Heads of agreement or heads of terms are used to document the key points of an agreement made between two or more commercial parties before formal, legally binding contracts are entered into, usually when they are involved in initial negotiations. Heads of terms are effectively an “agreement to agree” and do not create a legally binding agreement, except where specifically stated. They generally take the form of a fairly short document, and are used in a range of commercial contract situations.
Heads of agreement or heads of terms are not usually a legal requirement, but they do have certain advantages and allow the parties to document the key terms of the proposed contract before they enter into ongoing negotiations. By entering into a heads of terms document, the parties will have expressed their intent to create legal relations but not entered into a full blown commercial agreement with the other party.
Heads of agreement or heads of terms are not usually considered legally binding unless they expressly state otherwise. Typically heads of terms will include only a handful of legally binding elements, for example relating to any exclusivity period (see below) and confidentiality provisions.
Whilst the majority of the contents of heads of agreement or heads of terms are not usually legally binding some of the obligations contained within the heads will require the parties’ specific performance of those legal obligations.
Agreeing heads of terms will be subject to further negotiations in relation to a detailed commercial contract. Rather than being a legally binding contract, heads of terms should be viewed as a statement of intent by both parties.
It is important to expressly state whether certain provisions are intended to be legally binding or not. However, by using heads of agreement at the early stages of negotiations, terms that have already been expressly agreed can be documented in the heads of terms, after which the parties can move onto negotiate a binding contract further down the line, which will contain the obligations of the parties in relation to the ultimate deal.
The significance of whether a clause is legally binding or not will impact what happens if one or both parties breach the terms of the agreement. For example, failure to meet a non binding target completion date will not be actionable – it would simply be a record of the intent to complete by a particular date, rather than a binding agreement. However, non compliance with a legally binding confidentiality or exclusivity period could lead the defaulting party to be liable for the damages and costs of the other party.
Most commonly heads of agreement or heads of terms are used before two parties or more enter into a proposed commercial contract. The heads of terms could be for a significant commercial transaction, setting out the intent of the parties as to the key aspects of how they will do business together. They may also be used in a term sheet ahead of an investment, the sale and purchase of a business, or if several parties intend to enter into a significant joint venture.
Other transactions where heads of terms are commonly used include a commercial lease or other commercial property transactions, a complicated intellectual property deal, a other significant commercial agreement, and any other important commercial deal. Heads of terms are typically described as non binding heads or sometimes a term sheet.
One of the main benefits of preparing heads of agreement or heads of terms is to allow the parties to iron out the key terms of the agreement at the early stages of the deal before they get into negotiations in relation to the finer points of the deal later down the line with a view to entering into a final commercial agreement. The intent of the parties is not to create binding legal relations but rather to set out an intent to be legally bound in a future agreement that further negotiations will lead to. Heads of terms can also be useful to set down the parties expectations of not only the terms of the agreement, but how the transaction will be approached – for example, when completion might take place, whether there are any pre-conditions to completion, how any commercial property issues might be dealt with and who will be preparing the initial drafts of the formal agreement for the deal.
By putting into place the basic terms in heads of terms it will help the parties clarify any misunderstandings and highlight any major contractual issues or deal breakers at an early stage by setting out their intended obligations at an early stage in the negotiations. Setting down the terms expressly agreed between the parties can reduce the chance of the negotiations becoming protracted, or stalling at a late stage, causing a waste of time and money for the parties, particularly if they intend to go through a lengthy and costly due diligence phase, ultimately leading to a detailed contract.
Heads of agreement or heads of terms can also be useful if the parties wish to agree a period of exclusivity in respect of the proposed transaction. For example, if used in the context of selling a business, the buyer might want some comfort that the seller won’t be pursuing competing offers when the buyer is incurring fees and management time in progressing a deal they thought was agreed.
Typically, exclusivity is one of the legally binding terms commonly seen in heads of terms, because one party is likely to rely on that agreement in order to progress the transaction, often at great expense. This type of clause needs to be legally binding, as an incentive to keep a party committed to the agreement.
Before reaching a final agreement on a period of exclusivity, both parties should think carefully about what period of exclusivity is reasonable, and which party has the most leverage in negotiations over that.
It is usually beneficial to have the draft heads of agreement terms (even at terms sheet stage) checked or drafted by a lawyer, to ensure that they correctly reflect the intention of the parties and that the terms document what has been agreed in principle. A lawyer will be able to check which provisions in the heads of terms are legally binding, to ensure that the parties are not inadvertently committing themselves to a binding timeline or purchase price which they might not be happy with later on once further information about the proposed transaction has become available.
Even if heads of agreement or heads of terms are not legally binding, from a commercial and practical perspective, it can often be difficult from a commercial perspective to renegotiate new terms that have not been set down in the heads. In some circumstances (commonly investments) there will often be legally binding costs consequences if one party seeks to walk away from a transaction after signing heads of terms if they have simply changed their minds on agreed terms. Therefore, it is important to ensure that you are happy with all of the key terms set out in the heads of terms document.
By taking expert legal advice at the outset, a party can save itself unnecessary costs. In addition, we would always recommend taking further advice before walking away from a deal or breaching anything set out in the heads of terms to check whether the relevant provisions are legally binding, and whether by walking away any potential liability might be incurred.
Heads of terms do not need to follow any particular format and often taken different forms such as:
The form the heads of terms is not important. The key issue when drafting heads of terms is ensuring that the key elements which have been agreed in principle are clearly set out and understood. It is also important to ensure that there is clear evidence that both parties have agreed to the heads of terms – this especially important where the heads of terms contained legally binding terms, as in order to rely on them later a party will need to establish that they have a binding legal document. Practical tips to ensure that you can demonstrate this include:
We would advise ensuring the heads of terms are signed or counter signed wherever possible.
Heads of terms will typically contain some or all of the following provisions to document the intent of the parties:
By entering into heads of terms the parties intentions including any intended legal obligations can be expressed before they enter into a binding legal contract setting out their respective obligations. This will hopefully avoid legal issues arising at a later stage which might potentially scupper the negotiations on the way to agreeing a full blown commercial agreement. However, during this period, the parties might need to exchange confidential or commercially-sensitive information in order to progress negotiations on the heads of terms.
In these situations, the parties may wish to consider entering into a separate, legally binding non disclosure agreement (also referred to as a confidentiality agreement). This type of agreement ensures that if parties are exchanging confidential information at the early stages of their negotiations, the receiving party will be obliged to keep the information confidential and shall not be permitted to share that more widely.
For more information on confidentiality agreements, please see Confidentiality Agreements and NDAs
If you need any advice on Heads of Terms please contact a member of our corporate and commercial law team in confidence here or on 02920 829 100 for a free initial call to see how they can help.
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