Are heads of agreement really useful?
Posted on September 22, 2014
Using a heads of agreement when trying to reach a commercial agreement can be valuable for everyone concerned. In the wrong hands, they can create enormous legal problems. In this article, we explain how you can avoid those problems.
A eadsh of agreement (we will refer to them as ‘HoA’) are used to set out the commercial terms of a deal before entering into detailed, formal legal documents. It allows the parties to set out the important business points. This means they can focus on the key issues of value that are at stake. A HoA is sometimes also called a ‘Memorandum of Understanding’, a ‘Letter of Intent’, ‘Head of Terms’ or ‘Terms Sheet’.
The HoA can be helpful to set out:
- the identity of the parties;
- the goods or services included in or excluded from the deal;
- how the price is calculated (including any calculation formula);
- geographic scope; and
- any restrictions or exclusions, which will apply to the parties.
The HoA can give commercial direction and act as a road map in complex deals. It can be a good indication of a party’s wish to do the deal and sign a final, legally binding document.
Beware – The Drawbacks
Incorrect use of a HoA may create legal problems and liabilities. There are lots of legal cases featuring people who, by mistake, ended up with binding obligations. The intention of the parties, as decided by the court, is the key issue. Although the parties may have intended to create a non-binding list of commercial terms, the effect was they found themselves prematurely bound to a contract because they did not make that intention crystal clear. In such cases, as a HoA is not a fully negotiated legally binding agreement, it often lacks appropriate detail, rights and protections. It may also create unwanted liabilities.
Avoid the Problems
When agreeing a HoA, talk to your lawyers early on. It should help you avoid unintentionally creating a binding agreement. The lawyer may be able to help you achieve a better commercial deal. If you have to start before talking to your lawyer, say at the outset that your conversations are ‘subject to contract’. ‘Without Prejudice’ does not work (we will explain this concept on another occasion). Follow the discussions up in writing. State that the discussions, any emails or other documents are not intended to create legally binding arrangements but are for the purposes of commercial discussions only. Avoid using wording that may give the impression of being legally binding. If dealing with an overseas business, say your discussions are subject to English Law. Using these simple rules should reduce the risk of unintentionally creating a binding contract. In the right hands, a HoA is a great tool. In the wrong ones, it can be a shortcut to disaster.
The contents of this article are for the purposes of general awareness only. They do not purport to constitute legal or professional advice. The law may have changed since this article was published. Readers should not act on the basis of the information included and should take appropriate professional advice upon their own particular circumstances.