Heads of terms and letters of intent can save your business time and money. As commercial contract solicitors we see too many situations where, at the end of negotiations, commercial lawyers are asked to draft contracts only to find there is a fundamental 'deal breaker' issue the contracting parties can’t agree on. Business planning and early preparation using a heads of term document or letter of intent can highlight each parties’ expectations before a contract is formally draw up, saving you time and money later down the line.
In this guide we explain:
- What are heads of terms?
- Other names for heads of terms
- Alternatives to heads of terms
- What are the advantages of using heads of terms?
- Are heads of terms legally binding?
- Should heads of terms be expressed as ‘subject to contract’?
- Do you need a solicitor to prepare heads of terms?
- How do you draft heads of terms?
- What clauses should be put in heads of terms?
- Next steps and heads of terms
What are heads of terms?
‘Heads of terms’ is a very simple concept. When your business is planning on doing a deal with a third party, whether the deal relates to the lease of premises or equipment, a joint venture, a shareholder agreement, supply chain agreement or any other commercial transaction requiring the protection of a detailed contract, it’s a good idea to write down the basics of that deal in a short document.
With a heads of terms document, both you and your potential contracting partner can be sure that you are working on similar assumptions about how your planned business deal will work in practice. As an entrepreneur who knows their business, whether you are a tech company or a luxury brand, you know your ‘bottom lines’. Likewise, the other contracting party should know what they are prepared to negotiate in broad terms, leaving the fine detail and legalese for the commercial solicitor to include in the contract, based on the framework provided in the heads of terms.
It is less likely that your deal will fall through if you are agreed on the headline principles in the heads of terms. That’s because normally the detail can be negotiated and compromised by the lawyers once the big-ticket issues have been agreed in the heads of terms.
In essence, heads of terms are at the very start of your contract life cycle management and, as is the case with many things in life, get the beginning right and the rest is easy (or at least easier).
For information on commercial contracts take a look at our articles:
Other names for heads of terms
As an entrepreneur you may come across other phrases that are in essence ‘heads of terms’. Examples include:
- Letters of intent
- Memorandum of understanding
- Heads of agreement
- Term sheet
All of the above are essentially inter changeable names for heads of terms so in this article we are keeping things simple by sticking to the terminology, ‘heads of terms’.
Alternatives to heads of terms
If you don’t want a heads of terms document then other pre-contract document may be crucial to the success of your planned business deal, such as:
- A confidentiality agreement or non-disclosure agreement – for example, you may not want your competitors to know that you are negotiating on 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. Those confidentiality issues can be resolved through signing a separate non-disclosure agreement or by ensuring that confidentiality is addressed in the heads of terms and that the non-disclosure clause in the heads of terms is a binding agreement. For more information on non-disclosure agreements read our article Non-Disclosure Agreements: Answering your questions in this legal guide.
- An interim services agreement – this could be a short-term contract whilst you and the other party spend time negotiating the detail of a long-term business relationship. Do not be fooled into thinking that a brief short-term agreement will suffice. A detailed commercial contract is necessary to prevent your business falling out with the contracting party or to limit the dispute and clarify how it will be settled.
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.
- Keeping focus – if a point is agreed it can be included in the heads of terms and the negotiations can move on to the next topic or contentious point.
- A time saving aide memoir – so that rather than wading through minutes of meetings or email exchanges there is one concise working document that sets out what is agreed.
- An aid for third party checking of the proposed deal – you may need the go ahead of a third party to the deal. For example, a regulatory body or competition authority or to secure funding or to negotiate a back-to-back contract. A non-binding heads of terms enables you to disclose the key aspects of a deal to a third party for the purpose of checking that any commercial contract would be acceptable to them.
- Getting a quick binding agreement on one aspect of the deal – the heads of terms can be used to get an early binding agreement on a key aspect of the deal. For example, confidentiality. This can avoid the need for a separate confidentiality agreement.
- The commercial solicitors start point – when a commercial solicitor is asked to draft a detailed contract the options of what to include or not include are almost endless but the heads of terms give the start point and the key elements of the eventual commercial contract.
