Heads of terms are short documents setting out the main agreed terms between the parties in a commercial transaction. Heads of terms can take many forms including non-binding simple letters of intent, memoranda of understanding, term sheets where the aim is to highlight the agreed terms and there is no urgency in completing the transaction, etc. In situations where parties begin to incur costs before the terms have been agreed, the heads of terms can become binding and carry much greater weight. As a result there is no standard heads of terms and they can vary drastically, with parties agreeing a succession of heads of terms throughout a commercial transaction to simple letters of intent.
There can be several advantages of using heads of terms:
- increase confidence between the parties by creating a moral obligation on both parties to abide by the terms of the agreement
- the heads of terms can clarify any misunderstandings and highlight any major issues by clearing any major obstacles before time and money is spent
- the heads of terms can put a timetable in place to carry out certain actions during the transaction
- opportunity to introduce binding terms such as confidentiality, exclusivity, governing law and jurisdiction and protection for the parties in failed transactions and
- heads of terms can summarise the main terms of the deal, informing outside advisors and investors efficiently, whilst also providing the necessary information to any regulatory authorities.
Several disadvantages include:
- becoming a legally binding agreement when it was not the intention of the parties
- carrying a strong moral obligation, it could also reduce the flexibility of the parties to negotiate the final agreement
- competition law applying to the heads of terms once agreed and falling foul of international law, such as a duty to act in good faith, giving rise to a potential action by an injured third party and
- a disproportionate amount of time may be taken to agree the heads of terms, resulting in the parties negotiating the main agreement twice.
Heads of terms can be a useful tool in highlighting the main terms of a commercial transaction, but need not be overly used in simple transactions and should always be followed up with a final contract.