Heads of Agreement: What you need to know!

A ‘Heads of Agreement’ is a document that is commonly used in pre-contractual negotiations that provides a framework of the proposed terms of an agreement between the parties. It may be used, for example, for the purchase of a business, for the entering into a lease or other commercial agreement.

A Heads of Agreement may also be referred to as a Letter of Intent, Memorandum of Understanding, Terms Sheet and so on.

A Heads of Agreement is often used in a commercial setting, where the parties want to mutually “commit” to securing a formal contract.

What does a Heads of Agreement usually include?

A Heads of Agreement will vary depending on the commercial transaction but, will generally include:

• Details of the parties that are involved in the transaction;
• The consideration/price (if any);
• Key terms agreed between the parties;
• The intent to cooperate and secure a formal contract;
• What clauses are intended to be binding;
• Any conditions that must be completed before the final transaction occurs;
• Each party’s rights and obligations; and
• Clauses addressing pre-contractual issues of confidentiality, exclusivity, intellectual property rights, due diligence etc.

Is a Heads of Agreement required?

A Heads of Agreement is not legally required in order to later enter into a contract or agreement.

Is a Heads of Agreement legally binding?

Generally speaking, Heads of Agreement are not intended to be legally binding on the parties. However, it is always prudent to seek legal advice based on the document that you have signed, particularly if the other party is trying to enforce terms of the Heads of Agreement.

As to whether the Heads of Agreement is legally binding, comes back to the very concept of whether the document (irrespective of its title), is deemed to be a contract. For a contract to be formed, there must be offer and acceptance, meeting of the minds, consideration, capacity and legality.

Whilst the Heads of Agreement may not be considered a contract, there are certain clauses that may be legally binding such as confidentiality, exclusivity, intellectual property rights and due diligence clauses.

For example, it is typical to see a confidentiality clause in a Heads of Agreement that provides that the terms of the Heads of Agreement is strictly confidential and that the confidentiality clause is legally binding on the parties and survives termination of the Heads of Agreement.

Should you enter into a Heads of Agreement?

There are pros and cons to entering into a Heads of Agreement, some of which we have set out below.

Pros:

• Good way for the parties to negotiate key terms of an agreement before entering into a formal contract.
• Provides the freedom to do a deal quickly but also walk away if contract terms are not later agreed. This generally results in smoother negotiations.
• The lack of detail of key terms in a Heads of Agreement usually results in less disagreement between the parties and provides more flexibility in settling the final contract.
• A Heads of Agreement may save time and expense of parties drawing up a detailed and binding contract.
• Where parties progress to a final contract, the Heads of Agreement provides a framework for the contract.
• Useful to provide a Heads of Agreement to a lender (where finance is ought) showing that the parties intend to commit to a formal contract, so neither party wastes unnecessary time or money.

Cons:

• The most common risk involved with entering into a Heads of Agreements is that they are drawn up in a way that it is legally binding (either in whole or in part), even though this may not be the intention of the parties.
• Heads of Agreement are often drawn up by parties who are not lawyers which may result in unintended consequences.
• Uncertainty on whether the Heads of Agreement is binding or not.
• Due to the non-binding nature of the Heads of Agreement, one party may be much more committed to entering a formal agreement than the other. If one party decides not to proceed or comply with the agreement, the other party will (most likely) not be able to recover any remedy if they have acted in reliance of a formal contract being entered into. Remedies will only be available where binding terms have been breached.

Tips:

• Make sure the parties’ details are correctly recorded i.e. the full legal entity and ABN/ACN.
• Ensure the Heads of Agreement is signed by authorised persons for the parties.
• All essential terms should be addressed, including consideration.
• Do not record anything in the Heads of Agreement that you are not prepared to be bound by.
• Ensure the Heads of Agreement expressly states which terms are legally binding and which are not.
• The words and language in the Heads of Agreement are so important. Always seek legal advice on the terms and enforceability of the Heads of Agreement.

Please do not hesitate to contact our Property Team at Burke Lawyers.