What Are Tips for Entering Into a Heads of Agreement?

Summary

• A heads of agreement (also known as a term sheet or memorandum of understanding) sets out the key terms of a transaction before the final contract is signed, and courts will assess its enforceability by examining the language used, the parties’ intentions, and whether the document is certain and complete.
• Unclear or imprecise language creates a risk of different interpretations that could render the agreement unenforceable, so all terms should be expressed explicitly and be understandable to an objective third party with no prior knowledge of the transaction.
• A heads of agreement must include all relevant transaction details to be considered complete; omitting key information such as repayment terms in a loan arrangement may lead a court to find the agreement incomplete and therefore unenforceable.
• This article is a guide to heads of agreement for businesses in Australia, explaining the key considerations for ensuring a heads of agreement is enforceable and the risks of unclear or incomplete drafting.
• LegalVision is a commercial law firm that specialises in advising clients on commercial contracts and business transactions.

Tips for Businesses

Use clear and explicit language in your heads of agreement and include all relevant transaction details to reduce the risk of a court finding the agreement incomplete or unenforceable. Consider how an objective third party with no prior knowledge would interpret the document before finalising it. Engage a lawyer to prepare or review your heads of agreement, particularly for transactions involving significant sums, to minimise the risk of costly disputes arising later.

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On this page

• Entering Into a Heads of Agreement
• Binding Heads of Agreement
• Language
• Completeness
• Key Takeaways
• Frequently Asked Questions

A heads of agreement sets out the key terms of a relationship before the final contract is signed, and getting it right can prevent costly disputes down the track. Whether you are entering a joint venture or buying a company, understanding what makes a heads of agreement enforceable is essential. This article outlines some important considerations when entering into a heads of agreement.

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Entering Into a Heads of Agreement

The heads of agreement provides structure to the relationship between you and the other party. It also allows you to take the time to understand the more complex details that the final contract will include. In this way, a heads of agreement is a part of the negotiating process. A heads of agreement is also known as a term sheet and sometimes a memorandum of understanding.

Binding Heads of Agreement

The general principles of contract law apply to a heads of agreement. You should, therefore, consider:

• the language of the agreement;
• the intention of the parties; and
• whether the document is certain and complete.

If a heads of agreement is the subject of a dispute, a court will consider the language of the document. The court will analyse the language in the context of the surrounding factual circumstances. For example, the heads of agreement may expressly state that it is not legally binding. Although this is not definitive in itself, the court takes it into account when deciding whether there was an intention for the agreement to be binding.

Language

When entering into a heads of agreement, you should ensure it contains clear language. Although the meaning of the clauses may seem obvious to you, you should think about how an objective third party with no prior knowledge would view your agreement. Could they pick up a copy of the document and understand it? Or would they have questions about certain parts?  

If you think a third party would have questions, your heads of agreement may be open to different interpretations. The possibility of different interpretations is risky, especially in the event of a dispute. If the words and phrases used in a heads of agreement are uncertain or imprecise, your agreement could be unenforceable. To mitigate the risk, you should ensure the language is explicit about your intentions.

Completeness

You should also check that the heads of agreement includes all relevant details of the anticipated transaction. For example, if your agreement states that a loan is to be made to Party B, you should also include details of:

• who is providing the finances;
• who will repay the loan; and
• how and when that party will make repayments.

If your heads of agreement only states that a loan is to be made to Party B without further details, the court may view the terms surrounding the loan as incomplete, and therefore unenforceable. An unenforceable agreement may be a significant issue, especially if you were to receive a loan repayment but the agreement did not properly address how repayments were to be dealt with.

Key Takeaways

Entering into a heads of agreement can be a complex process. You do not want to leave the enforceability of your contract to chance, especially if it relates to a transaction involving a significant sum of money.

Having a lawyer prepare or review your agreement is a valuable strategy for managing risks in your transaction. Ensuring a legal professional prepares your agreement correctly may save you headaches in the future. It also minimises your risk of ending up in court trying to enforce the agreement.

If you need assistance with drafting or reviewing a heads of agreement, LegalVision provides ongoing legal support for all businesses through our fixed-fee legal membership. Our experienced contract lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee.  To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.

Frequently Asked Questions