What do we mean by Heads of Terms?
Heads of terms (HOTS) are also known as letters of intent, memoranda of understanding, heads of agreement, letters of potential interest, term sheets or protocols. This document sets out the terms of a commercial transaction agreed in principle between parties in the course of negotiations. HOTS evidence serious intent and have moral force, but do not usually legally compel the parties to conclude the deal on those terms or even at all.
When do we use Heads of Terms?
HOTS are commonly entered into at the beginning of a transaction, once preliminary terms have been agreed and before commencement of detailed due diligence and the drafting of definitive agreements (which is where the parties will begin to incur significant costs). The parties may enter into a series of HOTS throughout the negotiations, particularly when negotiations are prolonged.
What are Heads of Terms used for?
HOTS are used in a variety of commercial property transactions such as the sale, purchase or lease of a petrol station, but also loan finance and other transactions, including public mergers and acquisitions, joint ventures, project financing and private equity investments.
HOTS are used for a number of purposes:
- As written confirmation of the main terms agreed in principle.
- To outline the timetable and obligations of the parties during the negotiations.
- As a framework for certain preliminary legally binding clauses such as an exclusivity agreement (more on these in a future article).
Clear and relatively detailed HOTS are valuable. Have the parties considered the structure of the transaction? If a sale of a business, has the tax position been considered, the future of employees and the pros and cons of a transfer of a business as a going concern or a share acquisition? Failure to iron out such important features will likely result in increased legal costs so tackle them early.
Why are Heads of Terms important?
Lawyers find HOTs a useful reference point when negotiating the technical and legal points of contracts. There will still be legal points to thrash out, but the risk of any unexpected commercial issues arising during the final stages of discussions is reduced.
HOTs can include provisions to protect the confidentiality of the negotiations and restrict the parties from sharing details with third parties. An exclusivity period can also be established, stopping the parties entertaining other offers. However, this provides a moral obligation rather than a contractual one.
Are Heads of Terms legally binding?
If drafted inappropriately, particularly without legal advice, HOTS can be risky documents to use. Any ambiguity can cause uncertainty as to the exact nature of the relationship between the parties. There can be doubts over whether or not the parties had intended to be legally bound by the whole document or by particular terms within the document.
The basic legal requirements for the formation of a binding contract are:
- Offer
- Acceptance
- Consideration
- Intention to create legal relations
- Certainty of terms
Space does not allow us to examine each of these requirements in detail (yet another article!) but the Courts have had to examine what parties probably intended to be “heads of terms” and rule as to their enforceability.
However, most uncertainties can be eliminated or at least reduced by clear drafting.
The expression “subject to contract” may help to rebut the presumption of a legally binding contract. But simply labelling heads of terms “subject to contract” will not make them immune to the argument that a contract has been created, particularly if the parties start to perform the contract envisaged by the heads of terms. To make the position completely clear, it is preferable for heads of terms to spell out the parties’ intention expressly, rather than simply relying on the shorthand label “subject to contract”. For example:
“These heads of terms are not intended to be legally binding between the parties except as specifically set out in this letter“.
If parties do not include an express statement that the HOTs are not binding, the document must then make it entirely clear that the parties intend it to be a non-binding agreement, rather than a binding but conditional agreement. In the latter situation, a court may infer an obligation to use best or reasonable endeavours to satisfy the conditions. Courts have found that HOTS may carry moral force which could restrict a party’s future options.
Conclusion
Good quality HOTS are essential if parties wish for a smooth, non-protracted transaction. Too often we as lawyers are told “this one is straightforward” when what this actually means is that crucial aspects of the deal have not been negotiated. So, ensure you use professional agents, experienced at negotiating and drawing up HOTS and ensure that you speak with your accountants and lawyers at an early stage.
This article originally appeared in Petrol Heads-Up.
