Corporate & Commercial Lawyer
Heads of Terms (HOTs) are commonly entered into when parties are agreeing in principle the terms of a commercial transaction such as an agreement for a lease or the sale and acquisition of a business to name just two examples. It is crucial when entering into HOTs that the parties make clear whether the HOTs (or any part of them) are legally binding or not. Darwin Gray discuss Heads of Terms and when they should be legally binding.
The recent case of Pretoria Energy Company (Chittering) Ltd v Blankney Estates Ltd involved a £56 million dispute between the parties as to whether HOTs which were marked as “heads of terms” but not marked “subject to contract” were in fact legally binding.
Ultimately in that case, the Court of Appeal held that the HOTs were not legally binding on the parties for three key reasons:
- The HOTs contained a provision that a formal contract would be drawn up;
- Such a formal contract (in the context of a lease) would involve a detailed lease containing numerous provisions which would go beyond anything set out in the HOTs; and
- The HOTs included a specific term which, to be effective, would require other formalities to be fulfilled which had not been (and were not capable of being) fulfilled within the HOTs.
In order to avoid costly mistakes and disputes, it is best to ensure that the HOTs are categorically clear as to whether or not they are binding (either in whole or in part). In this article, we explain what HOTs are, and how to ensure you have clarity on terms.
What are Heads of Terms?
Heads of terms (also known as letters of intent, memoranda of understanding or heads of agreement) set out the terms of a matter, agreed in principle between the parties. HoTs are commonly used for company acquisitions or property transactions.
See our other articles where we discuss the importance of HoTs.
How to ensure Heads of Terms are binding or non-binding
The clearest way forward is for the parties to expressly state whether the HOTs are intended to be legally binding or not. It is common for HOTs to be labelled “subject to contract” if they are not intended to be legally binding.
However, it is common for parties to want certain elements of their HOTs to be legally binding, and the rest non-binding. For example, it is common to include a period of exclusivity whilst negotiations are ongoing, and for this provision to be legally binding.
In those circumstances, it is best to include a statement at the outset to say that the HOTs are not intended to be legally binding, except where specified. Every clause which is intended to be legally binding should be marked as such. This will give clarity to all parties and minimise scope for dispute.
When should Heads of Terms be legally binding?
There is no “correct” answer to this question. Whether or not heads (or certain aspects of them) should be legally binding will vary from agreement to agreement.
As a general rule of thumb, HOTs are not usually intended to be legally binding on the parties. They are usually used to set out the intentions of the parties, but are typically subject to a variety of matters such as undergoing due diligence, negotiating a formal contract or contingent on other conditions precedent.
The benefit to non-binding HOTs is that either party can walk away from the proposed deal at any time prior to a separate legal contract being signed.
There are however some provisions in HOTs which are usually stated as being legally binding.
What types of provisions should be legally binding?
The following clauses are usually specified to be legally binding:
- Exclusivity or “lock-out provisions”. A lockout provision will look different from agreement to agreement but will essentially prevent either party from entering into any negotiations with third parties in relation to the same matter. If Party A was negotiating the sale of their business to Party B, a lockout provision would prevent Party A from negotiating with Party C for the sale of the same business. It effectively gives Party B a period of exclusivity, and the comfort during which they can invest time and resource into due diligence without worrying that they will be gazumped before they proceed to completion.
- The exclusivity clause would typically have costs consequences if Party A were to breach it – such a clause therefore needs to be legally binding.
- Costs. If Party A has agreed to be responsible for all or some of Party B’s costs of the transaction, then there should be a legally binding provision in the HOTs relating to this. Typically, each party will bear their own costs in any commercial deal, however sometimes the circumstances might result in one party paying another party’s costs, either in a full or by way of a contribution. This is quite common in investment transactions.
- Confidentiality. HOTs will often contain confidentiality obligations relating to the sharing of information during the due diligence process. As with costs provisions, these clauses will need to be legally binding in order to be enforceable.
- Governing law & jurisdiction. There is typically a sweeping clause at the end of HOTs setting out which governing law will apply to the terms of the HOTs and how any disputes will be dealt with. Again, this should be specified as legal-binding.