A Transaction Term Sheet Can Be A Valid And Enforceable ContractPrint Article
- Posted on: Jan 26 2017
Parties to commercial/business transactions are no doubt familiar with “term sheets”, “letters of intent”, “memoranda of understanding” and “agreements in principle”. As the parties to these documents know, they outline the fundamental terms of the transaction being negotiated.
Terms sheets and the like have a number of advantages: they can be drafted without the expense of hiring a lawyer; they reduce later renegotiation and lapses in memory; they can facilitate discussions with financial institutions, as well as debt and equity financing providers; they can create deal momentum; and, where applicable, they allow filings with antitrust and other regulators.
These documents also can have a number of disadvantages: they can cause business owners/corporate executive to pass on alternative strategic opportunities because of the desire to conclude the transaction; they can cause business owners/corporate executives to kick the can down the road on more difficult terms for which agreement may never come; and they can cause business owners/corporate executives to lose focus on the operations of the company. Perhaps the biggest disadvantage of these documents is the possibility that they can be considered enforceable contracts.
McGowan v. Clarion Partners, LLC – Enforcing A Term Sheet:
On January 6, 2017, Justice Scarpulla of the New York County, Supreme Court, Commercial Division, held in McGowan v. Clarion Partners, LLC, 2017 NY Slip Op. 30019(U) that a term sheet was a binding contract because it contained all the material terms of the proposed joint venture that would reasonably have been expected to be included under the circumstances.
In February and March 2012, Clarion Partners, LLC (“Clarion Partners”), a real estate investment management firm, and Barry McGowan (“McGowan”), formerly the chief investment officer and managing director of non-party GLL Real Estate Partners (“GLL”), a multi-national real estate fund manager, held numerous discussions and meetings at Clarion Partners’ New York offices concerning the creation of Clarion Partners Europe (“CPE”), a real estate investment management business. As originally planned, CPE would maintain headquarters in Munich, Germany, where McGowan lived at that time.
On March 9, 2012, McGowan, non-party Steve Furnary (“Furnary”), the chairman and chief executive officer of Clarion Partners, and non-party Florian Winkle (“Winkle”), a former GLL colleague of McGowan, executed a document entitled, “A Term Sheet for Clarion Partners — Europe” (the “Term Sheet”). The Term Sheet set forth the terms concerning, among other things, the identity of the CPE management team, the management team’s income, funding for CPE, and the team’s investment in Clarion Partners, and provided that all terms are “[a]greed amongst the parties but subject to signed documentations.”
No additional documentation was executed by the parties.
Following execution of the Term Sheet, and at Clarion Partners’ request, McGowan formally ceased discussions with other potential joint venture partners, such as non-party Legal & General Group plc (“Legal & General”), a multi-national insurance company, in reliance upon Furnary’s assurances that the Term Sheet was binding on Clarion Partners. McGowan also asked certain GLL colleagues to resign from GLL, and join him at CPE.
On March 12, 2012, Clarion Partners stated that the management team would invest €1 million into Clarion Partners, instead of the $1million provided in the Term Sheet. This was a significant change because in 2012, the prevailing exchange rate from dollars to euros meant that Clarion Partners was increasing the management team’s investment by approximately 30%.
Clarion Partners also stated that the investment would be made in a Clarion Partners entity, rather than in Clarion Partners directly. At that time, the Clarion Partners entity was less valuable than Clarion Partners.
Although the changes were unilateral, McGowan decided to honor the Term Sheet, as modified by Clarion Partners. Winkle declined to accept the modification, and formally withdrew from the joint venture.
In March and April 2012, McGowan continued his efforts to move forward with the formation of CPE, and continued to correspond and meet with Furnary. McGowan sought office space in Munich.
McGowan also developed a business plan as referenced in the first paragraph of the Term Sheet, and a revised start-up budget for CPE. On May 13, 2012, McGowan emailed Furnary a copy of the “CPE Business Plan — Restructure/Delay (1 yr)” (the “Business Plan”). On May 24, 2012, Furnary advised McGowan for the first time that Clarion Partners would not perform under the Term Sheet, that the Term Sheet was not a binding agreement, and that Clarion Partners was no longer interested in forming CPE with McGowan.
In 2015, McGowan commenced the action, asserting two causes of action: breach of contract and specific performance. In the contract claim, McGowan alleged that the Term Sheet was a binding contract, and that by its actions Clarion Partners breached the Term Sheet and the covenants of good faith and fair dealing implied in that document. McGowan also alleged that Clarion Partners usurped his opportunity to form a European fund manager by opening a London office without McGowan, in order to take advantage of the European investment opportunities.
