Heads of terms can save your business time and money. By clearly setting out each party’s expectations at the outset of contract negotiations, you can avoid a ‘deal breaker’ issue cropping up later down the line, frustrating your efforts to reach an agreement.
Our commercial law solicitors can help you determine whether you need heads of terms and advise you on what to include, ensuring that your contract negotiations run smoothly.
In this guide we explain:
What are heads of terms?
Heads of terms are sometimes also referred to as a letter of intent, a memorandum of understanding, a heads of agreement, or a term sheet. Whatever name you use, the heads of terms is the document that deals with how the parties will work together before the signing of a contract. It can be a helpful first step on the road for various types of business agreements, including leases of premises or equipment, joint ventures, shareholder agreements, supply chain agreements, or any other commercial transaction you are starting to negotiate.
A properly drafted heads of terms will enable both you and your potential contracting partner to be sure that you are working on similar assumptions about how your planned business deal will work in practice. From the outset of negotiations, both parties will know in broad terms what they are prepared to bring to the table – having this set out in the heads of terms will provide a firm basis for the negotiations moving forward, and a sound framework for drawing up the final contract when the negotiation phase is over. It also reduces the risk of your deal falling through if both parties know from the start what their ‘bottom lines’ are, and what each expects to get out of (and put into) the proposed arrangements.
The heads of terms are the first step in your contract life cycle management, and, done properly, are a valuable tool in easing negotiations towards a successful outcome.
What are the advantages of using heads of terms?
The advantages of using heads of terms include:
- Demonstrating commitment – showing seriousness of intent towards the contract negotiation.
- Maintaining focus and showing progress – if a point is agreed upon, it can be included in the heads of terms, and the negotiations can proceed to the next topic or contentious point.
- Providing a deal ‘crib sheet’ – rather than wading through minutes of meetings or email exchanges, the heads of terms provide one concise working document setting out what is agreed. This can be useful both internally and when seeking external advice on the transaction (such as from accountants, lawyers, or other third-party experts) or when communicating details of the proposal to a parent company. The heads of terms will also be helpful when drawing up the final contract.
- Seeking regulatory approval – you may need approval from a regulatory body or competition authority, or you may need to secure funding or negotiate a back-to-back contract. Heads of terms will assist you in doing this.
There are some situations in which heads of terms may not be suitable, for example, in some circumstances they may be:
- Too time-consuming – the time taken to negotiate the heads of terms can be disproportionate to the benefits. Consider whether the parties have sufficient time and resources to deal with heads of terms.
- Unnecessary – if the commercial contract is straightforward, or you already have a longstanding business relationship with the other party, heads of terms may be an unnecessary complication.
Legally binding?
There is no straightforward answer to whether heads of terms are legally binding, as much depends on the context and circumstances. For this reason, it is best to obtain legal advice before preparing heads of terms, and certainly before signing heads of terms prepared by the other party. Here are the options:
- Legally binding – whether an enforceable contract has been created will depend on applying legal contract formation principles. A court will examine whether there was an offer and acceptance, whether any money was paid or other benefits were given, what the parties intended, and whether they established sufficiently precise terms. To avoid costly and time-consuming disputes about this later, it is essential to decide at the outset whether you want your heads of terms to be legally binding. Our commercial solicitors can ensure that you achieve this by drafting heads of terms that meet your objectives and are enforceable in court, if necessary.
- Non-binding – these are typically used to outline the key terms which have been agreed in principle, or to give a structured basis for negotiating the main contract later on. For example, you may need to enter into a series of non-binding heads of terms throughout your negotiations, particularly if the negotiations are lengthy or the transaction is complex. Our commercial solicitors can advise you on how to make sure you don’t inadvertently create a legally enforceable contract in this scenario.
- A combination of the two – the most common form of heads of terms is a partially binding one. The parties agree that specific terms will be legally binding (for example, confidentiality provisions or exclusivity terms), while others will not (such as commercial terms, including price and delivery obligations). Again, this will need to be carefully drafted, and our commercial solicitors can assist you with this process.
Should heads of terms be expressed as ‘subject to contract’?
Just because your heads of terms contain the words ‘subject to contract’ or ‘agreement in principle’, that does not necessarily mean that there is no binding agreement between the parties. Simply adding these labels will not make them immune to the possibility of a court deciding that a contract has been created, particularly if the parties begin to perform the contract as envisaged by the heads of terms.
If you do not want to be legally bound by the heads of terms, take expert legal advice from a commercial solicitor, as ‘subject to contract’ will not necessarily be enough to protect you in this situation.
Do you need a solicitor to prepare heads of terms?
Given the potential pitfalls as to whether or not heads of terms are legally binding, it is likely to save your business time and money to have your heads of terms drafted by a commercial solicitor. They will be able to ensure that you don’t miss points that would work to your advantage – for example, by making sure that essential elements such as confidentiality are dealt with before any confidential information is exchanged – and they will ensure that legal enforceability is dealt with properly.
Likewise, don’t be tempted to sign heads of terms drawn up by the other party without first taking legal advice. Our commercial solicitors can ensure that you are not committing your business to heads of terms that may, for example, be legally enforceable when that is not your intention, or which may reduce your bargaining power further in your negotiations.
Alternatives to heads of terms
If you don’t want heads of terms, then there are other types of contracts you can consider, which will protect your business's interests when negotiating with a third party. These include:
- A confidentiality agreement or non-disclosure agreement – you may not want your competitors to know that you are negotiating lease terms for a commercial property in a particular town, or you may not want a third party to reveal commercially sensitive information disclosed as part of the deal discussions. A separate article on confidentiality or non-disclosure agreements addresses this.
- An interim services agreement – this is a short-term contract that is put in place while the parties spend time negotiating the details of a longer-term business relationship. It enables the parties to proceed with the project in the meantime. As with heads of terms, it is not a substitute for a detailed commercial contract, and you will still need a comprehensive agreement in place when the interim arrangement comes to an end.
Next steps and heads of terms
Heads of terms play a crucial role in shaping expectations early in the negotiation process, helping all parties align on key commercial principles from the outset. When carefully drafted, they can significantly enhance the likelihood of reaching a successful agreement. However, it’s essential to strike the right balance – maximising their strategic value without unintentionally creating legally binding obligations.
Our experienced commercial law solicitors are here to support you in drafting clear, effective heads of terms that reflect your business goals. Whether you're navigating a complex deal or managing contracts as General Counsel, we can help you use heads of terms as a powerful tool in your negotiation and contract management strategy.
