What is a Heads of Agreement?
You may have encountered a Heads of Agreement under one of the other names by which it is sometimes known: term sheet, memorandum of understanding, letter of intent, or perhaps under one of the many acronyms which are also commonly used: HoA, MoU or LoI.
But what are we talking about?
Essentially, no matter its name, a Heads of Agreement is a written record which aims to summarise and clarify the intent of the parties to a potential transaction, the structure of that proposed transaction and its key terms. It is typical for Heads of Agreement to also include provisions regarding confidentiality, exclusivity, the enforceability of that document, timeframes around next steps and any other matters which have been agreed at that time. It is not intended to serve as an exhaustive list of terms and conditions.
Is it binding?
It depends – sometimes they are, sometimes they are not. That seem confusing? You’re right, it can be.
The parties to a Heads of Agreement may choose whether or not it is binding on, or enforceable against, them. It is possible for a Heads of Agreement to be binding on the parties in its entirety, or not at all, or for it to be binding in part only (in these instances, it is usually those provisions dealing with confidentiality, exclusivity, due diligence and costs which are binding).
If that is not confusing enough, add to that the fact that Heads of Agreements are signed by the parties, an action usually associated with giving an undertaking to be bound.
So how do you know if it is actually legally binding?
To be legally binding, a Heads of Agreement should:
- clearly and with certainty set out the terms and conditions which have been agreed by the parties at that time; and
- clearly convey that the parties intend to be bound by that document.
If you have any doubt, you should seek advice before signing a Heads of Agreement.
Benefits
When the parties to a transaction are keen to “just get it done” it may sometimes seem illogical to (seemingly) delay the transaction by spending time (and money) preparing a document which may not even be binding.
In fact, often the very opposite is true and Heads of Agreement can be very beneficial in a number of ways, including that they:
- Record the key terms agreed by the parties at the time;
- Provide the parties some level of comfort and assurance and so allow them to continue discussions in good faith;
- Provide a means for creating binding obligations around confidentiality, exclusivity, due diligence and costs (and so provide greater protection for the parties during the negotiation phase of the transaction);
- Assist in focussing the parties on key issues, the mechanics of the transaction, and other questions which may otherwise only have been discovered much later in the negotiations;
- Clarify the parties’ understanding of the proposed transactions and the key terms and conditions;
- Provide a structure or framework for subsequent formal agreements;
- Aid the drafting of subsequent formal agreements and other transaction documents (potentially resulting in cost and time savings).
Disadvantages
Although not the intention of the parties, a Heads of Agreement could be written in such a way as to be binding on them. However, given the common assumption that Heads of Agreement are not binding, less diligence is sometimes taken in reviewing or seeking advice regarding their terms before signing. Consequently, the results for the parties can range from unintended to quite disadvantageous.
To avoid these situations, Heads of Agreement should be clearly written and with certainty as to their terms. It is our recommendation that parties seek advice at the early stages of a transaction and before signing a Heads of Agreement.
If you have any questions about this article, or would like us to prepare or review and advise on a Heads of Agreement for a transaction in which you are involved, please feel free to contact Frank Law on (02) 9688 6023.
This is not legal advice.
