We agreed what now? The risks of being bound by a term sheet
New Media Holding Company LLC v Ivan Kuznetsov  EWHC 360 (QB)
18 April 2016
Parties often enter into “term sheets”, “heads of terms”, “memoranda of understanding” and myriad other variations on that theme with relative ease and little concern as to the consequences of doing so. The usual line of thinking is: this is only an initial marker; there will be a whole negotiation exercise to come and a formal agreement will be entered into; and it will be at that point that there is a legal agreement to govern the parties’ legal rights and obligations. Sometimes it works out that way but, as many cases have shown, parties often forget that term sheets do not always lead to more formal agreements and it may well turn out that they have unwittingly bound themselves to legal obligations, and legal consequences, that they had not appreciated.
A recent reminder of this has been provided by the case of New Media Holding Company LLC v Ivan Kuznetsov  EWHC 360 (QB), in which the High Court held that a document described as a “term sheet” was intended to create legal relations and that it was legally binding.
Given the frequency with which term sheets and similar documents, such as heads of terms, are used, and in light of the prevailing view that these documents are used to record parties’ intentions (rather than the minutiae of the rights and obligations), the lesson of this case is that these documents should not be treated so lightly.
In addition to considering the status of the term sheet, the court considered whether the requisite notice which was served pursuant to the term sheet was in fact valid – we will not, however, comment further on that aspect of the case in this article.
The facts of the case
Ivan Kuznetsov and Vladimir Gusinski were investors in a joint venture company called SIA Energokom (“Energokom”), a Latvian registered company operating in the atomic energy sector in Ukraine. Mr Kuznetsov and Mr Gusinski signed a document on 27 January 2010 which they called the “Term Sheet”.
Mr Kuznetsov and Mr Gusinski were, among others, investors in Energokom. Mr Gusinski asserted (and the court accepted) that his interest in becoming involved in Energokom was “purely as an investor” and that he had no intention of being involved in the day to day management of Energokom.
Mr Gusinski had expected his investment in Energokom “to produce quick and significant returns” but that did not prove to be the case. By May 2009, Energokom urgently needed funds to cover its operational costs, and so Mr Kuzentsov began to ask Mr Gusinski to provide replacement funding. Mr Gusinski, however, in light of concerns about his investment in Energokom, told Mr Kuznetsov that he would only continue as a shareholder if Mr Kuznetsov provided him with certain corporate governance rights (to protect Mr Gusinski’s position as a minority shareholder) and a redemption right in relation to his interest in Energokom. This led to the discussions which ultimately culminated in the Term Sheet.
The signed Term Sheet gave Mr Gusinski the right “upon his own discretion” to require the Company to purchase his shares at any time following the date of the Term Sheet.
Mr Gusinski claimed that, pursuant to the Term Sheet, he was granted a redemption right in relation to his Energokom shares. On 17 October 2012, Mr Gusinski sought to exercise that right by way of a notice, requiring Mr Kuznetsov to purchase the relevant shares. Mr Kuznetsov failed to do so.
Mr Gusinski later assigned his rights to New Media Holding Company LLC and it was this entity that brought the claim against Mr Kuznetsov.
Mr Kuznetsov contended that the Term Sheet was not legally enforceable because it was never intended to be legally binding or, alternatively, that the Term Sheet was not supported by any or proper consideration on the part of Mr Gusinski.
The court noted the following points as being particularly instructive:
- The Term Sheet was prepared by lawyers. It was signed by the parties, and there was no indication that the Term Sheet did not reflect what had been agreed in discussions between Mr Kuznetsov and Mr Gusinski.
- A draft of the Term Sheet had been circulated initially and was subsequently amended to include an exclusive jurisdiction clause.
- Despite the Company being registered in Latvia, the exclusive jurisdiction clause provided for English law to apply.
- The court described Mr Gusinski as “an experienced businessman… also an experienced investor,” and Mr Kuznetsov as “an experienced, sophisticated international businessman”.
In Mr Kuznetsov’s view, the Term Sheet was “no more than an informal protocol of understanding between Mr Gusinski and himself” which was designed to “record the points of principle that had been agreed between them”.
The court considered that the terms of the Term Sheet and the conduct of the parties (viewed objectively) led to the conclusion that the Term Sheet was intended to be legally binding. The court was satisfied that the Term Sheet was “workable when signed” and that the terms of agreement which were reached, the commercial context and the circumstances demonstrated on an objective basis that the parties intended the Term Sheet to be a legally enforceable agreement. The court noted that, after the Term Sheet had been signed, neither party did anything further “that could support an understanding or anticipation that any further written agreement was required in order to create a legally binding agreement.”
In reaching its decision, the court commented that the language used in the Term Sheet was “consistent with a legally binding agreement and not merely a document that was aspirational.” In particular, the obligations set out in the Term Sheet were “expressed in unqualified terms.” The Term Sheet included an express law and jurisdiction clause which the court noted was “expressed to apply to ‘this term sheet’ and not merely to some of its terms, or to any future agreement.”
Significantly, the court challenged commonly held opinions that term sheets and similar documents are merely used to record parties’ aspirations when it stated that, “there is no absolute rule that documents described as ‘term sheets’ are framework documents and cannot be contractual.”
Having considered the conduct of the parties and the language of the Term Sheet, the court then looked at the question of whether consideration had been provided. The court agreed that the Term Sheet did not, on the face of it, provide for Mr Kuznetsov to receive anything in return for granting to Mr Gusinski the rights set out in it. However, the court rejected Mr Kuznetsov’s argument that there had been no consideration on the basis that the Term Sheet represented a logical quid pro quo for Mr Gusinski to provide further funding in the Company and not to pursue any investigation into mismanagement of the Company at that time. On his own evidence, Mr Kuznetsov signed the Term Sheet in return for Mr Gusinski’s promise of further funding which the court described as “undoubtedly valid consideration moving from Mr Gusinski.”
This case shows that simply describing a document as a term sheet (or any similar form of document) is not enough to prevent it from being legally enforceable, as there is no absolute rule which precludes such documents from being legally binding.
The particular circumstances of this case clearly had a bearing on the outcome. The court regarded the parties as sophisticated investors. The court considered that the language used in this particular document suggested that the intention was for the document to be legally binding. The fact that neither party took steps, after the Term Sheet had been signed, to prepare a further binding agreement, was regarded as relevant. And yet, the court’s comments – and ultimately, its decision – challenge widely held views about the purpose and enforceability of term sheets and other similar documents. This should serve as a useful warning that a court will not automatically prevent a term sheet, heads of terms or similar from being held to be legally binding simply because of the label applied to the agreement.
This case provides useful practice points for those who typically enter into or advise on term sheets:
- Careful thought should be given to the language which is being used. Is the proposed language consistent with that of a legally binding agreement or is it merely aspirational?
- Parties should not assume that just because a document is stated to be a “term sheet” or “heads of terms”, that it cannot be binding in its entirety.
- If the document includes an express law and jurisdiction clause, is it expressed to apply to the whole document or only to some terms and/or any future agreement?
- The court has discretion to take account of all of the wider circumstances, including the relationship of the parties, the discussions leading up to any agreement, and any provision of consideration which may not be obvious from the document in question.
Undoubtedly, term sheets and other similar documents represent a useful starting point in commercial negotiations. Whilst they are valuable tools, however, neither parties nor practitioners should assume that these will necessarily not amount to legally binding agreements. The lesson provided by this case is that careful thought should be given to the content of these agreements and also the wider conduct of the parties and the context in which term sheets are prepared, as these will have a very large bearing on whether parties are found to have entered into a binding contract or not.