Heads of terms are advantageous in any complex contract negotiation but the only contra indicators are where:
- You do not know if the heads of terms are creating a binding contract as you have not taken legal advice on the format of the heads of terms.
- The agreement is so simple or you are planning to contract with a third party that you have had substantial business dealings with and you know that the previously agreed terms do not require amendment or refinement.
Are heads of terms legally binding?
There is nothing more frustrating than spending time on investigations, research and negotiation and thinking that you have a deal only for the other party to pull out before the contract is signed. Commercial solicitors are asked if the problem of withdrawal can be solved by getting heads of terms drawn up at an early stage of the contracting process.
As with many things legal, there isn’t a straightforward answer as it all depends on context and circumstances. Bear in mind that in some scenarios your business may not want to commit to a contract even after extensive negotiations, either because you can see the opportunity for a better deal with another contractor or your business needs have changed. Therefore, it might be in your interests to walk away from a heads of terms, without any legal commitment.
It is best to get legal advice prior to preparing heads of terms and certainly before signing a heads of terms document. That way you know if you or the third party are entering into a binding agreement. If you need help negotiating or drafting heads of terms for any business contract then our commercial solicitors can help.
The legal position on heads of terms can get complicated as the heads of terms may be:
- Legally binding
- A combination of the two
Confused? If so, it isn’t surprising. As a real-life example, the heads of terms could state the confidentiality and disclosure agreements and time limited exclusivity clauses are binding, and the remainder of the heads of terms is subject to contract and is not binding on both parties.
For a contract there needs to be:
- An offer and acceptance
- Intention to create legal relations
- Certainty of terms
Ultimately, if you cannot agree on whether the above conditions have been met in your heads of terms, the court can determine whether the heads of terms mean you are in a contractual relationship. However, commercial contract disputes and litigation is best avoided by understanding the scope of your document and making it fit for your purpose, whether that is as a negotiating aide or to commit your contracting party to a legally binding deal as soon as possible.
Should heads of terms be expressed as ‘subject to contract’?
When a heads of terms contains the words ‘subject to contract’ or ‘agreement in principle’, many entrepreneurs (and even some non-specialist solicitors) think that those words have almost magical properties and that there is no binding agreement between the parties. However, this may not necessarily be correct as it all depends on the prior negotiations and communications as all the heads of terms or some clauses in the document could amount to a binding contract.
If you do not want to be bound by the heads of terms, so you have ‘wriggle room’, then ideally the document should be headed ‘subject to contract’. That should help rebut the presumption that you intended to enter into contractual relations through use of the heads of terms. Even where a document is headed subject to contract, a contract can be formed. If you want to protect yourself from inadvertently entering into a contract, take expert legal advice.
Do you need a solicitor to prepare heads of terms?
A commercial solicitor does not have to prepare the heads of terms but it may save your business time and money to have legal input at an early stage and certainly before you sign the heads of terms. That is because if heads of terms proceed without legal advice you may miss points that would work to your advantage. In addition, your commercial solicitor may be on the back foot in trying to get some provisions included in the detailed commercial contract if there is no reference to them in the heads of terms. For example, the ability to terminate the contract on notice or the inclusion of annual inflationary price rises.
Successful entrepreneurs recognise that contract negotiation often takes a team approach. Whilst you may have the business and technical knowledge to understand whether the contents of a heads of terms is in your business' best interests, your finance director or accountant should be able to add value by advising on the financial or tax technicalities and your commercial solicitor on the legalities. That way you should end up with a commercial contract that is fit for purpose.
How do you draft heads of terms?
There is a fine art to drafting heads of terms. You do not want the document to be so brief that it is meaningless fluff but on the other hand it should not descend into detailed contractual legalese. An experienced commercial solicitor knows how to get the balance right on detail as you don’t want so much included that you are effectively writing the 50-page commercial contract. Equally you don’t want key principles left out altogether as then the other side will argue that they should not go into the contract at all as they did not form part of the heads of terms.
Practical tips on best practice in drafting any type of heads of terms (whether it is a lease, contract for the sale of goods or joint venture etc) include:
- Set out what the heads of terms are seeking to achieve - the headline is all that is needed rather than the detail. For example, the sale of company A to company B. The heads of terms do not need to list of the employees of company A or detailed TUPE arrangements or the extensive warranties.
