The Materiality Of Term Sheets On Banking Facility Agreements: A Note

The Materiality Of Term Sheets On Banking Facility Agreements: A Note

By A L R Joseph[1] The Question When is a working draft (or term sheet[2], as I prefer to call it), in a banking transaction, leading to an eventual banking facility agreement more than merely pre-contractual negotiation and of
material importance such that it has a bearing on the facility agreement? The Federal Court in Abdul Rahim Bin Abdul Hamid v Perdana Merchant Bankers Bhd[3] answered recently that it would be so if the term sheet was (1) of importance to the parties to the agreement; and (2) if it was the case that the facility agreement was to simply formalise what was agreed upon by the parties in the term sheet.[4] Finding of Fact On the facts of the case, the Federal Court observed that:[5] ‘It must be borne in mind, that from the evidence led by the parties, the [Term Sheet] was not some non-sequiter
document, but one that both parties had placed considerable importance on. It was from our observation of the evidence, a document borne out of months of negotiations on the understanding that all the clauses eventually agreed upon in the said document would be incorporated into the Facility Agreement.’ 

The Issue 

The issue at the nub of this case was that under the explicit terms of a term sheet a bank was not permitted to allow one draw down of the loan amount in one full swoop, but by two clearly stipulated draw downs. However, the bank allowed one draw down of the whole loan sum basing itself on the authority of a clause in the eventual facility agreement which provided that the bank can ‘make only one (1) Drawing on the Facility.’ By virtue of this clause in the facility agreement (‘Facility Agreement’), the respondent bank (‘Bank’) disbursed the whole of the said loan facility in one draw down. The appellant co-borrower (‘Co-Borrower’) argued that this single draw down, in one full swoop, went against the spirit of the term sheet (‘Term Sheet’) that had been
agreed between the parties (where it was stated that there would be two draw downs of the loan sum). The Co-Borrower argued that by doing this, the Bank was in breach of the contract between the Co-Borrower and the Bank. When Do Pre-Contractual Negotiations Get Incorporated?

 In essence the problem that confronted the Federal Court was whether the terms of the Term Sheet in the case – which amounted to pre-contractual statements (in terms of chronology, simply given that the Facility Agreement was made subsequent to the Term Sheet) – were incorporated into the Facility Agreement. The trial judge answered in the negative (finding that the clause regarding the two draw downs in the Term Sheet was merely pre-contractual negotiation and of no material importance) but the Federal Court disagreed.

In general contract law, the question whether statements made by the parties prior to the conclusion of a contract have been incorporated into the latter is an important one. The way in which the courts decide whether or not a pre-contractual statement has been incorporated as a term in the eventual contract is to look at the intention of the parties objectively.[6] As Lord Moulton observed in Heilbut, Symons & Co v Buckleton[7]: ‘[T]he intention of the parties can only be deduced from the totality of the evidence, and no secondary principles… can be universally true’[8] The Facts On the facts of the case the Federal Court found that the Facility Agreement resulted from a culmination of all the negotiations between the parties, which appeared to take account of the Term Sheet. However, it had a fundamental variation, i.e. the provision permitting one draw down. P S Gill FCJ[9] asked the following question: ‘Was the variation brought to the attention of the [Co-Borrower]?’ The Co-Borrower gave evidence that the Bank which was responsible for drawing up the Facility Agreement, had not mentioned the variation to it and was assured by the Bank that there was no change in the Facility Agreement from the Term Sheet. Based on this assurance the Co-Borrower signed the Facility Agreement. It was lulled into believing that there were no amendments to the Term Sheet terms which it believed were simply incorporated into the Facility Agreement. In other words, the Co-Borrower had been less than careful in not checking the Facility Agreement, better, one final time before signing it, or as the trial judge found: foolhardy. In respect of this, P S Gill FCJ had this to say in response:[10] ‘The Trial Judge had dismissed the reasons why [the Co-Borrower] signed the Facility Agreement despite the variation as an act of, singular foolhardiness. That may be so. We are not denying the fact that it was an act of imprudence on his part. However, one must also consider the background to this saga. The co-borrower was under the impression that the Facility Agreement would mirror the [Term Sheet] that had [been] negotiated on, over a period of time. There was an element of trust between the parties, that no one will renege on the terms agreed upon on the [Term
Sheet]. The period between the [Term Sheet] and the Facility Agreement was 29 days. The co-borrower unwittingly thought it safe to assume that there would be no substantial amendments from the terms agreed… ‘Further, the coborrower was not told by [the bank] that there was this new amendment to the Facility Agreement, against what was agreed to initially. This piece of evidence was not controverted in the court blow. And, if we accept the version of the coborrower in print that he was informed by [the bank] that the terms of the Facility Agreement were the same as the contents of the [Term Sheet], before he signed it, then it stands to reason why the co-borrower was almost blasé about the signing of the Facility Agreement. He had basically believed the word of [the bank] in this respect…. ‘Against this backdrop, we find that it was plausible for co-borrower to have safely assumed that the Facility Agreement was in compliance with the [Term Sheet]… when he signed the said Facility Agreement …’ The Behaviour of The Bank The Federal
Court found the behaviour of the Bank “intriguing” because it was not clear why, having negotiated with the Co-Borrower for over a considerable period of time and finally agreeing to a Term Sheet, the bank did a complete volte-face, without informing the Co-Borrower. The Court asked:[11] ‘Was it done in the pious hope that the [Co-Borrower] may not stumble upon it in the agreement? In this instance, the [Co-Borrower] did just that. If this is the case, then it is conduct that we do not propose to countenance from a financial institution.’ Moreover, it was found that the Bank had actually misrepresented to the Co-Borrower that there was no amendment to the Term Sheet and so the Co-Borrower in reliance of this representation signed it. In those circumstances – even if there was no suggestion of impropriety by the Bank - the behaviour of the bank placed a duty on it, which was expressed by P S Gill FCJ as follows:[12] ‘To our minds, if a bank executes an order knowing it to be dishonestly given, or shuts its eyes to an obvious fact of dishonesty, or acted recklessly in failing to disclose material facts, the bank will plainly be liable. In our judgment, it is an implied term of the contract between the bank and the customer that the bank will observe reasonable skill and care in and about executing customer’s orders.’[13] In respect of this behaviour, the Federal Court held that the conduct of the Bank in relation to the amendment of the Facility Agreement was in breach of a bank’s duties as bankers to their customers. 

