When and how to pull levers: intent and enforceability of term sheet/letter of intent

When and how to pull levers: intent and...


A term sheet (TS) should be able to document with reasonable clarity and transparency corporate intent to reach certain goals. Similar to a TS, a letter of intent (LOI), agreement in principle or memorandum of understanding (hereafter all referred to as the ‘preliminary agreement’) establishes a framework through which companies or individuals intend to complete future negotiations along mutually agreeable terms, as their negotiations become more detailed.

Therefore, intent and enforceability are the key formative components that should be accounted for when drafting preliminary agreements. Case law suggests there are two main types of preliminary agreements: Type I occurs when the parties have reached an agreement on certain or all issues and require no further negotiations. These agreements are only preliminary as a matter of formality and can be enforced as such even before the parties sign a more elaborate document. (Teachers Insurance & Annuity Association of America v Tribune Co (No 83 Civ 0047, 670 F Supp491, at 498, 499 (SDNY.1987)).

Type II occurs when the parties agree to negotiate a later agreement but do not specify some details. Parties are bound to reach the contractual objectives and are bound to negotiate the open terms in good faith. Type II agreements expose both parties to potential litigation if and when the deal collapses. The party that feels it has unfairly lost out will often seek damages for breach of contract, treating the preliminary agreement as if it were legally binding; at this point the analysis of intent and enforceability will be under scrutiny. (Ibid at 498, 499).

Judges will consider various circumstances surrounding the situation including any language or conduct that would indicate a binding agreement was reached. Its subjective nature has led scholars to call case law in this area ‘replete with incoherent guidance’, ‘all over the board’ and ‘in hopeless conflict’.[1]

In state courts, case law is unsettled.

We present suggestions in Section (A) that may be helpful in negotiating a preliminary agreement that mitigates risk of litigation, In section (B), we discuss breach of Type II agreements and applicable remedies.

What makes a preliminary agreement binding?

The question of whether a preliminary agreement can be enforced has been covered extensively both in federal and state courts. In Teachers, the question presented was whether a borrower (Tribune) could back out of a preliminary loan agreement with an institutional lender (Teachers) due to final disapproval from Tribune’s board of directors. Judge Leval from the United States District Court concluded that Tribune could not walk away from the agreement because ‘the borrower undertook a binding commitment to negotiate open terms in good faith and breached that commitment.’ (Ibid at 508). In determining that the agreement was in fact binding, he provides a five-prong test: (1) ‘expression of intent’, (2) ‘context of the negotiation’, (3) ‘open terms’, (4) ‘partial performance’ and (5) ‘the customary form of such transactions’. (Ibid at 499, 500–502, 503.)


To prove intent, plaintiff must look into ‘the language of the preliminary agreement for indication [of] whether the parties considered it binding or whether they intended not to be bound until the conclusion of final formalities.’ (Ibid at 499.) By the court’s own admission, this is the foremost factor in determining enforceability of a contract and should be weighed heavily by judges. After all, their role in settling contractual disputes is simply to determine the intentions of the parties at the time they signed a preliminary agreement and to protect firms from accidentally falling into an instrument they did not intend to have binding effects.

In analysing the expression of intent, Judge Leval looked to the language contained within the preliminary agreement and the language each party used in communication about the preliminary agreement. He determined that letters exchanged between the parties were ‘replete with the terminology of binding contract’, which ‘strongly supports Teachers’. (Ibid at 499.) Specifically, Tribune used the words ‘accepted and agreed to’ (ibid at 499) after signing the preliminary agreement, indicating that ‘the intention to create a mutually binding contractual obligation is stated with unmistakable clarity’. (Ibid at 499.)

As part of its argument, Tribune claimed that the binding nature of the preliminary agreement was contradicted by its statement that ‘acceptance and agreement is subject to approval by the Company’s Board of Directors and the preparation and execution of legal documentation.’ (Ibid at 494, quoting defendant at 14). Judge Leval answered this claim with the fact that ‘[a]lthough such reservations, considered alone, undoubtedly tend to indicate an intention not to be finally bound, they do not necessarily require that conclusion. Such terms are not to be considered in isolation, but in the context of the overall agreement. Such terms are by no means incompatible with intention to be bound.’ (Ibid. at 500.)

Similarly, in Bed Bath & Beyond Inc v IBEX Constr LLC (52 AD3d 413, 860 NYS2d 107, 2008 NY App Div LEXIS 5712, 2008 NY Slip Op 5785) the NY Appellate Division held that embedded language like ‘subject to’ (Ibid at 413) in a preliminary agreement ‘do[es] not amount to an express reservation of the right not to be bound, or a condition precedent to the formation of a binding contract.’ (Ibid at 413.) The court found that the preliminary agreement was binding because ‘the record demonstrates that by moving forward with the project even in the absence of the fully executed construction agreement, IBEX manifested its intent to be bound by the LOI.’ In this case, intent was proved by parties’ behaviour.

