Terms sheets, offer letters and letters of intent are commonly used to set out the principal terms of a deal, form a basis for further negotiations and are the platform for the parties’ due diligence. They are a fundamental part of private M&A, but come with some risks and traps, which we examine below:
What did you really intend?
The recent dispute between Archer Capital and Sage Group Plc – relating to a binding offer by Sage to acquire MYOB that was “subject to contract” – puts in the spotlight the disputes that can emerge in respect of a binding “preliminary agreement”.
Whether a terms sheet is binding or not will depend on the facts of each case. The “decisive issue” is always the intention of the parties objectively ascertained from the terms of the documents and the surrounding circumstances. In other words, what the relevant parties have expressed in writing, verbally and by their conduct.
Disputes often arise in respect of so called binding terms sheet that contemplate negotiation of the transaction documents and finalisation of the key commercial terms.
These types of “agreements to agree”, while possibly setting the commercial parameters of a deal and obligations to negotiate, have not traditionally been sufficiently certain to be enforceable and are usually not treated by Courts as a binding contract. On the other hand, if a document indicates an intention to be bound and the key commercial terms are sufficiently clear, a Court will give effect to that intention, irrespective of the complexity and subject matter of the deal.
From a practical point of view, it is important to carefully consider not just the binding nature of a terms sheet and the terms of it, but also a party’s conduct after a terms sheet is signed. If a party doesn’t do so, it may inadvertently bind itself to a deal it later regrets. Alternatively, a party may give the other side of the transaction an opportunity to walk away from the deal, in circumstances where they expected otherwise.
If a terms sheet is intended to be binding, but certain deal terms are to be agreed, the parties should agree on a clear mechanism and timeline for agreement and resolution of those outstanding issues. If a terms sheet is intended to be non-binding, it should expressly say so and you should conduct yourself consistently with that intention.
The dispute in Archer v Sage could provide a cautionary tale. Parties shouldn’t mistake a “preliminary agreement” as something that is of less legal effect or consequence than a fulsome transaction document.
An eagerness to be exclusive
A prospective buyer usually requires a seller to exclusively deal with it in relation to the sale of the relevant business, assets or company during the period the buyer will carry on its initial due diligence. This is a customary and reasonable request in transactions which are not a sale by bid, auction or tender.
However, buyers and sellers alike must carefully consider the nature and extent of any exclusivity arrangements, particularly when exclusivity is the only binding provision of a terms sheet and the basis on which considerable transaction costs could be committed. For instance, what “competing proposals” are subject to the exclusivity arrangements? Can the seller terminate the exclusivity arrangement if a superior offer is received? If so, does the potential buyer have a right to match the superior offer
Confidentiality and the perils of disclosure
While a seller might take some comfort from a buyer’s obligations under a confidentiality deed, inadvertent, intentional or improper use or disclosure of confidential or commercially sensitive information will remain a risk for a seller.
Once information is misused or improperly in the public domain, it may be difficult to adequately remedy the breach of confidence in a timely fashion or without significant legal costs.
For this reason, even within a confidentiality regime, sellers must carefully consider what information should be disclosed, and when. Among other things, sellers can manage this risk by redacting or de-identifying information or refusing to disclose commercially sensitive information (i.e. “black box” documents) until the deal has progressed to something more than a non-binding terms sheet.
A similar approach is usually taken to the disclosure of contracts containing confidentiality provisions which, customarily, do not contain a “carve out” permitting disclosure to a potential buyer.
On the buy side, without adequate disclosure, it is difficult to properly progress due diligence. Accordingly, this is matter that requires a careful balancing act.
Transfer duty and tax
The certainty of a binding terms sheet comes with the likelihood of a disposal or dutiable transaction for tax or duty purposes.
In an eagerness to do a deal, and without properly considering duty, the buyer could possibly have a liability to pay transfer duty before a transaction completes (or at least an earlier point in time than in a standard transaction).
Proper tax and duty advice is needed early in a transaction (and before the parties finalise the preferred structure of the transaction). Once the parties have committed to a deal, it may be difficult to unwind without adverse tax and duty outcomes or risks.