It’s fairly typical in land development or commercial deals for the parties involved to thrash out a few of the core commercial terms before “getting the lawyers involved”.
So, to take a commercial lease as an example, you might come to a consensus about the space to be leased, the price, outgoings, rent increases, options to extend the term, and any rent-relief for fitout purposes.
At this point a lot of agents will put together a short document summarising what’s been discussed and agreed upon.
It might be called a heads of agreement, a “terms sheet” or possibly a “memorandum of understanding”.
And it’s sometimes a massive dispute just waiting to blow up in your face.
Why do Agents Do This?
To be fair, it’s not only agents who use heads of agreement. We hone in on agents here because they are regularly involved at the coal face of negotiations, and therefore often the ones who prepare the heads of agreement documentation.
It’s true that sometimes lawyers will prepare them also – however the process tends to be more considered, less rushed, and less likely fraught with the risks we’re about to discuss.
It’s worth saying that agents aren’t usually trying to stitch anyone up with a heads of agreement.
What they are trying to do is capture the initial negotiations that have taken place, give everyone comfort that those core elements are largely agreed, and put people in a position where they are now comfortable investing time and money in further due diligence, legal advice, or the preparation of formal documentation.
There is also a bit of sales technique happening here – signing you up to a heads of agreement is an early “yes” which increases the chance you will go through with the deal later, when compared with just a bit of discussion around the topic. By showing enough commitment to sign on the dotted line of a heads of agreement, you’re invested in the process and more likely to complete.
Unfortunately, many hastily prepared heads of agreement cause more problems than they solve.
When is an Agreement Not an Agreement?
At what point of the negotiation phase could someone argue that you have a binding agreement?
To clarify, by “binding agreement” we mean “if you don’t proceed you could get sued”.
In legal terms there are three main possibilities at any given point prior to a complete formal document being signed:
- You don’t have an agreement in any way, shape or form and everything is still up for negotiation;
- You have an understanding in principle, but it is not binding on anyone until it is formally documented; or
- You have an actual agreement that is binding, although you intend to document it more formally.
The problem with a heads of agreement is this: it could be any of the above!
So Which Option do you Want in a Heads of Agreement?
So if it’s open for a heads of agreement be any of those three options we’ve set out above, which one is preferable?
In a sense, that’s entirely up to you.
If risk is your main concern, the lowest risk option is for a heads of agreement to be completely meaningless in every way. To that extent, it’s largely just a few notes.
The problem is that kind of document doesn’t really serve much purpose or offer any commercial comfort. After all, would you be happy starting to incur legal fees preparing a formal contract if you didn’t have a degree of confidence that you’ve agreed on the contract price?
At the other end of the spectrum, signing up to a binding heads of agreement is a high risk situation. Here, you are still bound by the agreement if a formal document never gets prepared (even if that was the intention) – you’re stuck no matter what. Given the many items up for negotiations in a complex contract, this isn’t necessarily a situation you want to be in.
Which leaves us in the middle and, for most situations, preferable option. You have elements of commitment to core areas that, generally speaking, people won’t just renege on. However, if negotiations go sour or you find out some new information that impacts your ability to complete, then you still have some ability to get out.
Or… The Mix ‘n’ Match Situation
Sometimes you might find a heads of agreement that tries to mix binding and non-binding provisions.
So, the parties might be contractually bound immediately by, say, confidentiality provisions or non-disclosure provisions. They might also be contractually bound by obligations to reasonably pursue the negotiation and finalisation of the formal documents. But otherwise the terms might not be intended to bind the parties.
So the big question at this point is: if those are the options, how can you achieve the outcome you want and avoid the risk of an unintended binding document?
The Answer: Clarity
Clarity is the answer to many legal problems, provided it is considered early in the piece.
The easiest way to design a heads of agreement that binds (or doesn’t) the parties in the way you want is to be clear about it.
The problem is that many heads of agreement simply don’t do this. They set out the “agreed” terms, people sign on the bottom line, and then everyone goes home happy with a good negotiation under their belt.
That is, until a week later when your financial situation changes unexpectedly and you want to pull out. The other side claims the HoA was binding immediately, and now you’re in a regrettable dispute that could have been avoided.
So:
- If you want a heads of agreement to be non-binding in every way, just say that: “This document is not intended to bind the parties in any way, and no party is legally bound by any of its terms.”
- If you want a heads of agreement to be binding, say that: “While the parties intend to formally document their agreement, this Heads of Agreement is intended to be immediately binding on all the parties to it.”
- If you want something in the middle – find clear language to express it.
But the real answer is this: even if it’s “just” a heads of agreement, don’t sign it without getting your lawyers to look at the document first.
They can catch potential headaches just like these, get things clear, and leave you in a good place moving forward.
And while there is often a deal of commercial pressure being placed on everyone to sign, taking a little time to get sound advice is usually a good plan.