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Term Sheet Strategies Helpful to Draft and Negotiate Joint Development Agreements 

Term sheets offer many advantages. They can simplify the negotiation process and make it less expensive to put in place a fully signed joint development agreement. With a term sheet in hand, the parties can hammer out the main concepts without getting lost in the clutter of specific details needed for a full agreement.

A term sheet can be very useful if a deal is complex.1

The term sheet can also be a useful element of your marketing folio when you are trying to entice another to enter a joint development relationship. Using a term sheet as a discussion guide in talks at these levels often is much easier and effective than a full agreement.

Even if the other party has taken the bait and wants to explore a deal, the term sheet can still be useful to test acceptance of certain aspects of the deal at an abstract level before any party commits to specific details. As just one instance of many possible examples of where this can be useful, a term sheet can specify that an initial fee is required without actually specifying the amount of the initial fee. By selling the concept of an initial fee first, the term sheet may catalyze acceptance of the details to come later. Otherwise, setting out the price too soon can be polarizing. Polarization can increase the likelihood that not just the amount of the initial fee, but also the very concept itself, would be unacceptable to the candidate licensee. Opening with a full agreement does not offer similar selling-the-concept-first opportunities, as the full agreement must be full of the details.

A term sheet also can be useful when one of the parties has little experience with joint development projects. The term sheet can act as a study guide to help the newbie through the agreement drafting, negotiation, and placement process.

A term sheet can also be a great tool for analyzing a full agreement that has been sent to you by the other side or a colleague. Start your agreement analysis by creating your own “ex parte” term sheet – one that only you and your client might see. This will allow you to evaluate the essence and architecture of the deal without obfuscating details. You will know right away whether you need to hammer out concepts or whether you are ready to focus on details. You will be in a better position to assess whether the deal could yield a good return or whether your putative cash cow actually lacks adequate cash (and perhaps the cow).

Clearly, a term sheet can be a useful tool to facilitate the drafting and negotiation of a license. The term sheet may help you reach a final agreement. Or you may not.

If you don’t reach a final agreement, you most likely want to walk away from the negotiation without any obligations or liability. This is where term sheets can be dangerous. If you are not careful in how you draft a term sheet, your term sheet unexpectedly (and undesirably) can end up being a binding, enforceable contract. The proposed joint development terms that you thought were suggestions can become obligations for one party and rights for the other. This can be quite a surprise if you intended the term sheet only to be a guide for negotiation and your expectation was that no binding agreement would exist until a final agreement was signed. Your negotiation must be handled properly, and your term sheet must have the right language in it, if you are to minimize this risk. Note, though, that not just term sheets but also agreement drafts and any negotiation process carry similar risks. Parties are not necessarily increasing this kind of risk by using a term sheet.

Even if you are careful in how you craft the language of a term sheet, a term sheet can still become a binding, enforceable contract and/or significant liability can accrue if your actual conduct under the term sheet is sloppy or improper. As one common pitfall, one or both parties may start performing under the putative license too soon. Overconfident that the final agreement will be placed, a party may ship supplies to the other party. One party might make royalty payments, and the other accepts those payments. Both parties might start development. One party might start the transfer of know how, which the other accepts. Even with the most non-binding term sheet language ever crafted, this kind of partial performance by both parties creates a high risk that a contract is in place whose terms are very much unclear. You may wish to walk away from a negotiation without liability or obligation in these circumstances, but your wish may not be granted.

Perhaps it is surprising that partial performance under a term sheet forges obligations and liabilities. But it should come as no surprise that misconduct under a term sheet can lead to significant liability. For instance, those who pirate information received in confidence while doing due diligence under a term sheet should expect to pay the consequences. Ditto if you make fraudulent misrepresentations or other malfeasance or nonfeasance.

Fortunately, some strategies can significantly reduce the risk that your term sheet, negotiations, and agreement drafts will haunt you with obligations and liabilities according to your worst nightmares:

  • Use a nondisclosure agreement to cover negotiations that is customized to include express language that the proposed agreement terms are non-binding and that only a fully signed, final agreement will bind the parties.
  • Recognize that the term sheet setting will involve some terms that are intended to be binding and then very clearly distinguish between binding and non-binding aspects. These are examples of terms that may be intended to be binding: identifying the parties, establishing confidentiality, excluding third partybeneficiaries, prohibiting assignment of the term sheet, setting up a period of exclusive dealing, defining the expiration of the term sheet, making sure the proposed terms of the license are nonbonding until a final deal is signed, setting up a period of due diligence, etc.
  • Consider partitioning binding and non-binding terms into separate documents. For instance, binding terms can be placed in a nondisclosure agreement to be signed by both parties, with the non-binding, proposed joint development terms in an attachment.
  • Expressly state that either party may withdraw from the negotiation at any time, including up to and until a final agreement is signed, without the acts of early performance or withdrawal triggering any obligation or liability to the other. Malfeasance or nonfeasance should be excluded, understanding that withdrawal per se is neither of these.
  • Specify a choice of law and venue applicable to construing the binding and non-binding aspects of the term sheet. The risks of term sheets are governed in large part by state law. Because state laws differ, it makes sense to specify the law that supports the strategies you are practicing.
  • Recognize that the initially proposed, non-binding license terms will be modified as the negotiation proceeds. The term sheet should expressly state that none of these modifications are to be binding. Many disclaimers against being bound address only the original proposal and do not encompass future evolutions. In the absence of a suitable disclaimer, these future evolutions can be deemed to be binding depending upon the course of dealing between the parties.
  • Refer to the non-binding terms as “proposed” or similar.
  • Leave out key details, addressing these aspects at a conceptual level. For example, propose that a royalty will be paid, but don’t specify the amount. The amount can be left for negotiation.
  • Avoid statements that the final agreement is intended to memorialize the understanding in the term sheet.
  • Avoid performing until after the agreement is signed.
  • Be aware that many states will imply a duty to negotiate in good faith under a term sheet. Fail to satisfy this duty and you may incur liability for this malfeasance. Don’t enter a term sheet unless you have a good faith intent to negotiate.

The more of these strategies that you practice, the more that you reduce your risk. However, we are not presently aware of any case that sets forth a bright line between binding and non-binding term sheets. There is no formula, if followed, that guarantees that your term sheet will be non-binding. Most of the case law arrives at decisions based upon the totality of circumstances, not by black letter rules. Not only term sheet language, but also party conduct comes into play. This means that term sheet danger can only be reduced, not eliminated.2

1 Sometimes complexity cannot be avoided; other times, undue complexity is an artifact of incomplete thinking. Before committing to a complex agreement structure, spend additional analysis time to see if the same business goals can be achieved with a simpler structure. Often, simplification is possible. Any simplification is desirable, as the drafting, negotiation, administration, operation, and enforcement of the agreement will be eased. If you have a choice between simple and complex to achieve the same goal, simple simply is better.
2 For additional information, please see Ballard and Lively, “Should You Sue Over A Term Sheet?”, The Practical Litigator, pages 43-56 (July 2007). See also Fairbrook Leasing, Inc. v. Mesaba Aviation, Inc. 408 F.3d 460 (8th Cir. 2005).