Commercial and technology contracts legal A-Z: H is for heads of terms

Heads of terms (sometimes also referred to as heads of agreement, a letter of intent, a memorandum of understanding, or a term sheet) are often entered into at the outset of a commercial transaction to document preliminary commercial terms agreed between the parties.

There is no standard form for heads of terms; they can vary from a simple letter to a carefully drafted document prepared by professional advisors. Heads of terms can help focus negotiations, highlight any misunderstandings or key issues at a very early stage and prevent parties from wasting time and money progressing a transaction if the issues cannot be resolved. Heads of terms can also be a helpful starting point for professional advisors when drawing up the subsequent commercial agreement. However, a party must also consider that heads of terms may limit the flexibility of subsequent negotiations and it is therefore important for them to be carefully considered prior to signing.

Heads of terms can be legally binding, non-binding or binding in part (for example, only binding in relation to provisions on confidentiality, intellectual property, exclusivity and/or costs). Where heads of terms are intended to be binding, or include provisions that are binding, the legal requirements for a valid contract must be satisfied. In particular, the terms must be sufficiently clear and there must be consideration (value or a benefit) moving between the parties, unless the heads of terms are to be executed as a deed (see our previous post on “D: Deed”).

Often heads of terms which are not intended to be legally binding are marked with the phrase “subject to contract”. This creates a strong presumption that the parties do not want to be bound by them, but it is not an absolute defence, particularly if the parties begin performing the contract envisaged by the heads of terms. Equally, heads of terms are treated differently in some jurisdictions where they may be considered binding regardless of the intention of the parties.

It is also important to be aware that statements made in heads of terms may have the potential to create liability for misrepresentation or negligent misstatement.

For more information please contact Gary Parnell or any member of our commercial contracts team.