- State if the heads of terms is a contract or not – remember there are lots of options and the heads of terms could be a binding contract in its entirety or certain clauses could be binding on the parties.
- Material assumptions – if you are planning to contract with a third party based on a material assumption then include this in the heads of terms. For example, if the other party is setting up a UK base of operation that will be open for business by the date of the contract, then specify this material assumption.
- Be clear – the whole point of heads of terms is to set out the basics so, for example, the document should not be full of technical specifications for widget manufacture (the precise product specification could be a separate schedule). Equally if there are elements of the heads of terms that you do want the parties bound by then this should be made obvious. For example, you may want a binding non-disclosure clause in the heads of terms if you have disclosed commercially sensitive information as part of a joint venture negotiation and confidentiality is critical whether the heads of terms eventually form part of a contractual joint venture agreement or not.
- State the unusual – if you want to put an unusual clause in your commercial contract then any unusual condition or clause should be a feature in the heads of terms. For example, there may be a condition precedent for the contract, such as the purchase of company ‘A’ will only proceed if company ‘A’ receives a prestigious industry award. Alternatively, particularly onerous warranties may be required over and above the usual lengthy warranties. Without the unusual warranty being highlighted in the heads of terms the commercial solicitors for the company being asked to provide the warranty are likely to object. They are unlikely to be able to persuade company ‘A’ to delete the offered unusual warranty if it is recorded as an agreed principle in the heads of terms.
- Mention if points are not exhaustive – if you know that the lawyers may get into a wrangle over detail make it clear that the heads of terms are not exhaustive on a particular point so that your commercial solicitor then has free rein to negotiate the detail. For example, you may agree that the contract can be terminated leaving the lawyers to negotiate all the triggers for termination of contract to safeguard your interests. Read more about the importance of termination clauses in commercial contracts in our article Can you terminate a commercial contact?
- Keep the heads of terms up to date – with meetings and emails flying around the heads of terms can be prepared but not updated as negotiations evolve. It can take a calm head to extract out of a long meeting the crucial points that need to be added to the heads of terms. Keeping the heads of terms up to date reduces the risk of one party seeing a new provision in the heads of terms as a new development or deal breaker.
- Do not sign the heads of terms without legal advice – that is because signing the heads of terms may (but not necessarily) convert the heads of terms to an agreement to contract to a binding legal contract that is enforceable. As your business would not sign a new 50-page commercial contract without taking legal advice it is just as important that you do not sign something that could be enforceable against you, especially in circumstances where a commercial solicitor would have warned against clauses in the heads of terms. If you do not take up front legal advice on the heads of terms then it can be akin to tying your commercial solicitors' hands when it comes to the fine detail of the commercial contract.
The key point about heads of terms is that it is not meant to cover everything and will be subject to change and refinement as the negotiations progress.
What clauses should be put in heads of terms?
The heads of terms document and clauses need to cover the key points, such as:
- Parties - who are the parties to the agreement.
- Confidentiality - are the heads of terms confidential or is any information supplied as part of the negotiation process confidential?
- Enforceability - will the heads of terms be a pre-contract agreement and ‘subject to contract’ or will all or some of the clauses be legally binding?
- Due diligence - what is the due diligence process and what are the material considerations on which the negotiations are based. For example, do the negotiations assume that tax clearance will be obtained or a licence secured or a finance deal brokered?
- What are the key terms? For example, the price of goods, provision for review of pricing and payment or timescale for signing the commercial contract.
- What standard terms are headlined in the heads of terms and need to be detailed in the contract? For example, warranties and indemnities or restrictive covenants.
- Jurisdiction – what governing law will cover the heads of terms and any commercial contract that flows from the heads of terms.
Next steps and heads of terms
Remember, approaching heads of terms as a team approach of multi-disciplinary professional advisors is likely to save you money, not just in terms of legal fees and contract drafting but in ensuring that the heads of terms are negotiated in such a way that your business gets the best out of the deal.