In our professional experience there are many advantages to clients using Heads of Terms, both when selling or purchasing a business or when selling or purchasing shares. They can also be used for loan finance and other transactions, joint ventures, project financing and private equity investments. You may also have come across other names for them, such as “heads of agreement“, “memorandum of understanding” or “MOU”, “letters of intent”, “letters of potential interest”, “term sheets” or “protocols”.
What are Heads of Terms?
Heads of Terms outline the main features of a proposed contract and provide both parties with a synopsis of the essence of the contract and how it would look in a final, full-length binding form. Importantly, many of the clauses within the Heads of Terms will be non-binding, but it may contain some binding clauses. In order to ensure no legally binding terms are created it is useful to include the phrase “subject to contract”. It is also crucial to include a term that sets out the duration of the Heads of Terms and in what circumstances it will cease to apply. Examples of terms that are often included are: the items to be transacted, price and method of payment, assumptions, conditions, due diligence, warranties, non-compete/solicitation clauses, proposed timetable, obligations of the parties, exclusivity and confidentiality. However, although the majority of Heads of Terms will cover many of the most usual commercial terms, each one will need to be adjusted for each particular deal.
What is the purpose of Heads of Terms?
Used at an early stage of negotiation the Heads of Terms result in a non-legally binding understanding between the parties – usually a seller and buyer. This understanding promotes a positive relationship between parties and facilitates further negotiations regarding full contractual terms. One great advantage of doing this is that it may highlight any irreconcilable differences before parties have incurred substantial costs, both financially and through loss of time. If the relationship between the parties is going to break down because of disagreement on one of the terms it is far better for this to happen at an early stage. Both parties then save money and time which can be used to find a replacement seller or buyer.
Why companies should use Heads of Terms
We recommend using Heads of Terms at an early stage in most situations as they provide parties with realistic expectations of the contents of the full contract. Through reading the succinct version of the main terms of the contract the parties will become aware of which terms are crucial to the essence of the contract and those which are not. The parties will have a better idea of how they want the contract to look, a greater understanding of the contract and will be more focused on their objectives. Heads of Terms also act as a guide to the wishes of both parties when drawing up the final document and may raise issues which need to be resolved before a contract is drawn up.
Heads of Terms can potentially save money for both parties when a proposed deal is frustrated because one party objects to some of the terms of the contract. Usually, they will be negotiated and settled prior to any due diligence taking place, meaning lengthy and expensive investigations can be avoided if it transpires that some of the main issues are irreconcilable. This is particularly true of more complex transactions, as they can provide much needed focus. However, Heads of Terms can also encourage more input from the parties at an early stage if they highlight issues and provide parties with realistic expectations of the contract and how the transaction is to be handled generally.
Another advantage is that Heads of Terms can be used with a “Confidentiality Agreement” (otherwise known as a “Non-Disclosure Letter” or “Non-Disclosure Agreement” or “NDA”) which helps to limit potential “fishing expeditions” by competitor outfits who might pose as buyers but whose intentions, in fact, lie elsewhere. They can also contain lock out or exclusivity provisions, which prohibit either or both of the parties from talking to other interested buyers or sellers at the same time.
There are other benefits to using Heads of Terms such as the moral commitment of the parties. They are more likely to proceed on the basis of the terms that have been agreed and less likely to change their tack on something at a later stage, unless there is a very good reason for it, giving both sides a sense of comfort. Where there are third parties involved, such as minor shareholders or lenders, a well thought-out Heads of Terms can be useful to explain the main aspects of the proposed deal.
An element not to be overlooked is how Heads of Terms can help the parties when instructing their advisers. Not only does it help to know that the seller, for example, has given due consideration to the main areas of the transaction, it also provides a steer on the course negotiations may have taken, and therefore assist in the further negotiations of the detailed contract. As a result, as solicitors, we feel we can offer our clients better advice and more easily draw up a final contract based on the Heads of Terms. This is best achieved by involving your professional advisers from the very beginning, rather than once the Heads of Terms have been agreed. It may seem time consuming and costly but our experience shows using Heads of Terms can undoubtedly save money, management time and provide a better result all round.
Are there any disadvantages to using Heads of Terms?
In a sale and purchase situation, using Heads of Terms is usually more advantageous to the Seller than the Buyer, who will usually know significantly more about the sale. It can mean that once signed, there is a strong moral weight attached to the agreement which can prevent room for manoeuvre later on in the contract negotiations. Whilst, generally speaking, Heads of Terms are not intended to create legal relations, with incorrect drafting or using the jurisdiction and law of another country, sometimes Heads of Terms can become unwittingly binding. Competition law can also affect certain contractual arrangements if they result in the restriction, prevention or distortion of competition within the UK or the EU. There can also be tax consequences of certain arrangements which may affect one or more parties’ ability to claim tax reliefs later on. For these reasons we would always advise involving solicitors and tax advisers early on in the process to help avoid these issues.
Top tips for using Heads of Terms:
- Get your professional advisers on board early to help draft the Heads of Terms
- Cover only the agreed principles and defer the detail to the final contract
- Consider what terms you want to be binding and what should be non-binding
- Ensure it is signed by all the correct parties and dated
- Try to stick to it!
For further information, please get in touch with Dixcart Legal: advice@dixcartlegal.com