FAQs
Also known as letters of intent, memoranda of understanding, heads of agreement, letters of potential interest, term sheets or protocols. A document which sets out the terms of a commercial transaction agreed in principle between parties in the course of negotiations.
Are heads of terms binding? ›
A head of terms document is generally an agreement in principle, but there is usually no legal obligation for the two parties to complete the transaction on these previously specified terms. There may be a moral obligation to do so, but the head of terms cannot usually be legally enforced.
What is the exclusivity clause in heads of terms? ›
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.
What are the heads of terms in M&A? ›
Heads of terms set out the most important terms of a merger and acquisition, such as the price the buyer will pay the seller for the company.
What is a commercial transaction example? ›
Examples of Commercial Transactions:
The sale of a business. The sale of real or personal property.
What is considered a commercial transaction? ›
Commercial transactions is generally defined as some sort of payment for a good or service. There are many forms of commercial transactions, including those that occur between two separate businesses, consumers and businesses, businesses and government entities and between internal divisions of a company to name a few.
Is a heads of agreement a legal document? ›
Heads of agreement can be binding or non-binding, depending on the language used, though they are not generally binding. That said, some aspects, such as intellectual property, exclusivity, confidentiality, and non-solicitation provisions, tend to be binding, though only if the time-frames are reasonable.
What is the purpose of the heads of terms? ›
Heads of terms are an agreement in principle between two parties, but which are subject to a formal contract. A heads of terms document sets out the key commercial principles which the parties have discussed during their negotiations and which they intend will form the basis of a future, more detailed contract.
Is binding legally enforceable? ›
A “binding contract” is any agreement that's legally enforceable. That means if you sign a binding contract and don't fulfill your end of the bargain, the other party can take you to court.
Are exclusivity clauses legal? ›
Exclusivity clauses are generally enforceable when they are properly drafted. Federal law typically permits exclusivity clauses in contracts, as do most state laws. Specific restrictions may be imposed depending on the nature of your contract, what services you provide, and the terms of the agreement.
This prevents the landlord from putting competing businesses in the same plaza, mall or building. For example, a coffee shop might have an exclusive use clause that prohibits the bookstore next door from adding a coffee bar, since that would put them in direct competition.
How do you negotiate an exclusivity clause? ›
- 1 Define your goals. Before you enter into an exclusivity negotiation, you need to have a clear idea of what you want to achieve and why. ...
- 2 Research the market. ...
- 3 Prepare your proposal. ...
- 4 Engage in dialogue. ...
- 5 Seek mutual value. ...
- 6 Finalize the agreement. ...
- 7 Here's what else to consider.
The three traditional ways of structuring an M&A deal are asset acquisition, stock purchase, and mergers. The methods can also be combined to achieve a more flexible deal structure.
What is the role of directors in M&A transactions? ›
Strategic Oversight: The board of directors is responsible for providing strategic oversight and direction during the M&A process. This includes setting the company's strategic goals, identifying potential acquisition targets or buyers, and determining the desired outcomes of a transaction.
What are the heads of terms? ›
Heads of terms are an agreement in principle between two parties, but which are subject to a formal contract. A heads of terms document sets out the key commercial principles which the parties have discussed during their negotiations and which they intend will form the basis of a future, more detailed contract.
What is the head of terms in business? ›
Also known as a "heads of terms," or "letter of intent," a heads of agreement marks the first step on the path to a full legally binding agreement or contract and a guideline for the roles and responsibilities of the parties involved in a potential partnership before any binding documents are drawn up.
What are considered commercial terms? ›
Commercial Terms means the Loan amount or the financial facility applied for or availed of by the Customer from BFL and includes the EMI, Loan tenure, applicable interest, fees, charges and such other payment terms.
What are some commercial terms? ›
Commercial terms are the provisions in a contract that relate to the business aspects of the transaction, such as the scope of work, the deliverables, the payment terms, and the performance standards. Commercial terms are usually negotiated by the parties and are based on their business objectives and expectations.
