Commercial transactions can be legally complex, particularly during a major transition, like the sale of a business.
One of the first pieces of documentation that you will come across when negotiating the sale of a business is the heads of terms agreement.
Understanding this process can help set even the most complex of transactions on the right path and ensure success further down the line.
In this article, BJ Chong, Supervising Director in our Commercial department, explains heads of terms and how to navigate them.
Understanding heads of terms
Heads of terms (HOTs) typically consist of a document setting out the main terms of a commercial transaction, such as the sale of a business or a lease agreement on a commercial property.
They may also outline a timeline and obligations of each party.
These agreements are made between two or more parties. In the case of a business sale, these would comprise those parties seeking to sell the business, and those seeking to buy.
Heads of terms may also be known as heads of agreement, letters of intent, term sheets or memoranda of understanding.
Although not usually legally binding, HOTs form a written record of intent to proceed with the transaction.
What goes into heads of terms?
Heads of terms do not have to follow a certain format, but there are a set of items that you should include within them:
The most important element is your agreed terms, clearly laid out in full.
HOT agreements will usually contain some or all of the following provisions:
Once they have been agreed, the HOTs must be signed by all parties, either in-person or electronically.
Why put heads of terms in place?
Legally, you do not have to put heads of terms in place prior to a transaction.
However, there is a sound business case for putting an HOT agreement in place, for the mutual protection of both parties.
Mutual understanding
Heads of terms help all parties involved to come to a mutual understanding and outline each party’s obligations.
As a statement of intent to progress with the transaction, both parties may later rely on the HOTs and terms agreed in principle when signing the contract.
Accelerating the process
By setting out terms and obligations prior to drafting and signing the contract, parties can speed up the transaction process.
The HOTs can include whatever documentation that parties deem necessary. This means that you can integrate disparate information and agreements into one document.
This is particularly beneficial when the timeline is long.
Pre-contract agreements
The heads of terms agreement will outline any issues that need to be raised prior to signing a legally binding contract.
Most commonly, these involve exclusivity and confidentiality.
HOTs benefit all parties in this way, as these clauses are considered to be one of the few legally binding clauses within an agreement of this type.
Be aware of challenges
Implementing heads of terms is a common practice, but they may present problems for either party if not prepared correctly.
The most common issues with a heads of terms document are:
Timings
HOTs can take a large amount of time to prepare, which can be a challenge for keeping the sale of a business or lease agreement on a tight schedule.
Due diligence
Heads of terms are usually put in place prior to the seller beginning any kind of due diligence on the business.
This may mean that a lot of careful negotiations have been carried out, only for the transaction to stall at a later date.
To navigate this issue, you should be sure to set out any major issues or concerns during the HOTs phase.
Legal status
HOTs are not intended to be legally binding unless expressly stated.
However, this is not always enough for HOTs to be considered as such under English law.
Certain elements of the HOTs will be legally binding, including confidentiality and exclusivity clauses.
For extra security, some parties may choose to employ a separate, legally binding non-disclosure agreement (NDA).
When drafting HOTs, you should always consult an experienced solicitor to ensure that your agreement is not unintentionally legally binding.
For guidance on preparing and implementing heads of terms, please contact our expert team today.
