The costly risks of term sheets that add up to agreements

David Donato was an experienced and successful investment banker with experience in the mining sector. In 2016, he was recruited to join PearTree, which worked with mining companies to arrange flow-through donation financing placements. PearTree hired Donato to serve as president and co-head of banking.

In January 2018, PearTree terminated Donato’s employment without cause. So he sued PearTree for wrongful dismissal and amounts he claimed he was owed — between $3.2 million and $3.9 million.

However, PearTree said Donato was owed somewhere between $240,000 and $627,516, depending on the methodology selected and findings of fact.

After a 10-day trial, the court found that Donato has been undercompensated.

Binding employment contract

The court concluded that the two parties entered into a binding employment contract on April 11, 2016.

“I do not accept PearTree’s submission that this first employment contract was merely an agreement to agree or was a non-binding term sheet,” said Justice Robert Senta.

“I find that the March 31 letter is an enforceable contract. It manifests offer, acceptance, and consideration. It contains the essential elements of an employment contract. It was a bargain, and it is worthy of enforcement.”

However, the parties also agreed to a second employment contract in July 2016, which governed Donato’s entitlements on the termination of his employment, said Senta.

The court did not accept Donato’s submission that there was no consideration for this agreement as he received two weeks’ additional paid vacation and a $40,000 payment that was referable to the second employment contract.

“PearTree repudiated the first employment contract and offered Mr. Donato employment on new terms, which Mr. Donato accepted after over a month of substantive negotiations and with the benefit of legal counsel,” said Senta.

‘Plain and obvious’ language needed to avoid binding agreement

The court cited several elements of the first “employment contract” that were included, such as Donato’s annual salary, annual bonus, start date, confidentiality provisions and non-competition and non-solicitation covenants.

“PearTree drafted the first employment contract after extensive discussions with Mr. Donato over the month of March and chose language that demonstrates that it intended to be bound by the contract. I do not see any indication that PearTree retained an element of discretion over whether or not to execute a further agreement.”

The practical takeaway from the decision is that any offers have to be “plain and obvious to the reader — not just to lawyers or to judges, but to business people, to non-legally trained people — that the document in question was never intended to be a binding agreement, and was only intended to help guide the parties through the negotiation with a view to entering into a more robust agreement, once the once the key terms had been settled,” says Paul Boshyk, a partner in McMillan LLP's Advocacy & Employment Law Group in Toronto.

In this particular case, the employer didn't intend for the original document to be a non-binding term sheet, he says.

“In the absence of that really, really clear and obvious language, there's always going to be an immense risk that the term sheet will be viewed as the employment contract itself. And I think that the employer in this case fell into the trap of not including that really plain and obvious language… ultimately, that was their downfall.”

In this case, the judge found that the original offer contained enough information to be an agreement, says Andrew Monkhouse, founder and managing partner at Monkhouse Law in Toronto.

“He found that there was an intention to enter the contract and even though what they would call a term sheet, but could be called a sort of job description, doesn't contain all of the information relating to the employment, it was sufficient for the parties to work on and, therefore, was an enforceable contract of employment.”

Why use term sheets?

Typically, this type of approach is used to negotiate the essential terms and conditions of an employment relationship in a non-binding way, says Boshyk.

“It's a common tool that's used a lot… in the context of commercial transactions — when the purchaser is wanting to negotiate terms and conditions of employment with key employees from the target company.”

In addition, a lot of employers use these term sheets when they're negotiating with potential executives, especially in looking to hire or recruit somebody away from existing employment, he says.

“The reality is that those executives are going to want assurances about what their employment with the new prospective employer will look like, before they go too far down the road of doing things like giving notice to their current employer. So we see these term sheets used a lot, actually, in the day to day of employment.”

Often the terms of these terms or job descriptions focus on the positive side of things rather than the negative ones, says Monkhouse.

“You focus on things… that are going to attract someone to a position, not the things that might make them concerned about the position,” he says. “People want to focus on the positives, but companies have an interest in slipping in onerous terms on termination as much as they can, even if they are in that honeymoon phase.”

When parties are negotiating a term sheet, the employer is still in recruitment mode and doesn't want to scare off a key employee by introducing terms into the negotiation around the relationship ending, says Bolshyk.

“Just as a practical matter, and as a business point, there is a lot of hesitancy on the employer side to start raising things, to start raising issues of termination, and issues of non-solicitation and non-competition.”

HBC recently faced challenges after terminating a long-time employee.

The risks of employers using term sheets

Too much negotiation might not be a bad thing, but the risk is that the term sheet becomes the employment agreement, he says.

“And when you try and get a second employment agreement — a more robust employment agreement with termination provisions and restrictive covenants, and IP assignment provisions, all the things that the employer typically wants in order to protect itself — it may not be enforceable if the term sheet was, in fact, an employment agreement in the first place.”

Mishandled, these term sheets set up liability for employers, says Monkhouse.

“With any employment contract — for a stockbroker, janitor to the president, in this case — you could run into issues about contractual interpretation otherwise, with the employee arguing that the first document they got, and not the later document, is the true employment contract.”

Tips on how to use term sheets properly

So what are best practices around term sheets? For one, if you do send an employee something that outlines the terms of employment, pre-employment, make sure that one of the terms states that a future, more detailed contract will be signed, says Monkhouse.

“So you’d outline ‘Here's the salary, here's the vacation,’ whatever those details are, but then say that a future, more fulsome agreement would be signed by the parties as one of those terms. So that way, it's clear that there would have to be that future agreement that would come later,” he says.

“You can always make the agreement conditional on signing more detailed terms later. And then if that precondition doesn't happen, then the contract doesn't come into being.”

Some employers love using these term sheets for, essentially, any type of employee – but that’s not advisable, says Bolshyk.

“These term sheets can be really valuable tools when it comes to recruiting talent, but you should be limited because of the risks,” he says.

“If you think that you need a term sheet, it had better be for a legitimate business reason. And usually that translates into executives, other key employees, people who have special experience or training or skill sets that would be invaluable. But I think that for rank-and-file employees, the vast majority of employees, a term sheet is not going to add a lot of value at the end of the day, and is only going to cloud things and increase the employers risks.”

That could be, for example, phrasing such as “This is a non-binding document and no agreement is in force or effect until the parties enter into a subsequent agreement containing customary terms regarding termination, et cetera,” says Bolshyk.

Fresh consideration protects employers

One notable part of the decision is that the employer provided additional consideration when the two parties entered into the new agreement.

It’s a smart move, according to Bolshyk.

“In addition to making it obvious to everyone that this document is a non-binding negotiation tool, when you do enter into the more robust agreement, keep a little something in your back pocket to give to the employee so that there's consideration for the second, more robust document — in case there's ever cause to call into question whether the original agreement was meant to be binding.”

That could be a small signing bonus, small equity grants or an additional week or two of vacation, for example, as seen with this case “to protect against a future argument that the term sheet was actually an agreement,” he says, adding this proves the new agreement has sufficient consideration, and therefore it cancels, supersedes and replaces the term sheet.

If the first contract is found to be an actual contract, it can only be changed with consideration, says Monkhouse.

In this case, the court considered the company’s additional $40,000 payment created that consideration, “and therefore the second employment contract was enforceable,” he says.

“It has to be something in addition to what they would have gotten. And it should be clear that they get something extra, otherwise, there's no consideration, which means the second contract would not be enforceable.”