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Heads of terms agreement

Heads of terms are a document setting out the main terms of a commercial agreement reached between parties in a transaction. Heads of terms can also be known as a letters of intent or memoranda of understanding.

Following the parties initial negotiations, heads of terms are prepared to set out the agreed basic terms of a contract or commercial lease before the finer details are negotiated.

Although heads of terms are usually not legally binding, the document records the future intentions of parties wishing to take part in a transaction but does not enforce obligations on them.

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Heads of terms will usually cover these basic features and major points:

  • The price
  • The identities of the parties
  • The fundamental purpose of the contract
  • The terms of the contract/transaction
  • Confidentiality agreements
  • Any protection for the parties in the event of a failed transaction
  • Any unusual provisions which are key to whether a party would proceed with the transaction or not

In addition, heads of terms can also highlight any major issues or irreconcilable differences/misunderstandings between the parties. These issues can then be resolved at an early stage. It is far better to do this at the outset, rather than during the course of a transaction when fees and expenditure may have been incurred.

In addition to these benefits, these agreements may contain ‘lock out’ clauses which can be legally binding. These lock out clauses stop the parties concerned from negotiating with any other party or person for a fixed amount of time. This is to stop either party from feeling pressured into going ahead with a transaction for fear that the other party is negotiating with someone else regarding the transaction.

Our commercial property team has extensive experience of drafting and reviewing heads of terms, letters of intent and memorandum of understanding. We can negotiate and draft heads of terms agreements regarding any kind of commercial contract or business transaction. The legal ramifications of heads of terms documents can be difficult to understand, and as such if you are about to enter into a commercial property transaction and need the help of a dedicated and experienced law firm to ensure your best interests are protected, we are able to assist.

For more information on heads of terms, contact a member of our specialist team on 01616 966 229.

Alternatively please complete our online enquiry form and a member of the team will contact you.

Benefits and risks of using heads of terms

The first complexity that heads of terms may introduce relates to whether or not they are legally binding. In most cases it will not be the intention of the parties to create legally binding Heads of Terms – they are essentially simply the skeleton for the negotiations and the legally binding documents that will follow. It is key to avoid creating legally binding Heads of Terms, as in their raw form, these will not fully reflect what the parties to the transaction want. As a result, it’s important to include an express provision as to whether or not they are legally binding when drafting them.

Using the words ‘subject to contract’ can also create the presumption that the Heads of Terms are not to bind the parties, however, this can be undermined if the parties start performing the obligations outlined in the Heads of Terms before the legally binding documents are finalised. This is particularly the case with respect to a short-term lease (under three years), which does not require a deed and where there is a disposition of an interest in land.

With respect to the latter, the risk comes from the Law of Property (Miscellaneous Provisions) Act 1989, which may assume the terms are legally binding if they are in writing, signed by all parties, include the terms expressly agreed by the parties AND they include offer, acceptance, consideration and intention to create legal relations.

The other risk area to be aware of with Heads of Terms is that even if they are not legally binding in themselves they can be used as evidence of the parties’ intentions with respect to the relationship. This could provide the basis for a rectification claim, which has the effect of overriding - or ‘rectifying’ – a binding legal document. There are a number of circumstances in which rectification is available to the court, for example where it is clear that the legally binding agreement doesn’t reflect the deal that the parties to it were trying to document.

So, how do you successfully employ Heads of Terms? They should be used to identify those issues that will provide the structure for a transaction and to raise at the start those that could stop it going ahead. A balance needs to be struck on the detail – not too much to tie the parties’ hands and not too little to provide no guidance when it comes to document drafting, resulting in confusion and delays. While it is customary for Heads of Terms to be left to the parties and their surveyors, it is worth involving a commercial property solicitor from the start, as this way any legal issues can be identified and dealt with early on. Given the consequences for a contract if the Heads of Terms are not used correctly, it is worth the early effort.

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