The same rule is stated in Guggenheim: ‘where the parties contemplate further negotiations and the execution of a formal instrument, a preliminary agreement does not create a binding contract.’ (Guggenheim Corporate Funding LLC v Access 1 Communications Corp, NY, LEXIS 3568, (NYSC, 2009), at 30 referring to Williamson Picket, Gross Inc v LVMH Inc, 20 Misc 3d 114, 873 (Sup Ct, New York County 2008) NY Slip Op 51815[U] at 2, citing Adjustrite Sys v GAB Bus Servs, 145 F3d 543, 548 (2d Cir 1998).)

‘The law is clear that a party is not contractually bound to an agreement where such agreement provides that it is not binding until the execution of a formal agreement.’ (Williamson, Ibid at 29 referring to Williamson, ibid at 2 citing Jordan Panel Sys Corp v Turner Constr Corp, 45 AD3d 165, 169, 841 NYS2d 561 (1st Dept 2007).)

Inserting a clause indicating that the preliminary agreement is non-binding or subject to further action may not preclude enforceability.

Despite Teachers and Bed Bath & Beyond, in Arcadian Phosphates Inc v Arcadian Corp (No 1282, Docket 89-7277(SDNY 1989)), the court held the opposite position. It stated that a Type II agreement was not binding based on its language, which contained ‘two references to the possibility that negotiations might fail and the reference to a binding sales agreement to be completed at some future date.’ (Ibid at 72.)

In McGowan v Clarion Partners LLC (2017 NY Misc LEXIS 39, 2017 NY Slip Op 30019(U)), the plaintiff contended that a TS agreed to by Clarion constituted a binding contract to establish a new real estate investment management business in Germany. The defendant counter-argued with evidence that the parties continued negotiating after the TS had been signed, among which the fact that one of three members of its management team signed the TS but viewed it ‘as a non-binding offer.’ (Ibid at 19.) The court stated that ‘the language of the Term Sheet indicating that it was “subject to documentations”, the material terms that were left open for negotiation, along with the evidence showing continued negotiation of those terms show that the Term Sheet [was] not enforceable as a matter of law.’ (Ibid at 19, 22.)

These cases demonstrate that the language used and the context of the TS are crucial in proving intent. Therefore, after a non-binding TS is exchanged, it is critical that the offeror remains aware of if and when the ‘Rubicon is crossed’, namely if and when the non-binding intent of the TS is destroyed by contradictory behaviours and context: such behaviour may be subject to future judicial review.

The outcome of a preliminary instrument is decided by what a party sets in motion at the outset of the negotiations.


The context of negotiations relies on an analysis of the ‘particular facts of the negotiation’. (Teachers at 500.) Judge Leval noted that Tribune wanted a commitment letter from a lender in order to secure the loan by the end of the year. This, and the fact that Tribune had been turned down by five other lenders, indicated that Tribune was actively pursuing the loan offered by Teachers with the intent to obtain a firm commitment letter. Moreover, Tribune’s lawyers had warned Tribune that such an agreement would likely be binding. In the context of Tribune’s operations, this loan was of paramount importance with a deadline and the company’s leadership was aware of the consequences of signing it. Therefore, Judge Leval had reason to believe that ‘Teachers would not have been free to walk away from the loan by reason of a subsequent decision that the transaction was not in Teachers’ interest. Nor could Tribune.’ (Ibid at 501.)


Under the ‘open terms’ prong, when certain essential terms of the agreement are present, the instrument is binding. For an agreement to pass the muster of enforceability, ‘a plaintiff must establish an offer, acceptance of the offer, consideration, mutual assent, and an intent to be bound. That meeting of the minds must include agreement on all essential terms.’ (Kolchins v Evolution Mkts Inc, 128 AD3d 47, 59, 8 NYS3d 1 [1st Dept 2015], citing 22 NY Jur 2d, Contracts s 9.) Without these essential terms, preliminary agreement cannot be considered enforceable.

‘Where the parties have manifested intention to make a binding agreement, the mere fact of open terms will not permit them to disavow it.’ (Teachers at 502.) Once the substance of the deal has been negotiated and agreed upon, the fact that there may be smaller details still to be negotiated does not render the agreement non-enforceable.

In Luxor Capital Group LP v Seaport Group LLC, (2016 NY Misc. LEXIS 1454, 2016 NY Slip Op 30728(U)), the Supreme Court of New York held that a binding agreement can only exist when there is ‘an objective meeting of the minds with respect to the material terms of the agreement.’ The New York Court of Appeals later affirmed.

In Am Cyanamid Co v Elizabeth Arden Sales Corp, 331 F Supp 597 (SDNY 1971), the court stated that a (Type II) meeting of the minds was reached on various aspects of the deal, but the LOI lacked mutuality of obligation because one term present in the letter was considered fatal: the required approval by Cyanamid’s board. Absence of this approval meant that Cyanamid was not yet bound. (Ibid At 605.)

