Heads of terms

Heads of terms

Heads of terms, often referred to as memoranda of understanding, are, as the names suggest records of the basic understanding between parties about to enter into contractual relationships. They are intended to give comfort to those parties by recording in general , often non-legal language, what has been agreed but are almost always expressed to be non binding, save for certain critical conditions which are enforceable.

Heads of terms are typically short, often informal, documents setting out the main agreed terms between the parties to a commercial transaction. Heads of terms can take many forms from non-binding simple letters of intent and memoranda of understanding to detailed term sheets where the aim is to commit to writing the agreed terms in detail, often including technical information and structure.

 Where, for instance, parties incur costs before terms have been agreed, some of the Heads (or paragraphs) may be expressed to be binding. Often there are confidentiality issues and restrictions on the disclosure or use of confidential information or non-circumvention (going behind the other party’s back), which should be be binding. As a result there is no standard form or content for heads of terms and they can vary substantially, as parties use them as the vehicle for negotiating, agreeing and recording the commercial terms to be incorporated in a legally binding contract. once the heads are agreed. In this way the parties are able to separate the commercial from the legal requirements of the proposed agreement.

One great advantage of Heads of Terms is that lawyers are not necessarily required. In a perfect world the parties would deliver signed Heads to their respective lawyers who would then embark on the exercise of translating the Heads into a binding contract. In reality, though, it is often a false economy as the lawyers may identify commercial terms which are expressed in such a way that they cannot be made easily, or at all, to fit into the format of a legally drafted agreement. Items essential or at least advisable in the binding agreement may not occur to the lay client. By the time all these issues are addressed, negotiated and documented the parties may well have saved time and money involving lawyers at the outset. Better, in many cases to involve the lawyers at the pre-agreement stage so that the parties will be pre-warned of the consequences flowing from their layman’s understanding of their agreement or the need to address matters which will be obvious to the smart lawyer but  most likely not obvious to the layman. Its what we do!

Such issues, borne of experience are the “what if’s, as in “what if A sells his shares?” “What if you fall out with each other.”

The benefits of Heads of terms or memoranda of understanding may be summarised as follows:-:

?increasing trust between the parties by creating an ethical obligation on the parties not to depart from the heads of terms when the binding agreement is being drafted;

?The process of producing heads of terms may identify misunderstandings and highlight major issues which may be capable of resolution before the Parties incur too much cost or the lawyers become involved.

?An opportunity to introduce binding terms, such as confidentiality and protection for the parties in failed transactions;

?heads of terms can summarise the main terms of a deal, informing outside advisors, or investors efficiently, whilst also providing the necessary information to any regulatory authorities.

However there can be some disadvantages of using heads of terms:

?heads of terms may inadvertently become legally binding when it was not the intention of the parties;

?The moral obligation which may be a benefit may also be a curse in that it may, reduce the flexibility of the parties to negotiate the final agreement;

?competition law may apply to the heads of terms once agreed and fall foul of international law, such as a duty to act in good faith, giving rise to a potential action by an injured third party This will apply only to the larger transactions

?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 may be a diversion or unnecessary in simple transactions

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