Heads of Terms, Heads of Agreement, Letters of Intent: they all refer to and mean the same sort of thing.
They serve the same purpose.
In business, they also go by the names of "term sheets", "memorandum of understanding", "MOU", "letters of understanding", "heads of agreement", "heads of terms agreement" and "letters of interest".
They're all different expressions that means the same thing: preliminary agreements or pre-contract agreements.
In the construction industry, heads of terms are often wrapped up and packaged as letters of intent or “LOIs” for short. Different terminology with the same meaning.
Heads of Terms are precursor to a legally binding agreement. The process involves:
Heads of Terms is a document:
Formal, legally binding contracts are intended to follow agreement to the heads of terms.
That’s when the legally binding relationship is intended to start.
And so it is with heads of agreement, term sheets, memorandum of understanding, letters of understanding.
It’s when the intending contracting parties change their relationship intentionally or unintentionally that heads of terms and letters of intent become legally binding.
They’re the same thing as heads of terms and heads of agreement: a document presented in a different format: as a letter.
They’re the same thing from a legal perspective. That's because the law prefers the substance of things over form or presentation.
The form of the document and what it's titled is far less important that what it does from a legal perspective.
So like a document entitled "Heads of Terms" which isn't a contract (or hasn't become a contract since it was signed), a letter of intent isn't - usually - intended to be legally binding.
More on that below.
Letters of Intent and Heads of Terms can be used:
Really, they can be used as a lead-in to any business agreement.
If they’re used, and negotiations break down, you're no worse off, because you don’t make a legally binding contract by implication - ie by mistake.
But often businesses go further and use heads of agreement for purposes beyond their primary purpose.
Which can create problems.
They can become legally binding, even if they weren't when the commercial agreement was reached, and even if you don't intend it to happen.
They’re a means to agree in a written form a non-legally binding agreement.
Here’s a process on how heads of terms might be used in your business:
Heads of Terms documents will reduce the main terms of an intended contract to written form.
The exchange between the negotiating parties is a way to reach the "commercial agreement" referred to above.
It’s meant to be a short, succinct, structured summary of the fundamental terms of the contract. Most of the time, they’re not meant to include every last detail, like this.
If parts of the heads of terms aren't meant to be legally binding, there is no need to sign heads of terms. It's about reaching commercial - non-legally binding agreement after-all.
If however parts of the heads of terms are meant to be legally binding, then they should be signed or some other method used to form the contract, so that it is legally binding.
There’s some subtlety in that last sentence. Heads of terms serve to consolidate understandings.
They’re not as informal as a conversation or as a pre-contract meeting to negotiate (talk is cheap) and they’re not as formal as a contract (they don’t impose legal commitments).
They’re somewhere in-between.
It’s a step in between to move in a semi-structured fashion to move towards a legal binding relationship.
It commits the "pre-agreement" to writing.
They're not meant to include every last detail.
The level of detail you go into will probably be dictated by the complexity which will be necessary in the final agreement.
They set out the structure the basics of the transaction to:
It’s what’s important to you, and what’s important to your counterpart to get the deal done, and keep it moving in that direction.
It's the fundamentals of the transaction without descending into nauseating detail which will probably stall discussions and negotiations.
You might include:
When you use Heads of Terms, Heads of Agreement or a Letter of Intent (whichever term your industry prefers), they can:
There's more on what is included further below.
Negotiations and discussions can get quite complicated. Negotiating the final terms of a contract can get even more complicated.
When they do, the situation ripens for misunderstandings. If misunderstandings mature at the time the contractual documentation is exchanged, it can waste your time and obviously money.
It's that Heads of Terms and letters of intent serve a real purpose: they minimise the chances that misunderstandings mature at a late stage. You probably want problems identified early so that they can be addressed. If they can't be solved early, you can move on to the next opportunity.
You’re trying to reduce complexity at an early stage to reach a commercial agreement. The final terms of contract follow, in turn.
There’s no point kicking something critically important to you down the line.
It can be useful to include matters that are likely to cause friction later in the negotiations, to draw out the conversation in the terms, early on.
If you don't, it just delays the matters and raises the question, “Well, if it was that important to you, why didn’t you raise it earlier?”.
Raising prickly issues late in the day might cause proposal to disintegrate for reasons which might have been revealed earlier, and waste your time.
You might even test and prod for a reaction: you might get better terms than what you expected because your counterpart doesn’t have the reaction that you expect that they might. Even then you want a business partner who will react maturely.
They can also be a test of trust.
If your counterpart agrees to the non-binding Heads of Terms but then reneges on what was commercially agreed late in the day - before contracts are signed - you have something tangible to raise with them at a later date for an explanation. and why they didn't tell you about the change of position earlier.
And if your counterpart flies off the handle easily - even before a contract has been signed - what will they be like after it has been signed?
You can reassess whether you should be contracting with them at all.
Business is hard enough, without having high maintenance contracting partners.
But the deal might be worth it. Obviously, it's your call.
