When you’re negotiating a business contract, you always need to be sure that the terms are in your favour, otherwise you can get yourself into a situation that’s legally binding and hard to get out of.
Heads of terms agreements, which can be legally binding, give all parties forming a business relationship an idea of the other sides expectations, before a contract is formally drawn up.
They need to be carefully negotiated to avoid an unfavourable legally binding agreement.
When wisely put together, heads of terms agreements can help save your business time and money, as there will be no need to undo certain elements of a contract.
In this article, we cover:
What’s included in a head of terms property transaction
The benefits of heads of terms agreements
The risks of using heads of terms
Whether heads of terms can be legally enforced
Do heads of terms need to be signed?
How does subject of terms relate to heads of terms?
What do heads of terms mean?
Heads of terms are essentially the basic elements of what a contract will include, written down in a short document. They are often used in commercial deals, for example the purchase of a business.
They allow you and the other parties in the contract to be on the same page and work from the same assumptions about how your deal will work in practice.
This gives both sides of a business agreement the opportunity to mull over the particulars of a deal before committing to something that potentially won’t suit them.
Heads of terms can include the red lines of the deal, such as the dealbreakers and the broad terms of what you will negotiate on. The detail is then left for a solicitor to deal with, carefully crafting a contract to ensure all the terms are correctly worded to be legally binding.
So put simply, heads of terms act as the skeleton of a contract. They can also be known as letters of intent or heads of terms documents.
What are heads of terms in a property transaction?
When heads of terms are used in property transactions, they outline the basic terms agreed between parties before a legally binding lease is drawn up.
They are also used in commercial property sales, but are known as a memorandum of sale. They work in the same way as other heads of terms agreements by setting out the basic terms of an agreement between a buyer and seller before the contract is drafted.
In commercial property, heads of terms are written out by the landlord or the agent of the seller and aren’t usually legally binding.
What is included in heads of terms?
Heads of terms agreements include basic information and key indications related to a contract. The purpose of the agreement and any cost involved should be included, as well as any hard lines which will cause the contract to be considered void. Confidentiality clauses are valuable to ensure the nature of the deal is not revealed and most businesses include details about protections that are in place in case the deal falls through.
Typically heads of terms include the following:
Key terms
Information relating to both parties
Confidentiality clauses
Exclusivity clauses
The price or rent in property transactions
A timeline for completion
Issues that require further discussion
The length of the agreement
What are the benefits of using heads of terms?
There are many benefits of using a heads of terms agreement - primarily they ensure that both parties are singing from the same hymn sheet and gives each party the opportunity to make changes to their agreement before signing a legally binding contract.
The benefits of heads of terms agreements include:
Highlighting commitment – towards the contract negotiations, ensuring that momentum is kept up
Demonstrating progress – agreed upon points can be included in the heads of terms and put to one side, this way focus can be turned to unresolved issues
Saves time – as all agreed upon points are in one document, rather than spread across emails and various documents both paper and digital
Reference point for third parties – including solicitors who will draft the contract on which the heads of terms is based. Other thirds parties like regulators may need to approve the deal between you and the other business. A non-binding heads of terms agreement allows a third party to review the terms and consider whether they would allow the terms to be crystallised into a legally binding contract
Some terms can be legally binding – this allows both parties to agree terms on one element of the deal
What are the potential risks of using heads of terms?
Heads of terms aren’t always legally binding - in some cases certain elements of them are and others aren’t. We’ll explore when heads of terms agreements are legally binding below.
On most occasions, both parties would prefer not to create legally binding heads of terms agreements. However, there is a risk that legally binding terms are created unintentionally, which means you might be liable if you later break a term included in the agreement.
In this case, it is important to include a provision which expressly defines whether the heads of terms are legally binding, or which specific clauses are, if any. Often the confidentiality agreement included in heads of terms documents are enforceable under the law.
Even when heads of terms are not legally binding, they can be used as evidence to point out the intentions of the parties that enter into a contract. So, if a rectification claim can be made, in effect this can take precedence over a binding legal contract.
Rectification powers are available to the court and can be used when the contract doesn’t reflect the deal that was originally outlined in the heads of terms agreement.
Is a heads of terms agreement legally binding?
Under the Law of Property (Miscellaneous Provisions) Act 1989 heads of terms agreements are legally binding if they are:
In writing
Include terms expressly agreed by all parties
Signed by all parties
Include offer, acceptance, consideration and an intention to create a legal relationship
Offer, acceptance and consideration are the key building blocks that make contracts legally enforceable.
It’s worth remembering that some terms in an agreement can be legally binding and some not - it really depends what’s included in the document.
Are heads of terms legally enforceable?
Typically, heads of terms agreements aren’t legally enforceable.
Some of the most commonly enforceable elements in a heads of terms document include:
Exclusivity – terms obligate each party to negotiate exclusively with the other so that the deal goes ahead smoothly without any wasted time talking with third parties
Confidentiality – as they contain sensitive details the nature of the agreement is usually confidential between the parties involved. This means the terms in the agreement cannot be discussed with outside parties. For confidentiality terms to be respected they need to be legally enforceable, for this reason a legally binding obligation is usually put on all parties involved including all solicitors helping to draw up terms
Negotiation – some agreements will include terms that make it a legal obligation for you to act in good faith - this means you must do everything in your power to make the agreement work for you and your partners. If you do not, other parties may be able to enforce damages claims against you
Closing costs – some agreements force businesses to pay admin fees or legal fees at the end of the contract or transaction. These fees only apply if a deal is completed
Should I use a heads of terms agreement?
Whether you should decide to use a heads of terms agreement prior to signing a contract with another party depends on your circumstances and relationship with the other party.
They can be useful in complex transactions. By setting out the proposed terms of agreement as early as possible, both parties can quickly work out whether the deal is acceptable before deciding to readdress certain areas and commit more resources towards finding a suitable arrangement, or pulling out of the deal entirely.
It’s always a good idea to consider expert legal assistance before committing pen to paper on a heads of terms document.
Do heads of terms need to be signed?
As heads of terms are not usually designed to be legally enforceable, they do not always have to be signed. However, when agreements are signed by all parties, this is one prerequisite for heads of terms to be legally binding.
In many cases all parties will sign a heads of terms agreement as this demonstrates an intent to acknowledge the agreement.
The document may reference other documents that need be signed to ensure the deal goes ahead.
What does subject to contract mean in heads of term agreements?
Often the terminology ‘subject to terms’ is included in heads of terms, or agreement in principle may be used. This is typically done under the assumption that this prevents the terms included from being legally binding.
If you want to avoid giving the impression that you intended to enter into a contract with the other parties, subject to contract wording should be used.
However, even when this wording is used, a contract can still be entered into if either party starts performing the obligations laid out in the agreement before the iron clad contract is finalised.
Lawhive can help you draft heads of terms agreements
If you want help drafting a heads of terms agreement, we can help. To avoid unwittingly entering into a contract, or to make sure you understand everything you are agreeing to, ask one of our solicitors about including a subject to contract clause in your heads of terms document.
For personalised help with drafting a contract or commercial lease, get in touch with our legal assessment team today.