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Heads of Terms in commercial property transactions

Head of terms is a document that sets out the intended terms of a commercial transaction. They are generally not legally binding, but act to show the intent to complete the transaction and can act as a starting point for further negotiations between parties.

Heads of Terms can provide a simple way to identify the needs of both parties to a commercial property transaction and can provide the basis for consequent negotiations.

They have the potential to speed up the process by introducing an element of clarity and focus from the start, however, like any additional layer to the transactional onion there is also the prospect that an additional complication may also be introduced. Below are some of the benefits and risks to bear in mind when using heads of terms in commercial property.

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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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