Understanding the significance of heads of terms in commercial agreements
Introduction
Heads of terms are often used at the basis for discussions ahead of parties entering into a commercial agreement. They typically set out the key commercial details that will form the basis of the contract between the parties and can be useful to encourage negotiations between parties and to act as a prompt to ensure that all key terms have been considered and agreed ahead of putting in place the main contract.
Although a useful document, some aspects of heads of terms can be problematic, particularly where discussions stall or the parties fail to enter into the main contract. In this article we set out the most common issues which arise in relation to heads of terms.
Legal status of heads of terms
Typically heads of terms are not legally binding and will often state that they are “subject to contract”. The advantage of this is that they are usually straightforward, simple to put together and can be agreed relatively quickly.
Scenarios where heads of terms might be used:
Heads of terms can be used to set out the basis of property transactions, corporate deals, and for a variety of general commercial arrangements such as manufacturing agreements and sale and purchase agreements.
In the retail and leisure sector, for example, they may be used when negotiating distribution agreements or hotel management agreements.
In the sports sector, heads of terms are often used to set out the basis of commercial arrangements such as sponsorship deals, player/driver engagement and catering arrangements.
In all these scenarios, there is a possibility that a potential supplier or customer may ask you to enter into a heads of terms for the supply of goods and/or services. It is important that you make sure that the terms agreed are formulated into a legally binding commercial agreement before the supply of goods and/or services commence.
Issues
Difficulties can arise if the parties subsequently fail to enter into a legally binding contract. If this happens it may be that the only written document between the parties is the heads of terms. Whilst this can be a useful indicator of the parties’ intentions, a heads of terms document does not replace the need for a contract, nor does it gain contractual force simply because the parties failed to enter into a legally binding agreement at a later date. The result is that the parties may find that they have an unwritten contract and key aspects of it (for example relating to limitation of liability, when payment is due and termination rights) will be governed by terms implied under English law, which will not always be favourable to the party seeking to rely on them.
Issues can also arise where the parties intend certain provisions of the heads of terms to be non-binding and others to be legally binding. Often these binding terms relate to confidentiality of the discussions or will prevent the parties from entering similar discussions with a competitor.
Where there is a mix of binding and non-binding terms the parties need to have a clear understanding and agreement on which terms are intended to be binding and which are not. Careful drafting will be required to make sure that terms which are intended to be non-binding remain so, and vice versa.
Another potentially troublesome aspect of heads of terms arise where parties have failed to agree certain key points. The heads of terms should set out the key points agreed between the parties relating to key aspects of the contract. Where points are not agreed, or are potentially contentious, there may be a temptation to miss out, or attempt to fudge, these terms with the intention of resolving the issue at a later date. This should be avoided, however. The risk of leaving potentially contentious issues to be resolved later is that the transaction could stall (or be called off completely) if the parties are unable to reach agreement. Attempting to negotiate unresolved, or contentious issues, during the drafting of the main agreement is also likely to be a time-consuming process and more expensive than if the parties had resolved the issue at the heads of terms stage.
Next steps
Heads of terms remain a valuable part of pre-contractual negotiations, but parties should remain mindful of their legal status, and which clauses (if any) are intended to be legally binding. Following agreement of the heads of terms parties should maintain momentum to ensure that the legally binding documents are put in place promptly. Parties should also consider which issues are potentially problematic or contentious at an early stage of negotiations and take steps to address these points.
For more information on heads of terms or for other commercial agreements advice, please speak to Amy Peacey or contact us online.
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