If the contracting parties are not prepared to enter into a binding agreement, they might nevertheless consider some kind of non-binding commitment. In view of the somewhat slippery case law on precontractual liability, many lawyers are very cautious in drafting letters of intent or term sheets. In many cases probably overly cautious, repeating the non-binding nature in every provision, which makes the entire document difficult to read. Other than expressing that a term sheet or letter of intent is non-binding, there are a few techniques to create a functional non-binding document. That’s what this blog is about.
Other than expressing that a term sheet or letter of intent is non-binding, there are a few techniques to create a functional non-binding document. In order to prevent that a letter of intent or term sheet is considered to be binding, it is recommended to:
- be selective (as regards the provisions in which intentions are expressed instead of obligations) and more accurate (as regards the wording used to express such intentions);
- include conditions precedent (cp’s); and
- state which specific matters are to be settled in order to achieve an agreement.
Let’s explore the three recommendations. As regards selectivity and accuracy, a drafter should focus on the provisions that matter and reflect those in non-binding words. Of course, a non-binding LOI will talk about the parties intend to rather than the parties agree that. Also, an LOI may well refer to provisions that will be inserted or elaborated in the definitive agreements: In the SPA, Party 1 shall undertake to… or The License Agreement shall contain the following provisions: … If a provision is irrelevant or ineffective as long as the key provisions are non-binding, it is not necessary to stuff it with non-binding signals. Be careful, however, that a letter of intent does not contain many avoidable signals of being binding.
Given that generally, a contractual condition has a strong legal impact, providing that any agreement is ‘subject to approval‘ (e.g., by the shareholder or the board or board representative of a parent company) and ‘subject to contract‘ are effective means to establish the non-binding character of an LOI. Other conditions commonly included in a non-binding LOI include a reasonably satisfactory outcome of due diligence investigations and the involvement of a works council. The conditions in a letter of intent may relate to two or even three different objects, one being the letter of intent itself and the other the anticipated definitive agreement (and its completion). Accordingly, the LOI may state that a transaction is subject to due diligence, subject to contract and subject to obtaining finance; whilst the LOI may also state that the binding agreement (or completion of the obligations in the definitive agreement) will be subject to regulatory approvals and the payment of the purchase price.
Finally, the drafter of an LOI could list specific items that are pending agreement. Listing such matters is a clear indication that a final agreement has not been reached with as the main ‘risk’ that the other party who claims that the LOI was binding simply accepts the proposals made. This should not be the reason not to list such items. Similarly, a drafter could include a time table and a table allocating the drafting tasks (i.e., who is expected to prepare the first draft of an agreement).
It would of course not be very supportive to convey the non-binding nature of a letter of intent (or worse, a ‘heads of agreement’) by starting with words of (full) agreement. Accordingly, the body text could be preceded by:
THEREFORE, THE PARTIES INTEND to negotiate [and subsequently agree on] the following subject matters:
Clause identifying binding provisions. In many letters of intent, a specific provision is included to establish that none of the provisions is binding, except for certain specific clauses. The purpose of such provision is obviously to satisfy those lawyers who fear that, as a consequence of the non-binding nature of the letter of intent or term sheet as a whole, also the subjects that do matter at the preliminary stage would be considered as non-binding. The clauses that would normally be identified are those on exclusivity (of negotiations), confidentiality and public announcements, applicable law, dispute resolution, liability for termination (if applicable) and that clause itself.
