Heads of terms - the benefits and dangers

Heads of terms are usually intended to be a non-binding record of the main commercial terms agreed between the parties in relation to a particular transaction, setting out what the parties wish to happen, the structure as to how that should happen and the timescales for achieving it.

The benefits

The heads of terms should be prepared and negotiated at the outset and prior to legal documentation being prepared.

Typically, the parties themselves or their agents will prepare and negotiate the heads of terms, not legal advisers. But in our opinion the party’s respective legal advisers should still always be given the opportunity to review the heads of terms and advise on them before they are agreed, not least so that they can explain any legal implications of the proposed terms, any potential dangers (see below) and spot anything that may have been missed.

Once agreed by the parties, the heads of terms will then be used by the legal advisers as the basis on which to draft the transactional legal documents and to speed up the drafting process. Having a set of detailed heads of terms from the outset will also usually streamline the subsequent negotiations as the likely issues will be drawn out at the start and the parties are less likely to try and resile on those terms at a later date if they are recorded in the heads of terms.

The dangers

Whilst it is important to have heads of terms, it’s equally important that the heads of terms don’t inadvertently create a legally binding agreement between the parties.

In the context of property transactions, for a binding contract to come into effect the agreement must satisfy both the following requirements:

Section 2 of the Law of Property (Miscellaneous Provisions) Act 1989 (LP(MP)A 1989):

• be in writing;
• incorporate all the terms that the parties have expressly agreed; and
• be signed by or on behalf of each party.

The general contract law requirements which require:

• offer;
• acceptance;
• consideration; and
• intention to create legal relations.

The heads of terms could quite easily, unintentionally, satisfy the formality requirements of Section 2 LP(MP)A 1989 above. Therefore, to make the intention of the parties clear, so that the general contract law requirement for there to be an intention to create binding legal relations isn’t also satisfied, the parties should mark the heads of terms as “subject to contract” and include a statement that the provisions are not intended to be legally binding.

Any terms which the parties do intend to be binding, such as an agreement for a period of exclusivity, should then be documented elsewhere, for example, by way of a separate exclusivity agreement.

This blog is intended to provide general information only. If you are looking for advice, please call 01926 954694 and speak to a member of our team.