Construction of a Term Sheet under English law

“Term Sheets” are ubiquitous in transactional practice, but whether or not they are binding remains a thorny issue. Depending on the applicable law, the risk varies. Determining whether a term sheet is binding or not is therefore fundamental.

Under English law, courts consider that the existence of a binding contract depends on two cumulative conditions: (i) the parties have shown an objective intention to create a contractual relationship, and (ii) the parties have agreed on all the essential terms required for the formation of a binding contract (New Media Holding Company LLC v Kuznetsov [2016] EWHC 360 (QB), §99). The way a reasonable, business-savvy person would understand the exchanges between the parties will be important in determining the parties' intent to enter into an agreement (Maple Leaf Macro Volatility Master Fund v Rouvroy [2009] EWHC 257 (Comm) §223).

For a contract to be formed by means of a term sheet, there must be a clear intention to create a legal relationship. By including "Subject to contract", you create an almost irrefutable presumption that the document is not binding (RTB v Tinkler [2010] UKSC 14).

However, the conduct of the parties will also be important to the judge in making a determination. If a party claims that the term sheet is not binding but has performed its terms, the judge may conclude that the intention to be contractually bound exists, even where "subject to contract" was drafting in (RTS Flexible Systems Ltd v Molkerei Alois Muller GmbH & Company KG [2010] UKSC 14, §45).

"Agreements to agree", or agreements by which the parties undertake to agree on terms at a later stage, are not considered binding agreements because the judge would have to fill the gaps and make up for any uncertainties, whereas English judges refuse to draft terms in lieu of the parties (Hillas & Co Ltd v Arcos Ltd [1932] All ER Rep 494).

The use of terms such as "best efforts" or "reasonable endeavours" will not create an enforceable contract where the terms are otherwise uncertain (Little v Courage Ltd [1995] CLC 164; Teekay Tankers Ltd v STX Offshore & Shipbuilding Co. Ltd [2017] EWHC 253 (Comm)). However courts have considered that an undertaking to use best efforts to contract financing was binding as there was no uncertainty of object: determining if the undertaking party had endeavoured to contract financing was objectively and factually verifiable (Astor Management AG v Atalaya Mining [2017] EWHC 425).

Furthermore, English courts consider that a contract extension whose duration has to “reasonably” be agreed at a later time has no contractual value (Morris v Swanton Care & Community Ltd [2018] EWCA Civ 2763). For the judge, the extension required the conclusion of a new agreement and the parties would have been free to accept or refuse the proposed duration without any obligation to negotiate in good faith (Walford v Miles [1992] 2 AC 128). The term “reasonably” described how to negotiate, but was not an objective standard which would have allowed the judge to set a duration for the parties.

In this sense, if, upon reading the “agreement”, the judge is in a position to resolve the uncertainty regarding the parties' intention and the binding nature of the document, the agreement will be considered as binding. This is particularly the case in the presence of terms that could ordinarily be construed as uncertain but which, in the context of a given sector, are common (Mamidoil-Jetoil Greek Petroleum Co SA v Okta Crude Oil Refinery AD [2001] EWCA Civ 406) or in the presence of specific provisions (Foley v Classique Coaches Ltd [1934] 2 KB 1), or an uncertainty which does not challenge the parties' intention to be bound (Neilson v Stewart (1991) SLT 523).

The agreement is also binding if the contract provides for a third-party mechanism (expertise, arbitration) or objective criteria (Tramtrack Croydon Ltd v London Bus Services Ltd [2007] EWHC 107 (Comm); Openwork Ltd v Forte [2018] EWCA Civ 783). If the mechanism fails, the court can even provide a new one without having to question the parties' intention to create a binding agreement between them (Sudbrook Trading Estate Ltd v Eggleton [1983] 1 AC 444).

In essence

It is essential to use clear and unambiguous language to specify which terms and obligations are intended to be binding and which are not, and to specify "draft" or "subject to contract" only where the document is not intended to have contractual value.