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A guide to heads of terms
What are heads of terms, why are they important and are they legally binding?
Karen Edwards is an associate in Frettens’ specialist Corporate & Commercial Team and is recognised as one of the region’s Rising Stars in the Legal 500 Guide.
In the latest in her series of articles on selling a business, Karen looks at heads of terms, what they include, why they are important and whether they are legally binding.
What are heads of terms?
It is often the case in a corporate transaction that the buyer and seller will agree to sign heads of terms (sometimes also referred to as a letter of intent, memoranda of understanding or heads of agreement).
This is a document which sets out the main terms of the transaction, which have been agreed in principle, between the parties during the course of their negotiations. They are prepared and agreed before the parties move to negotiating the main contract.
Why use heads of terms?
What are the advantages of having a heads of terms agreement in place?
Using heads of terms has the potential to speed up the process by clarifying from the outset what main terms are agreed. Those initial conversations can help to iron out any potential issues and save on lengthy negotiations between legal advisers later down the line. If buyer and seller are miles apart on any particular aspect of the transaction, it is better to know early on.
Are heads of terms legally binding?
Whilst the majority of the provisions in heads of terms are not legally binding (see details below for those which typically are), they do set out the serious intentions of the parties and it would therefore not be considered that a party is acting within the spirit of those intentions if they were to deviate from any of those terms.
What part of heads of terms is legally binding?
Heads of terms will usually include an exclusivity period which prevents the seller from speaking to and negotiating with any other interested parties for a fixed period of time- typically somewhere between 3 and 6 months from the date on which the heads of terms are signed off.
The purpose of this is to acknowledge that the buyer will incur expenses and commit their time and resources to the proposed purchase and therefore that the seller should not, during that period, seek to find an alternative buyer. The exclusivity clause in heads of terms should always be legally binding.
More often than not there will also be a binding obligation on all parties to keep the heads of terms and its contents confidential. The heads of terms will also usually state who is responsible for any (legal and other) costs incurred by the parties and again, this will be legally binding.
It is important therefore, that before entering into heads of terms you should make sure you have found the right buyer for your business, something I wrote about in a previous article that you can read here.
What is included in heads of terms?
Heads of terms commonly also include the following, non-legally binding provisions:
What is being purchased?
Details of what is being purchased by the buyer, for example, business and assets, or shares in a company, including any assets or liabilities which the parties have specifically agreed will be excluded from the sale.
Price and payment
The purchase price, including how this will be paid. For example, is this being paid in instalments? Is it performance based? Is the amount to be determined by completion accounts or some other accounting mechanism?
Conditions on completion
Any events on which completion is conditional, such as the purchase of a business being conditional upon the buyer being granted a lease of the premises, or, the purchase of shares in a company being contingent on the seller, as an employee of the company, entering into a settlement agreement.
Property
If the buyer is taking over premises, the terms of that element of the transaction. Is this a freehold purchase? Is the buyer taking a new lease or is the existing lease being assigned the buyer?
Restrictions and covenants
Any restrictions to be imposed on the seller following completion, which could include a duty not to compete with the business being sold, and/or not to solicit its staff, suppliers, customers etc.
Indemnities
Any indemnities that the seller has agreed to give the buyer against any actual or contingent liabilities.
Liabilities of the seller
Limitations on the seller’s liability for any potential claims for, say, a breach of any of the warranties that the seller is likely to be required to provide, or a tax claim. What financial cap is being placed on that liability?
Read more about warranties in our dedicated article here.
Employee matters
The terms of any handover or of any ongoing employment or consultancy of key staff (including TUPE Regulations).
Timetable
A timetable of target dates for each stage of the process, for example, completion of the due diligence process, agreeing the main contract, the seller providing disclosure, and completion itself.
When do you need a set of heads of terms?
Heads of terms are often drawn up directly between the parties in the early stages but it is always worth involving your legal adviser from the start. This ensures that any legal issues can be identified and dealt with early on. It is also a useful way of establishing whether this is actually the right deal for you.
How to draft heads of terms
It is worth investing the time in getting the heads of terms correct. There needs to be a balance between leaving some room for the parties to negotiate the finer details, once, perhaps, the due diligence process has been conducted and the buyer knows more about the business, whilst also not being so brief that a lack of guidance on what has actually been agreed, results in confusion and delay.
Do you have to sign heads of terms?
Once heads of terms are in an agreed form, the parties will sign these, as they would any contract.
So, how binding are heads of terms?
It is also worth mentioning that although, as stated above, heads of terms are not, for the most part, legally binding, they have before now been used as evidence of the parties’ intentions in the courts.
Here, the courts have applied the heads of terms to override the main contract (known as a ‘rectification claim’) where it is clear that the latter does not reflect the parties’ actual intentions. It is therefore always worth treating them with the same significance as you would the contract itself.
Read what makes a strong commercial contract here.
Specialist business sale solicitors
Our Corporate and Commercial Teams are happy to discuss any issues that this raises for you and we offer a free initial meeting or chat on the phone. The team can assist of all aspects of corporate transactions, from drafting and negotiating heads of terms, right through to completion.
If you have any questions, you only have to ask us at Frettens. Please contact us here or call 01202 499255 and Karen or a member of the team will be happy to chat about your situation and your particular requirements.
Related articles on selling a business:
You can read Karen’s other articles on selling a business by following the links below:
