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A heads of agreement is the agreement that you enter into before the final contract. It is used widely within the construction industry for large projects between contractors and principals. If you are a contractor, it is a good idea to negotiate a heads of agreement with the principal before you enter into a final contract. This article will explain what you should include in a heads of agreement for a construction project.

Is a Heads of Agreement Legally Binding?

A heads of agreement only provides a framework for the final contract. You and the principal still have the intention to continue negotiations to finalise the contract. However, you may find that after negotiations, you do not have an agreement and there is no formal contract. In that situation, you or the principal may argue that the heads of agreement does represent the final contract. Therefore, any obligations under the contract would be legally binding on the parties. 

If there is a dispute, a court will interpret the heads of agreement like any other contract. When deciding whether the heads of agreement is legally binding, the court will take into account the:

  • intention of the parties;
  • terms of the agreement;
  • language used within the document; and
  • circumstances at the time of signing the agreement. 

Therefore, your heads of agreement should expressly state that:

  • it is not legally binding; and
  • the heads of agreement is subject to negotiations and the final contract.

Including those words would remove ambiguity about whether the heads of agreement is legally binding. 

What Are the Key Benefits?

The two key benefits of negotiating a heads of agreement for a construction project include:

  1. establishing the contractual framework; and
  2. reducing the risk of the construction project.

Contractual Framework

Construction projects often require multiple documents that cover important areas such as:

  • the project timelines; 
  • payment methods; and
  • distributing risk between the parties.

When you use a heads of agreement, you have a starting document that sets out the key terms that you want to include in the final contract. That gives you a strong base to negotiate terms that are favourable to you or to check for any discrepancies.  

Reducing the Risk

Once you establish the contractual framework, you and the principal will know what needs to be done before signing the final contract. Therefore, a heads of agreement helps set the key dates and outlines the documents you and the principal need to prepare before you finalise the contract. This process helps to reduce risk in the contracting schedule. 

What Are the Key Risks?

It is always ideal to prepare and sign a contract rather than a heads of agreement. However, that is not always possible in large construction projects that may involve millions of dollars. The two main risks that may occur as you develop a heads of agreement include when:

  1. negotiations fail, but the principal wants to enforce the heads of agreement as the final contract; and
  2. the heads of agreement is inconsistent with the final contract.

Negotiation Failure

You and the principal may not be able to negotiate a final contract beyond the heads of agreement. In that situation, you had not signed a final contract. If the heads of agreement does not state that the agreement is not legally binding, you may risk having the principal attempt to enforce the heads of agreement as a legally binding document. That process may include the principal taking you to court to compel you to enter into a final contract based on the heads of agreement.

Inconsistency

On the other hand, you and the principal can agree that the heads of agreement can form part of the final contract. However, if the heads of agreement is not drafted properly, the terms and language used may be inconsistent with the final contract.

These inconsistencies can create ambiguity within the contract about how each party should interpret the obligations under the contract. Your heads of agreement should be subject to the final contract. Address any potential inconsistencies before signing the final contract.  

Disputes Mechanism

Your heads of agreement should include a provision (known as a dispute mechanism) that sets out how to resolve a dispute over the terms of the heads of agreement. That mechanism should stress the need for confidentiality. You or the principal cannot reveal sensitive information to other parties that comes up during negotiations or when the parties do not sign the final contract. 

Additionally, you may want to include provisions that address how you would address certain events that occur before the final contract.

For example, you or the principal terminates the heads of agreement before signing the final contract. Will both parties go separate ways, or should the person that terminates provide compensation for the time and effort spent on negotiations?

Checklist

What Should You Include in a Heads of Agreement for a Construction Project?
  • Ensure the final contract’s terms and language is consistent with what was agreed under the heads of agreement.
  • Remember to include words such as ‘subject to the final contract’ and that the heads of agreement is not legally binding on the parties.
  • Outline that each party has not entered into any legally binding relationship, such as agency, a partnership or a joint venture.
  • Include a provision in the heads of agreement that you will negotiate in good faith for the final contract.
  • Provide for an expiry date (or a ‘sunset’ clause) for when the heads of agreement will expire.
  • Clarify that neither party owes obligations to each other once the heads of agreement ends. 
  • Require both parties to keep sensitive information confidential.
  • Highlight that either party can end negotiations at any time when drafting a heads of agreement or a final contract.
  • Set out the process for what will happen when the heads of agreement expires or one party terminates the agreement.
  • If you perform any work before the final contract, include the payment process and scope of work in the heads of agreement.

Key Takeaways

A heads of agreement can help contractors and principals set out the key terms of a construction project before entering into a final contract. As a contractor, you do not want to risk agreeing to terms that you did not intend to be legally binding on you. If you have any questions or need help signing your agreement, get in touch with LegalVision’s construction lawyers on 1300 544 755 or fill out the form on this page.

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