentioned in the preamble, the sole arbitrator had ruled on the contrary. The contents of the Term Sheet negated the contention that the Term Sheet was a non-binding and merely exploratory document. Considering that Oyo had conducted due diligence on Zostel and had access to sensitive commercial data relating to Zostel, created a binding obligation for Zostel to give necessary material information to Oyo. Hence, the arbitrator held that the Term Sheet cannot be a non binding Term Sheet in its entirety. The parties had already met most of the obligations stated in the definitive agreements after deciding upon the basic form and structure of the definitive agreements. The arbitrator was of the view that the conduct of the party makes the intention in pursuance of completing the transaction clear that the parties agreed on completing the transaction. The arbitrator also held that the Term Sheet contained a framework for the acquisition, subject to which the parties were required to execute the definitive agreements. Additionally, certain key closing obligations were also enlisted, which suggests that the parties by their conduct and by fulfilling their conditions had waived the non-binding preamble of the Term Sheet. Hence, in conclusion, the arbitrator held that the Term Sheet was a binding contract between the parties.
Analysis of the Arbitral Award
The arbitrator relied on the nature of the contents within the Term Sheet and the conduct of parties of the transaction. As per the award of the arbitral tribunal, the Term Sheet also contained all the essential terms of acquisition and had identified the assets to be acquired, rights of the shareholder and acquirer, consideration, warranties and indemnities, pre and post-closing obligations, subject to the due diligence being conducted. Hence indicating the closing nature of the obligations in the Term Sheet in pursuance of the said acquisition. Also, in furtherance of the obligations mentioned in the Term Sheet, Zostel had effected the transfer of employees, owned properties, customer databases and also terminated vendor agreements. Additionally, the conduct of the parties in pursuance of the terms mentioned in the Term Sheet were held to be such that the intention of the parties could be adjudged to be to complete the proposed transaction. The judgment highlighted that since majority of the obligations were acted upon alongside the inclusion of the closing nature of obligations stated in the Term Sheet it did not corroborate with the intended non-binding nature and subsequently due to the conduct of the parties it waived the non-binding nature contained within the preamble of the Term Sheet and thus created an enforceable contract which bind both the parties to perform their respective obligations.
Conclusion
It can thus be concluded that the obligations mentioned in a Term Sheet, can be considered to be enforceable on a case-to-case basis, depending on the facts and circumstances of the case, including performance and non-performance by parties to the Agreement. The abovementioned arbitration between Oyo and Zostel, thereby reminds one to be mindful of one’s conduct pursuant to the execution of a non-binding Term Sheet so as to ensure that definite intention to complete transaction or implementing certain obligations, which make the inherent transaction valid, does not take place.
Upon the critical evaluation of certain judgments passed in this regard we can opine that the binding nature of a Term Sheet can be adjudged from a drafting perspective and from an enforceability perspective.
From a drafting perspective, a Term Sheet can be specific of its binding nature by the way it is drafted and how it specifies its nature. A Term Sheet can mention its “Non Binding”, “Binding” or “Unilaterally Binding” nature, as per the terms that it is drafted.
- A “Non Binding” Term Sheet is the most common position of the Parties executing a Term Sheet. As the name suggests, such Term Sheet is not binding on the Parties. Notwithstanding, the mention of the nature of the Term Sheet in such a way, typically an exception would be created for clauses like Exclusivity, Confidentiality, Term and Termination, Governing Law and Dispute Resolution, and the like, which would remain binding between the parties.
- A “Binding” Term Sheet is the one drafted to make all provisions in the Term Sheet binding on the Parties from an enforceability point of view and has more credibility when the enforceability of such Term Sheet is in question.
- A “Unilaterally Binding” Term Sheet is a kind of Terms Sheet which is drafted to make it binding for only one specific Party among the Parties to the Term Sheet. In other words, for one party it would be non-binding (with the exception of clauses cited above), while for the other party all obligations and commitments would be binding. This is normally done to a party that is perceived to be one that could significantly try to alter principles agreed in the term sheet during negotiations of definitive documents, or for start-ups where at term sheet stage the investor/acquirer does not have sufficient visibility of the facts. However, clauses like Exclusivity, Confidentiality, Term and Termination, Governing Law and Dispute Resolution would still be binding on both the Parties.
From an enforceability perspective, the various facets of the binding nature of a Term Sheet can be illustrated as:
- Enforceability of a Term Sheet is best tested through a judicial evaluation of the Term Sheet. In normal circumstances, a judicial evaluation of the binding nature of a Term Sheet can only be conducted if the parties to the Term Sheet have a dispute regarding the enforceability of the Term Sheet.
- A court or an arbitrator may not rely only on the clause stating whether the Term Sheet is binding or non-binding, and will often look at whether in the Term Sheet there existed a concluded contract between the parties. If the court is of the view that there existed a concluded contract between the parties to the Term Sheet then it is held to be binding. Therefore, it is entirely possible for a non-binding Term Sheet to be construed as having sufficient agreement between parties and, therefore, being enforceable. Similarly, a Term Sheet that is silent on its binding nature, may also be construed as concluded contract, thereby making it enforceable.
Reference
1. [2012] EWCA Civ 548, 27 April 2012
2. AIR 1968 SC 1028
3. Civil Appeal No. 2679 of 1992
4. AIR 1960 Cal 752
5. https://www.livelaw.in/pdf_upload/zostel-v-oravel-award-dt632021-390236.pdf
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