In addition, McGowan alleged that he lost the salary, benefits, and investment opportunities promised him by Clarion Partners in the Term Sheet, and was forced to remove his children from private school in Germany, put his house in Germany up for sale, and return to the United States, where he began renting a property in Rye, New York, at great personal cost and expense. McGowan alleged that he lost more than $3 million in compensation that he would have earned had Clarion Partners kept its side of the bargain.
In the specific performance claim, McGowan alleged that the opportunities guaranteed in the Term Sheet could not be obtained anywhere else, and sought a 30% ownership interest in Clarion Partners’ European business, an opportunity to invest $1 million in Clarion Partners, and ownership of 1% of Clarion Partners’ income units and performance units.
Clarion Partners moved to dismiss both causes of action.
The Court’s Decision:
As noted above, the Court held that the Term Sheet was a legally enforceable agreement and not a mere “agreement to agree” that “lack[ed] the material terms essential to the formation of CPE,” as Clarion Partners had contended. The Court found that the Term Sheet embodied “all essential terms” of a contract – that is, “an offer, acceptance of the offer, consideration, mutual assent, and an intent to be bound” sufficient to find a meeting of the minds:
The Term Sheet and the Business Plan referenced therein set forth the material terms of the proposed CPE joint venture.
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The Term Sheet includes identification of the purpose and form of the proposed joint venture — the creation of a Clarion Partners entity in Europe headed by a management team comprised of McGowan, nonparty Oliver Kachele, and Winkle. The Term Sheet specifies the initial funding for CPE’s operations by the management team and Clarion Partners, and the management team’s salary, salary increase, and bonus calculations. It also specifies the percentages of CPE ownership interests — Clarion Partners would own 70% of CPE’s equity, and the management team would own 30%, and what will happen to those interests, in the event of a sale of Clarion Partners. It also provides that the management team will be given income units and performance units in Clarion Partners.
The Business Plan referenced in the Term Sheet projects CPE’s expected cash flow, expenses, and number of employees during a six-year period, from 2012 through 2018. That Plan provides target start dates for CPE’s CEO (July 1, 2012), CFO (January 1, 2013), and fund managers and researchers. It also projects business expenses, including office rent, travel, entertainment, and attorneys’ fees.
The Court concluded that the Term Sheet and the actions of the parties, manifested their intent “to be associated as joint venturers,” to mutually contribute “to the joint undertaking through a combination of property, financial resources, effort, skill, or knowledge,” to maintain “a measure of joint proprietorship and control over the enterprise,” and an agreement “for the sharing of profits and losses.”
The Court was not persuaded by Clarion Partners’ argument that “even if the Term Sheet [was] a binding agreement, it did not breach that agreement because an express condition precedent to the formation of CPE — the execution of additional documentation — never occurred.” The Court found that the parties’ actions spoke louder than words. In this regard, the Court noted that “Clarion Partners clearly signaled … that it considered the Term Sheet itself to be a binding agreement.” In fact, Furnary “expressly assured McGowan that the Term Sheet was binding on Clarion Partners, and requested that he cease negotiations with Legal & General.” With that assurance, McGowan formally terminated those negotiations.
Additionally, the Court declined to accept Clarion Partners’ argument that the language in the Term Sheet itself – “[a]greed amongst the parties but subject to signed documentations” – demonstrated that the Term Sheet was not intended to be a binding agreement. That language did not “conclusively” change the result, said the Court, because the use of “subject to” language and the reference to the execution of a formal agreement at a later date, did not amount to a reservation of the right not to be bound.
Finally, the Court refused to accept the emails exchanged between the parties and non-parties to the venture to be conclusive proof of the parties’ intention to be bound by the Term Sheet, given the stage of proceedings: “At this juncture, it would be premature to hold that these emails conclusively demonstrate McGowan’s understanding that that essential material terms of the joint venture were still in negotiation.”
McGowan is illustrative of most litigation concerning the enforceability of term sheets and similar documents. Disputes arise when one side of the transaction argues that the term sheet does not clearly reflect the intent of the parties on the issue of enforceability. As McGowan shows, a court will find a term sheet binding if it includes the material provisions of the agreement and the parties conduct themselves as though they have a firm agreement.
So, what can business owners/corporate executives do to minimize the risk of the unintended enforcement of a letter of intent or term sheet? For starters, the parties should consider using language that expressly imposes a duty to negotiate a final agreement in good faith. They should also: (a) state their intent that neither subsequent communications nor course of conduct will give rise to binding obligations before a definitive agreement is signed; (b) identify material contingencies and conditions precedent for completing the transaction, such as obtaining financing, required permits or consents, and satisfactory completion of due diligence; and (c) state that neither party is relying on, or is entitled to rely on, the term sheet or letter of intent for any purpose.
In the end, business owners/corporate executive should proceed with caution when drafting term sheets or letters of intent and in their course of conduct surrounding the negotiation of a final agreement to ensure that they are not later bound to their non-binding term sheet or letter of intent.