What Is a Heads of Agreement and Are They Legally Binding?

A “Heads of Agreement” is one of those legal terms that you may come across for the first time and find yourself doing a quick Google search. To make things more confusing, the term is sometimes used interchangeably with terms such as “Letters of Intent” or “Memorandum of Understanding”.

So, what do these terms actually mean? Simply put, they refer to a preliminary agreement, a document that is signed before the parties are ready to enter into a final agreement.z

Are Heads of Agreement Binding?

Businesspeople should understand the effect of signing a Heads of Agreement. Often, someone will consult a solicitor after signing to ask if they are bound by its terms.

There is no simple answer. You cannot rely on the words at the top of the agreement to decide if it is binding. An agreement becomes binding only when it clearly states what the parties agreed and shows that the parties intended to be legally bound.

Are the Terms of the Agreement Certain?

A Heads of Agreement binds parties only if it clearly sets out the “essential terms”. At a minimum, the agreement must list:

• The parties entering into the agreement
• The object of the agreement (what the parties intend)
• The consideration (usually the price to be paid)
• Any conditions precedent or subsequent (what must happen before or after the agreement for it to be valid)
• The time frame for completing the agreement

If the essential terms are missing, the agreement is generally just an “agreement to agree” and cannot be enforced. It lacks enough certainty about the parties’ obligations.

However, some agreements can be binding even if details are not finalised. For example, an agreement could include a mechanism to determine a price, such as using an independent valuation. In this case, courts can enforce the agreement by ordering the valuation.

Did the Parties Intend to be Bound?

Preliminary agreements should state whether they are intended to be legally binding. Clear language, such as “in principle” or “does not create a binding legal contract,” usually proves the parties did not intend to be bound.

Even so, a party must avoid creating reliance by the other party. If one party encourages the other to rely on the preliminary agreement, courts may enforce it despite its wording. To prevent this, make your position clear in both words and actions.

When Should You Use a Heads of Agreement?

Heads of Agreement help parties clarify points of agreement, identify areas for further negotiation, and allow parties to seek approval, such as from a Board of Directors. In this context, use terms like “proposes” and “understands” instead of “agrees,” “promises to,” or “must.” Avoid calling it the “agreement” or “contract” to prevent confusion.

A well-drafted Heads of Agreement ensures both parties feel protected during negotiations. This approach creates a better environment for reaching a final agreement. It may include termination and confidentiality clauses to provide added security.

Termination Clause

A Heads of Agreement should include a termination mechanism. This might be a date by which a final agreement should be signed, otherwise the interim agreement to agree will lapse. There may also be conduct by either party that would trigger a termination clause. The aim is to give both parties peace of mind that they are not locked into an agreement.

Confidentiality Clause

If sensitive information is being exchanged as part of the negotiations, the Heads of Agreement can include a binding confidentiality clause. This allows both parties to offer the necessary degree of frankness without concern over future misuse of information if the deal does not go ahead.

Key Takeaways

Heads of Agreement are a useful tool for parties who are in the midst of negotiations but are not ready to enter into a final agreement. However, without careful drafting, a Heads of Agreement can bind parties to terms before they are ready.