UNDERSTANDING THE ROLE OF PRE-CONTRACTUAL INSTRUMENTS
Harish Shetty,
NA Global Law School
Usually, we see news in business newspapers regarding signing of MoU between the parties or ironing out differences before signing the master agreement. These are nothing but pre contractual instruments coming to play and helping the concerned parties navigate through complex negotiations before signing the master deal.
Contracts are the backbone of any process-oriented system and contract management plays a critical role in running any type of business. Before getting into a master agreement, it is necessary for all the parties to be on the same page and also, it's very important that all the differences are ironed out. It is very critical that all the parties involved are acting in good faith while engaging in the negotiation with the intention to get into a contract.
This is where pre contractual instruments play a vital role. They help the parties to come up with a high-level agenda, identify & protect confidential information and come to an understanding on the intent & structure of the ultimate deal. This is all happening even before the main contract is signed.
Three main pre contractual instruments which we are going to discuss in this article are Non-Disclosure Agreement (NDA) / Confidentiality Agreement, Term Sheet and Memorandum of Understanding (MoU).
A. Non-Disclosure Agreement (NDA) / Confidentiality Agreement
Main purpose of NDA is to safeguard confidential information. It's an agreement between two or more parties with the sole intention to protect the identified confidential information.
Usually, we have a disclosing party and receiving party of the confidential information. NDA can be a separate agreement or you can add a confidentiality clause inside another agreement and its binding in nature.
One of the critical steps is identifying the confidential information and this helps to protect the disclosing party’s business interest and trade secrets.
Confidential information is identified based on contract type, business involved and domain.
Usually, Confidentiality clause is a survival clause and it will be binding for a reasonable duration of time beyond the survival of main contract.
NDA can be a unilateral or bilateral agreement. Bilateral agreements are signed when both the parties are both giver and receiver of the information.
In case of breach of confidentiality clause there are remedies available for the aggrieved party in the form of injunction or damages.
At the same time there is some protection for the receiving party in cases where the information involved is already public, information is disclosed by some third party, information disclosed due to the rule of the land or if the information is against the general good of the public and national security.
B. Term sheet
Term Sheet is a pre investment document which is used to ensure that all parties are aware of the investment details and are on the same page as far as critical investment details are concerned.
It's an agreement before the main contract is signed. Some of the examples that can be quoted here are Term Sheets before finalizing a Share Purchase Agreement or Share Holder Agreement.
Typically, Term Sheets are in tabular format resulting from bilateral negotiation.
It's usually non-binding as the parties involved can walk off from signing the main agreement without penalty.
Terms Sheet can be changed any time before signing the intended main agreement.
Includes important information like name of the company, promoters & investors details and financial stakes.
Usually, people get confused between Letter of Intent (LOI) and Term Sheet. Generally, Term Sheet is preferred in investment proposals and involves bilateral discussion, whereas LOI is for all business transactions and it's usually a Unilateral proposal.
C. Memorandum of Understanding (MoU)
MoU is a bilateral or multilateral understanding between the parties involved in the contract and is usually non-binding in nature.
If required, some clauses of the MoU can be made binding in nature e.g., Confidentiality Clause within the MoU is binding in nature.
Usually, MoU is followed by a formal contract when parties involved act in good faith.
If things don’t work out as planned then the parties involved can walk off without signing the main agreement with no penalty.
MoU is signed for some duration, which is mentioned in the contract, and if needed Exclusivity clauses can be added.
Conclusion
Whether it might be interviewing a candidate for a critical leadership position or getting into a partnership or looking into getting into shareholders agreement pre contractual instruments play an important role. They help in navigating the negotiations or outlining business terms or safeguarding the confidential information. As business becomes more sophisticated these instruments play a vital role in protecting the interest of the parties and facilitate negotiation.