As a consequence, the more specific major terms are outlined in the TS, the higher the likelihood the instrument is to be deemed enforceable. However, to avoid such risk, it may be reasonable to consider the insertion of a clear term stating a condition precedent to the completion of the deal.


Partial performance analyses steps the parties have taken to implement the terms of the preliminary agreement. In Teachers, the court viewed plaintiff’s informal allocation of funds towards the defendant’s loan as evidence that the agreement was intended to be binding. When Tribune argued that the allocation was informal and, therefore, of little significance, Judge Leval responded that their argument ‘misses the point’. (Teachers at 502.) Teachers’ allocation of funds meant that they ‘would forego opportunities to procure commitments from other borrowers.’ (Ibid. at 502.) ‘This factor [a party’s partial performance] favours the conclusion that both sides considered the commitment binding.’ (Ibid at 502.)

Bed Bath & Beyond took a similar position. ‘Ibex manifested its intent to be bound by the [letter of intent]’ by moving forward with the construction despite not having a finalised agreement. Partially on these grounds, the court held that the parties were bound by their preliminary agreement. (Bed Bath & Beyond at 413.)

As a consequence, actions that indicate a party’s belief in the binding nature of certain terms of a TS make it more likely that a judge will consider the entire preliminary agreement binding. A similar outcome was reached in McGowan, where plaintiff’s partial performance defied defendant’s argument that TS wording was not conclusive and, therefore, not binding.


Consistency and customary approach are also significant indicia of a binding instrument when ‘the agreement at issue is the type of contract that is usually committed to writing.’ (Teachers at 503 quoting R G Group, and Winston, 777 F2d at 77, 751, 801.) The law requires certain agreements to be in writing. Otherwise, ‘each transaction must be examined carefully to determine its characteristics.’ (Teachers, at 503.) Thus, typical market customs may help the judge to make a determination.

Damages associated with breach of a Type II agreement

Determining the damages owed to a party who has suffered loss from breach of a Type II agreement varies by state.

In Bulldog New York LLC v Pepsico Inc (No 3:08cv1110 F Supp 3d 152 (US District Court of Connecticut 2014)), PepsiCo’s decision to walk away before the negotiation period had concluded, combined with various other actions surrounding the TS, indicated to the court that Pepsico did not abide by its obligation. In applying New York State law, the District Court of Connecticut held that the party in breach of a Type II agreement was liable for reliance damages (ie, damages equal to out-of-pocket expenses for the negotiation).

In considering the award amount, the court held that ‘proving damages’ is a ‘necessary element’ (ibid at 46) even when a breach of a Type II has been demonstrated by the plaintiff. Thus, ‘lost profits are generally not available where no agreement is reached’ (ibid at 45 quoting Learning Annex Holdings LLC v Whitney Educ Grp Inc, 765 F Supp 2d 403, 417 (SDNY 2011)) because ‘the deal might not have been closed’ and ‘lost profits to the [defendant’s] bad faith may be speculative at best.’ (Goodstein v City of New York, 145 Misc2d 870, 876 [quoting Arcadian Phosphates v Arcadian Corp, 884 F2d 69, 74 n 2 (2d Cir)]). Instead, only ‘out-of-pocket costs may still be appropriate’ because only out-of-pocket expenses can be demonstrated. (Bulldog at 45.)

By contrast, in SIGA Technologies Inc v Pharmathene Inc (No 2627-VCP, 67 A3d 330 (S C 2015)) the Supreme Court of the State of Delaware ruled that parties in breach of a Type II agreement are liable for expectation damages (ie, damages equal to the amount of the contract’s value) where the court determines through its fact-finding process that, were it not for one party’s breach, the parties would otherwise have reached an agreement.

Expectation damages may be more costly for the losing party.

In New York, bad faith means a breach of the negotiation without an ‘ulterior motive.’ (Bulldog at 44 quoting Big Apple Car Inc v City of New York, 204 AD2d 109, 111 (NY App Div 1994))Even when a breach of the negotiation is due to some external factor, the entity seeking damages must reasonably prove the amount of money lost. Therefore, only reliance damages – out-of-pocket expenses during the time of the contract – constitute an adequate remedy for the non-breaching party.


Altogether, these few cases highlight the factors that regulate preliminary instruments and the consequences of breaching any of its terms. Those setting in motion a cross-border M&A in the US, therefore, should be aware of the effects of the combination of behaviour, intent, context and written documents. When a preliminary agreement is deemed to be binding, there may be significant financial implications for both parties. Keep these factors in mind for drafting a more reliable preliminary instrument.

Published on January 22, 2020 by the IBA Corporate and M&A Law Committee.

Available at https://www.ibanet.org/Article/NewDetail.aspx?ArticleUid=E360A15C-910E-4343-82CE-12A049F130BA


[1]          Omri Ben-Shahar, Pre-Closing Liability, p 979, 77 U Chi L Rev 977 (2010).