Here's some of the sorts of matters which might be covered when you're looking to reach agreement on heads of terms for different sorts of contracts.
A letter of intent for a business proposal, heads of terms for a partnership agreement, or a joint venture company might mention:
It's pretty obvious that money is usually paid for a business.
What's not so obvious is to specify exactly what is being purchased.
Warranties and indemnities obtained by the purchaser from the vendor should support and maximise the chances that the value of the money paid by the purchaser is transferred to the purchaser with the sale.
Even a basic letter of intent or heads of terms for the sale of a business should include:
There are a whole host of considerations for agreements to settle disputes. For a settlement agreement to manage the exit of a person who owns shares in a company might include:
We’ve included some templates for you to start with below.
Heads of Terms (and LOIs) can provide that:
There’s nothing wrong with having legally binding Heads of Terms, provided the terms that you don’t want to be tied to are stated not to be legally binding. Clearly and unambiguously.
Because of the way the law works, after parties have signed the non-binding or even legally binding type, they can by their words and actions make the non-legally binding parts . legally binding.
When all of the elements to form a contract are present, a contract is formed.
There are limited things which prevent a document agreed by two or more parties with a business relationship which would be a contract, becoming a legally binding contract.
Usually, Heads of Terms prevent a contract being formed, by using:
To form a legally binding contract, the parties must have an intention to create a legally binding agreement.
“Subject to contract” communicates that the parties don’t have the required intention to be legally bound.
Assuming that there is no trading relationship between the parties or anything else that would impute a legally binding relationship - those words "Subject to Contract" remove the intention to create legal relationship.
Is an agreement in principle legally binding?
The words “agreement in principle” communicate a meaning that:
But it could become binding at a later date.
And here's the trap with the words.
You might see words in a letter or email that say something like, "We're all agreed in principle".
Looks like you're agreed, doesn't it? You're not, for the reasons above.
New players read those words (or something similar to it) and think they have a . legally binding commitment.
Well, odds on, it's not. Something further needs to be done to conclude the contract to reach a legally binding contract.
Whether or not a contract has been formed depends on the facts of particular case. It's highly fact sensitive: a small change in the facts can change the outcome.
Commercial negotiations are free flowing exchanges. Proposals and counter-proposals are passed with counterparts.
They can be recorded in Heads of Terms (or not).
But let's say they are, and the Heads of Terms aren't intended to be legally binding.
Businesses frequently think that “there is no contract”, because:
But the law operates differently. When work has been carried out by one business for another, the situation changes.
The commercial character of the relationship changes. Work has been carried out by one side. Odds on, it's a contract of supply.
And if money has been paid, (or some other consideration has been provided) the odds lower.
The Supreme Court says that these commercial relationships (as opposed to just negotiating):
will often make it unrealistic to argue that there was no intention to enter into legal relations.
Businesses are seen to have intended to enter into a legally binding relationship. Whether they thought they were or not.
There will almost certainly be a legally binding contract created on some terms or another.
When it comes to forming contracts, law works on an objective standard: personal intentions aren't a significant factor in the equation when deciding whether a legal relationship (ie a contract) has been formed.
In this way, the law of contract deems a contract has been formed when all of the elements of a legally binding contract are satisfied - and the parties' behaviour bear all the hallmarks of a contractual relationship.
So, if the Heads of Terms has been signed, and the parties to the Heads of Terms have started working together, the binding contract might be:
It depends on what has happened in terms of the conduct of the parties, and the communications passing between the parties.
That’s not to say that businesses can’t use heads of terms intentionally to negotiate and enter legally binding arrangements.
It's a matter of knowing when they do, and what the legal consequences are.
Need to structure a deal in a certain way, but can't find the words to say it?
It’s not a false economy to run your situation by a qualified and experienced solicitor to help you avoid pitfalls and traps negotiating a contract at an early stage.
If you have concerns that your Heads of Terms won't work as you want it to, our specialist contract lawyers can help you:
We've done it before for others, and can do it for you.
We can also help you prepare your contracts to help you do what you need to do to finalise your deal, so you can get on with business.
Avoid pitfalls and traps that others have fallen into in the process.
Sidestep problems and difficult conversations altogether.
You can avoid having to revisit negotiations at a later stage because something has been missed at an early stage.
Call us now on +44 20 7036 9282 to speak with one of our specialist contract lawyers for legal advice.
Here are examples of the some of the different forms of commercial heads of terms and letters of intent in templates:
If you begin with the end in mind, you'll be in a better position to review your contract prior to signing it once it's ready.
If you're trying to fit your commercial agreement into a legal framework, the deal might be re-structured from a legal perspective to make the formal documentation more straightforward to prepare later.
When you prepare heads of terms, you're able to:
You can save significant legal costs later by addressing potential problems and gaps early on. Some times, a framework agreement may be more appropriate for setting up your contracts.
For specialist legal advice on contracts, call us on +44 20 7036 9282 or email us now at contact@hallellis.co.uk.