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A heads of agreement is the agreement you enter into before the final contract. It is important to take the time to correctly review your heads of agreement before you enter into your contract as it sets out the key terms of the relationship. For example, you may sign a heads of agreement before signing a joint venture agreement or before buying a company.

By carefully considering the agreement and thinking ahead about what issues the contract should address, you can avoid disputes should your relationship with the other party sour. This article outlines some important considerations when entering into a heads of agreement.

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.

Tip: A heads of agreement is a good way to record understandings and formalise negotiations between parties.

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 itself, the court takes it into account when deciding whether there was an intention for the agreement to be binding.

Tip: If you want your heads of agreement to be binding, ensure that the agreement explicitly states this.

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.

Tip: Ensure the language is clear and says what you mean. Including definitions of terms and numbering each clause or section can assist in structuring the document.

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.

Tip: Ensure that your heads of agreement is complete and enforceable by recording any understandings in full detail.

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, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

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