Term sheets and commitment letters are documents frequently used by lenders to outline the terms of a potential financing. However, these two documents differ with respect to what is required of, and whether the terms are binding on, the parties.

What is a term sheet?

A term sheet is a summary of the main business terms and possible options for a prospective financing. Term sheets are provided by lenders to prospective borrowers prior to a full underwriting of and credit approval by the lender. The terms are intended to be a starting point under which the lender will consider providing financing to a prospective borrower. Generally, parties are under no financial or legal obligation to each other based on the provisions of the term sheet.

What is a commitment letter?

A commitment letter is a document that intends to establish specific deal terms regarding an extension of credit from the lender to the borrower. Commitment letters are provided by lenders after a full underwriting of and credit approval by the lender and frequently contain identical business terms to the final agreed to version of a term sheet. To form a commitment letter, the letter must meet the following requirements:

A commitment letter differs from a term sheet in that it creates a binding agreement on the part of a lender to make a loan on the stated terms. In addition, a commitment letter generally requires that a borrower reimburse a lender for out-of-pocket expenses and possibly pay a break-up fee if the loan transaction does not close, whereas there is generally no obligation for the borrower to pay these costs and fees in a term sheet. Because of this, it is recommended that lenders obtain a commitment letter and a good faith deposit prior to engaging counsel or ordering any third party reports.

In drafting commitment letters and term sheets, lenders should be aware that:

  1. A statement that it is non-binding, is for discussion purposes only and does not constitute a commitment on the part of the lender;
  2. A general description of the conditions precedent to closing, such as receipt and approval of third-party appraisals and other customary due diligence deliverables; and
  3. A statement that the terms are subject to formal underwriting and credit risk approval.
  1. A general description of the conditions precedent to closing, such as receipt and approval of third-party appraisals and other customary due diligence deliverables;
  2. A condition that there has been no material adverse change in the borrower’s financial condition between the date of the commitment and the closing of the loan;
  3. A condition that the borrower may not shop competing financing or disclose the terms of the commitment letters to other lenders while the commitment is outstanding; and
  4. An accept by and close by date after which the commitment expires.

Understanding the differences between a commitment letter and a term sheet is critical and should be a point of emphasis to all lenders.

We would like to acknowledge the help of our 2015 summer associate, Preetha Suresh, in the preparation of this article.

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