One of the first pieces of documentation that you will come across when negotiating major commercial transactions is the heads of terms agreement.

Heads of terms (HOTs) typically serve to:

• Set out the main terms of a commercial transaction
• Remove misunderstandings between two parties
• Save time at the negotiating stage
• Provide timeline guidance
• Be a source of information for third parties, such as regulatory bodies

Heads of terms may also be known as heads of agreement, letters of intent, term sheets or memoranda of understanding.

Although not usually legally binding, HOTs form a written record of intent to proceed with the transaction.

Understanding this process can help set even the most complex of transactions on the right path and ensure success further down the line.

In our latest update, we provide an insight into key things to consider before entering into a heads of terms agreement.

What goes into heads of terms?

The most important element is your key commercial terms.

HOT agreements will usually contain some or all of the following provisions:

• A statement of intent regarding the legality of the HOTs
• The main commercial terms
• Negotiated pre-conditions
• A timeline towards the progression of the agreement
• Dispute resolution
• Any period of exclusivity
• Confidentiality agreements
• Obligations of any of the involved parties
• The consequences of non-compliance

Once they have been agreed, the HOTs must be signed by all parties, either in-person or electronically.

Are heads of terms legally binding?

Heads of terms do not tend to be legally binding, however, it usually suits both parties to include some clauses that are legally binding, such as confidentiality and exclusivity, to prevent details of the transaction from being leaked, or one party seeking other offers.

It’s important to make sure that your legal intentions are set out clearly in the HOT agreement. For example, if a document does not refer to its legal status, then it may open to interpretation at a later stage. Courts have been known to enforce the letter of intent where a full contract has not yet been entered into.

Similarly, if you do not follow the proper procedures for making a clause legally binding, then this may result in an unenforceable contract.

For extra security, some parties may choose to employ a separate, legally binding non-disclosure agreement (NDA).

To avoid miscommunication, your language needs to be clear and avoid vague phrases.

Reliance on heads of terms

Legally, you do not have to put heads of terms in place prior to a transaction. It particularly may not be necessary if the transaction is simple and can be completed quickly. Their use should be proportionate to the complexity of the transaction.

However, there is a sound business case for putting an HOT agreement in place, for the mutual protection of both parties.

Heads of terms helps all parties involved to come to a mutual understanding and outline each party’s obligations, often creating a moral obligation.

As a statement of intent to progress with the transaction, both parties may later refer to the HOTs and terms agreed in principle when signing the contract.

By setting out terms and obligations prior to drafting and signing the contract, parties can speed up the transaction process. The HOTs can include whatever documentation that parties deem necessary. This means that you can integrate disparate information and agreements into one document. This is particularly beneficial when the timeline is long.

Do I need to seek advice?

Implementing heads of terms is a common practice, but they may present problems for either party if not prepared correctly or properly considered. Whilst they may not be legally enforceable, deviating away from the agreed terms can be difficult. You should therefore seek expert legal advice before entering into a head of terms agreement with another party.

Heads of terms are also usually put in place prior to the seller beginning any kind of due diligence on the business. This may mean that a lot of careful negotiations have been carried out, only for the transaction to stall at a later date.

To navigate this issue, you should be sure to set out any major issues or concerns during the HOTs phase. This can be done with the help of a solicitor.

Summary

When drafting HOTs, you should always consult an experienced solicitor to ensure that your agreement is not unintentionally legally binding, and that you don’t exclude any crucial information.

Heads of terms can be an incredibly useful tool when undertaking a large transaction – saving time and money, and simply laying out terms. Any HOT document should:

• Identify key terms and obligations of all parties
• Be clear in content
• Set out the legal status of relevant clauses
• Be reviewed by a legal adviser
• Cover conditions and assumptions made by both parties

For guidance on preparing and implementing heads of terms, please contact our expert team today.

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