The Conclusions

On the facts the Federal Court concluded as follows:
- The trial judge had erred by de-emphasising the importance of the Term Sheet as a merely a pre-contractual document that did not deserve much weight. In fact the Term Sheet was found to be an important document, given the evidence that the Facility Agreement was merely meant to formalise what was agreed upon by the parties in the Term Sheet.
- The conduct of the bank in relation to the amendment of the Facility Agreement was in breach of a bank’s duties as bankers to their customers.

The Answer 

The answer to the question posed at the outset (i.e. when is a term sheet, in a banking transaction, leading to an eventual banking facility agreement more than merely pre-contractual negotiation and
of material importance such that it has a bearing on the facility agreement?), is that a term sheet in these circumstances is an important document, if there is evidence that it was regarded as important by the parties, and if the eventual facility agreement was to merely formalise what was agreed between the parties in the term sheet. 

The Solution 

There is, however, a simple threefold solution to this problem. First, a term sheet which makes it clear that it is not binding and that there is no intention to create legal relations might suffice to keep its terms out of any future contract which follows.[14] Second, a term sheet which clearly states that it is “subject to contract” would have the same effect. Such words (or words to the same effect) would show that the parties intended further negotiations or that certain events were contemplated. In those circumstances, it could be argued that the terms of the term sheet were not intended to be the last words in the transaction.[15] Lastly, the employment of an “Entire Agreement” clause in the eventual facility agreement would also keep terms of the term sheet from being incorporated into the agreement. The purpose of such a clause is to ensure that the contractual relationship of the parties is contained in one written document that sets out the agreement that has been concluded. As Lightman J said in Inntrepreneur Pub Co (GL) v East Crown Ltd,[16] ‘… a clause which merely says that the agreement constitutes the entire agreement between the parties is effective to rob any precontractual or collateral agreement of legal effect.’ For the avoidance of doubt, a clause in a term sheet to the following effect should save the day (from a bank’s point of view): ‘This Term Sheet is a non-binding understanding between the parties which evinces no intention on either party to create legal relations. This Term Sheet is concluded by the parties hereto subject to a binding final facility agreement to be entered into by the parties subsequently’. Finally, an “Entire Agreement” clause in the final facility agreement, as follows, should obviate any confusion: ‘This Agreement, inclusive of all schedules and exhibits, constitutes the final, complete, and exclusive statement of the terms of the agreement between the parties pertaining to the subject matter of this Agreement and supersedes all prior and contemporaneous understandings or agreements of the parties. This Agreement may not be contradicted by evidence of any prior or contemporaneous statements or agreements. No party has been induced to enter into this Agreement by, nor is any party relying on, any representation, understanding, agreement, commitment or warranty outside those expressly set forth in this Agreement.’ [1] MA, LLB, of Gray’s Inn, Barrister, Advocate & Solicitor (Malaya & Singapore) [2] A “Term Sheet” may be defined as ‘a non-binding agreement setting forth the basic terms and conditions under which an
investment will be made. The term sheet is a template that is used to develop more detailed legal documents.’

( [3] Mahkamah Persekutuan Rayuan Sivil No.02-12-
2005(W) (date of judgment 07.04.06) ( (Pajan
Singh Gill, Alauddin Bin Dato’ Mohd Sheriff & Richard Malanjum FCJJ) [4] 

This is a case of considerable significance to bankers and their legal counsels, so much so that alarm bells must be going off in many bank and law chambers. [5] Supra n 3 at p 7 [6] Even though this principle is the one applied by the courts to ascertain whether a pre-contractual statement has been incorporated as a term or remains a representation (and if false a misrepresentation), it is submitted that the same principle applies to all cases where a question arises whether pre-contractual negotiations have been

credited to The Malaysia Bar