Before signing contracts and entering into formal legal relationships, many businesses first sign a heads of agreement (HOA). An HOA outlines the key commercial terms of the arrangement and can be used as a negotiation tool. When entering into an HOA, it is important to consider whether it is legally binding, so you understand any risks involved. This article explains when you should use a heads of agreement (HOA) and when it will be legally enforceable.
When Should You Use an HOA?
You may use an HOA to set out the key commercial terms of a legal arrangement before entering a binding contract. You can use it as a negotiating tool and demonstrate a strong intent to collaborate.
Some example scenarios where you might need to use an HOA include if you are:
- selling your business and wish to negotiate the terms of the sale before agreeing to the legal terms in a formal contract;
- planning to enter a collaborative arrangement with another business to conduct research where each party provides funding and resources; or
- in discussions to form a new business that relies on the skill set of another party.
A HOA is also sometimes known as a letter of intent, sales advice, initial offer or expression of interest.
What Does an HOA Include?
Because an HOA intends to cover the key commercial terms of a legal relationship, it can include anything relevant to what you have agreed to with the other party. Generally, you can expect it to outline:
- some background that contextualises the parties’ relationship so far and their intent to enter a formal relationship;
- what each party will bring to the table;
- what information must be kept confidential;
- conditions that need to be met for the transaction to occur;
- that each party has received advice and will pay for its own legal expenses;
- some standard clauses, such as the applicable law and how to change the terms of the document.
Importantly, the HOA will also include a clause regarding whether the document is binding or non-binding.
There are various benefits to drafting an HOA, including:
- recording the terms that have been agreed on;
- providing the parties with a structure to use in drafting the final documentation; and
- finalising negotiations.
When Is an HOA Enforceable?
The HOA should expressly state the extent to which it is enforceable. In most cases, the HOA will state that it is not enforceable save for specific terms related to confidentiality. Where this is the case, you will not be able to force a party to agree to the deal if they pull out.
However, if they breach the confidentiality agreement, you may be able to claim against them.
It is of course possible to create legally enforceable HOAs. However, in practice, this is unusual.
Either way, you should ensure that your HOA acknowledges whether it is legally binding to avoid confusion.
If you do intend for the HOA to be binding, you should also make sure that:
- the parties’ details are accurate and include the full legal name and ACN or ABN;
- it is properly signed and dated; and
- all essential terms of a contract are addressed.
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Key Takeaways
An HOA is an important document that sets out the legal obligations of both parties before they enter into a formal agreement. It is often non-binding because it usually precedes a binding and more comprehensive contract. However, this does not mean that an HOA is always non-binding. The key item to look out for is a clause setting out the binding or non-binding nature of the agreement.
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Frequently Asked Questions
As a matter of commercial practice, no. They are drafted specifically so that they are not binding. Though there may be certain provisions that are binding, such as confidentiality agreements.
Heads of agreements are primarily used as negotiation tools. They clarify the issues at hand and help parties work towards finalising the arrangement into a formal agreement.
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