Heads of Terms: Legal Effect? Part Two

As mentioned in part 1, heads of terms can create legally binding agreements, however the issue relating to a ‘subject to contract’ term is one that must be considered when putting these agreements together. The courts have held a strong presumption that ‘subject to contract’ terms do not generally bind the parties however this may be challenged especially if the parties begin to perform parts of the contract as set out in the heads of terms.

Hence, if the parties wish to ensure the heads of terms are not legally binding they need to make it clear this is a not a conditional agreement but a non-binding pre agreement. Parties who fail to make it clear the heads of terms are non binding, risk entering into a conditional agreement. As illustrated by the case of DMA Financial Solutions Ltd v BaaN UK Ltd & Ors [2000], where the High Court held negotiations in which all essential terms had been agreed resulted in the formation of a binding contract and were not on a ‘subject to contract’ basis even though it was necessary for a formal written contract to be prepared. The case of ProForce Recruit Ltd v The Rugby Group Ltd [2005] reiterated a ‘subject to contract’ document was binding.

However, the High Court held in the case of MJ AND SC Collins v H Padfield & Sons Ltd [2005] that no binding agreement had been formed as:

  • It was clear from early correspondence that the parties negotiated “subject to contract” and never expressly lifted or had any intention of lifting this condition and
  • At least one of the essential terms had not been agreed between the parties.

The case law highlights the use of ‘subject to contract’ clauses as being potentially very problematic. It is essential that all parties should be careful they do not enter into an implied contractual relationship by failing to execute the documents contemplated in the heads of terms as soon as possible and by carrying out actions in their attempt to implement the heads of terms.

Hence, it is essential that heads of terms are drafted clearly and precisely, clearly setting out that the terms are non-binding agreements.

Muhammed Poswall is a legal assistant to Izaz Ali (Izaz.Ali@lawdit.co.uk). Izaz is a commercial lawyer who specialises in information technology law and intellectual property law with an emphasis on IT, escrow, online and off-line contracts, and the buying and selling of online businesses.

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