Term Sheet and Letter of Intent: Can they be legally binding?

People often feel more comfortable in executing documents like term sheet, letter of intent, terms of understanding and other similar documents at the pre-contractual stage without concerning about the future consequences. There is also a misbelief that these documents are not binding. The general understanding is that these documents merely provide for an interim arrangement to negotiate and reach a legally binding agreement. That’s true, however, the problem arises when the negotiations do not culminate into legally binding definitive agreements and yet the party gets bound by the terms of so-called non-binding documents and could face legal consequences.

The two most-commonly used documents in commercial transactions are letter of intent and term sheet. A letter of intent is a document showing preliminary intention of a party to enter into a legally binding contract in future. It is more common in transactions relating to sales and procurements and is mostly written in the form of a letter. Similarly, term sheet lays down the preliminary grounds/terms on which the parties intend to further negotiate and enter into a legally binding agreement. It is more prevalent in commercial negotiations and is drafted mostly in the form of bullet points.

Status under Indian Contract Act

The terms ‘letter of intent’ and ‘term sheet’ are not defined in Indian Contract Act, 1872. Yet these terms are invariably used in commercial transactions because of the broader consensus of parties on such terms as they are assumed to be of less legal force.

The golden rule under Contract Law is to give primacy to the true intent of the parties. Any document, by whatever name it is called, can be a legally binding contract if it shows the mutual intention of the parties to enter into a legally binding transaction, provided they are made by free consent of the competent parties and are not expressly covered under the exceptions provided for in the law. For gauging the intent of the parties, the whole document has to be considered in totality.

Case Laws

A two judge bench of the Supreme Court in South Eastern Coalfields Ltd vs. S. Kumar’s Associates AKM (JV), 2021 SCC OnLine SC 486 while holding that the letter of intent was not binding in that specific case, sounded a note of caution: “It is no doubt possible to construe a letter of intent as a binding contract if such an intention is evident from its terms. But then the intention to do so must be clear and unambiguous as it takes a deviation from how normally a letter of intent has to be understood.”

In Bhoruka Power Corporation Limited v. State of Haryana and Ors, AIR 2000 P&H 245, the cancellation of a letter of intent (LOI) issued by a government department for development of small hydro power plant was under consideration in a writ petition before the Punjab and Haryana High Court. The court observed that if steps had been taken for award of contract subsequent to LOI, it creates a legitimate expectation that contract would be awarded in absence of adverse factors. The court therefore held that the cancellation without giving opportunity of hearing was contrary to principles of natural justice and was liable to be quashed.

In the dispute regarding proposed acquisition of Zostel by Oyo, the Arbitral Tribunal held the term sheet executed between the parties to be binding even though the preamble explicitly mentioned that it is non-binding. The Tribunal observed that the term sheet was not merely an exploratory document as certain conditions in the term sheet were in the nature of closing obligations. Further, it noted that Zostel had taken steps to perform its obligations under the term sheet which would not be the case if the term sheet would have been non-binding.

Important Considerations

There is no fixed rule or formula to check if a document can be considered binding or not. However, there are few relevant considerations which should be kept in mind:

1. Merely mentioning ‘term sheet’, ‘letter of intent’ or ‘non-binding document’ in the title is not sufficient. Even the inclusion of the ‘non-binding clause’ is irrelevant. The complete document has to be read as a whole and the true intent of the parties has to be ascertained.
2. The language should not be consistent with that of a binding legal document. The proposed document should be merely exploratory.
3. The non-binding obligations should not be in unqualified terms because non-binding document simply records parties’ aspirations. Therefore, it should not impose closing obligations in certain terms.
4. The governing law and jurisdiction clause should apply only to some terms or to any future agreement. It should not apply to whole document as it gives the impression that parties wanted the entire document to be binding.
5. The courts usually take into consideration the totality of circumstances surrounding the execution of a document. Therefore, the discussions prior and subsequent to the execution of such non-binding document, the relationship between the parties and the conduct of the parties are important to ascertain true intent of the parties.

Concluding Remarks

Undoubtedly, term sheets plays an important role in laying down the framework for commercial negotiations. However, it is naïve to assume them as completely non-binding without properly reviewing them. It is, therefore, important for parties to get term sheets or other similar documents properly reviewed from a third party before signing them so as to avoid future legal consequences.