Term Sheets - Part III

Reasons for Not Using Term Sheets

Term sheets are not always useful. In many cases, it may be better for the parties to skip the term sheet stage and go directly to negotiating the definitive transaction documents (particularly if the parties have a limited amount of time to complete the deal). Disadvantages to using term sheets include the following.

Costs of Negotiation and Preparation

Term sheets are one extra document to negotiate and prepare. Depending on the complexity of the transaction and the number of terms to be included, it could take a considerable amount of time to work through structural and deal issues, in most cases with involvement of attorneys and specialists. The cost can be disproportionate to the benefit of using the term sheet. Parties should avoid effectively negotiating the definitive transaction documents twice.

Impair Deal Momentum

Negotiation of the term sheet can stall over points of unnecessary detail and cause a delay in preparing the definitive transaction documents. This can increase the length and cost of negotiations. Also, when the momentum of a deal stalls, it may weaken a party's desire to complete the deal. Further, if there is an exclusivity period, a delay may cause negotiations to extend past the exclusivity period and the parties may not agree on an extension.

Unintentional Creation of Legally Binding Commitment

Depending on certain circumstances and the language contained in the term sheet, courts may find a provision binding even if one party did not intend it to be so.

Inadvertent Creation of Duty to Negotiate in Good Faith

Even if the term sheet does not expressly contain a duty to negotiate in good faith, courts may impose a duty to negotiate in good faith under certain circumstances. This limits a party's ability to walk away from a deal if it changes its mind.

Weaken Negotiating Position

Although the terms set out in a term sheet may not be binding, they carry moral force and can weaken the party's negotiating position if it later seeks to change the terms. In most cases, the other party will not agree to a change in the terms unless new facts or circumstances develop or new information is discovered during due diligence.

Disclosure Obligations

If one of the parties is a public company, the term sheet can create a disclosure obligation under applicable securities laws or the rules of applicable securities exchanges (depending on the binding nature and level of detail contained in the term sheet). To avoid the obligation to disclose at such a preliminary stage of a transaction, it is more common to have an unsigned deal summary describing the fundamental terms in deals involving a public company. In public merger transactions, parties often omit the price or exchange ratio (if the buyer is issuing stock) from the deal summary to avoid the suggestion of an agreement on the material terms.

In some circumstances, however, the buyer may push for an announcement of the signing of a term sheet(or other preliminary agreement). For example, if the target company's stock price rises over the purchase price under negotiation because of rumors in the market of an impending deal, the buyer will often want the target company to disclose the agreement of a term sheet, or at least the expected price of the deal, to lower stockholders' price expectations. However, the buyer will usually be subject to a confidentiality agreement and will need the target company to agree to this disclosure. Although a target company will generally oppose this type of disclosure, there may be circumstances where it may agree to do so (for example, if it believes that the increase in its stock price may jeopardize an imminent value-maximizing transaction).

NOTHING IN THIS ARTICLE SHALL CONSTITUTE LEGAL ADVISE. IT IS FOR GENERAL INFORMATIONAL PURPOSES. IF YOU ARE ENGAGED IN A TRANSACTION THAT REQUIRES A TERM SHEET WE RECOMMEND THAT YOU RETAIN LEGAL COUNSEL. THIS ARTICLE IS NOT INTENDED TO, NOR DOES IT, CREATE AN ATTORNEY-CLIENT RELATIONSHIP WITH ANY PARTY.