Heads of Agreement: When are they used and are they binding?

Heads of agreement are also commonly referred to as letters of intent, term sheets, memorandum of understanding, memorandum of intent, or commitment letters.

Why are they used?

Generally, these documents set out the intention of the parties with respect to formal agreements that will be entered into at a later date. Heads of agreement typically set out the terms that have been agreed and the parameters that will govern future negotiations between the parties.

There are a number of benefits to using heads of agreement including that they:

  • can record the terms that have been agreed to date;
  • provide a structure for final documentation;
  • assist in the drafting of final documentation; and
  • allow the parties to continue negotiations in good faith.

Heads of agreement will typically include a statement on the purpose of the document, an overview of the proposed transaction, clauses on confidentiality and publicity, clauses on exclusivity, a clause about the enforceability of the document, a timeline, and any other terms that have been agreed at that stage.

Are heads of agreement enforceable?

Heads of agreement will be legally enforceable if the terms are sufficiently clear and certain and it is the intention of the parties, as evident from the document, to be legally bound. There are four recognised categories of heads of agreement and these are:

  • where the parties have reached agreement on the terms of a contract and agreed to be immediately bound but wish to restate those terms in final transactional documents;
  • where the parties have reached agreement on all of the terms of the transaction and intend to be bound by them but have made performance conditional upon execution of final transactional documents;
  • where the parties agree to be immediately bound but expect to make a final transactional contract that will substitute the heads of agreement and add additional terms; and
  • where the parties do not intend to be bound by the heads of agreement.

It is common to find the words ‘subject to contract’ or ‘subject to the finalisation of a formal contract’ in heads of agreement. This is prima facie evidence that it is the intention of the parties that the heads of agreement are non-binding.

To avoid disputes about the nature of heads of agreement it is preferable for the parties to clearly specify whether or not they intend to be legally bound by its terms, and where they do wish to be legally bound to ensure that its terms are sufficiently clear and certain.

Connor James

Connor James

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