Heads of terms

Barry Riley

Heads of terms

Heads of terms (also commonly referred to as  a memoranda of understanding, heads of agreement or letter of intent) set out the terms of a commercial transaction agreed in principle between the parties.

They are generally contained in a short document, outlining the main terms  which have been agreed. They help evidence serious intent, and have moral force, but do not legally compel the parties to conclude the deal on those terms or even at all.

There is no standard form for heads of terms. They often vary from a simple letter (which is probably the most common format) to a carefully drafted document prepared by advisers. Although it is more common for the preparation of this document to be prepared by the buyer, there is no set convention that must be followed when it comes to putting together heads for an acquisition.

Purposes

Heads of terms are used for a number of reasons:

–  To provide a  written confirmation of the main terms agreed in principle between the buyer and the seller;

–  To outline the proposed and expected timetable, as well as any obligations of the parties during the negotiations.

–  As a framework for certain preliminary legally binding clauses, such as exclusivity.

Heads of terms are usually entered into at the outset of an acquisition, once the parties have come to an agreement on terms, prior to the commencement of detailed (and often time consuming) due diligence and the drafting of a definitive agreement. This is because these two key stages is where significant costs really start to rack up.

Legal effect of heads of terms

Subject to contract

It is a well-established principle of English law that an agreement made on terms that the parties do not intend to be legally bound unless and until they enter into a more formal contract is not itself legally binding. The use of the traditional words “subject to contract” in negotiations is sufficient to create a very strong presumption that this was the intention.

Only in “very strong and exceptional” circumstances will the courts be prepared to find that the parties actually intended to be bound when these words are used.

Under English law, the “subject to contract” formula is simply a short and widely-recognised method of making a point that can equally be made in other, if not fewer, words. Where the formula is not used, however, the heads of terms must make it entirely clear that the parties intend them to be a non-binding pre-agreement, rather than a binding but conditional agreement.

Binding provisions of heads of terms

Where the heads of terms include provisions which are intended to be binding, these must be clearly identified and the legal requirements for creation of a valid contract must be satisfied:

-The terms must be sufficiently certain to be enforceable; and

– There must be consideration moving from the party benefiting from the agreement to the other party, either in the form of a promise in return, or a payment, action or forbearance.

For more information on Heads of Terms, their legal effect, or their role in respect of private acquisitions, please contact Barry Riley on 0117 9453 042 or briley@metcalfes.co.uk.

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