Understanding Heads of Terms

05 Apr 2024

What are Heads of Terms?

Heads of terms, also known as letters of intent, memoranda of understanding, or term sheets, summarise the key points of a deal before the final contract has been signed.

Drafted during the early negotiation phase, heads of terms outline the key terms and conditions agreed upon by all parties involved. Although predominantly non-binding, certain clauses within the heads of terms can be specified as legally binding, such as confidentiality, exclusivity, and governing law clauses.

Purpose and Benefits of Heads of Terms

The primary purpose of the heads of terms agreement is to ensure that all parties have a mutual understanding of the deal's main terms and a clear framework within which detailed legal agreements will be constructed.

They serve several functions:

• Clarifying intentions: Heads of terms help make the parties' intentions explicit, reducing the risk of misunderstandings as negotiations progress.

• Facilitating negotiations: By identifying and agreeing on the key terms early on, parties can streamline the negotiation process, focusing on finer details with a solid foundation already in place.

• Resource and cost efficiency: Establishing the main terms early can help in assessing the feasibility of the deal, potentially saving significant time and costs associated with drafting and negotiating detailed agreements if fundamental disagreements exist.

• Due diligence framework: They provide a basis for conducting due diligence, allowing parties to specify the scope and terms of the due diligence process.

Legal Considerations

From a legal standpoint, while some parts of the heads of terms may not be binding, they play a crucial role in shaping the negotiation and formation of the final agreement.

It's essential for parties to clearly state which (if any) parts of the document are intended to be legally binding. This distinction helps prevent unintentional legal obligations during the negotiation phase.

Furthermore, the inclusion of certain binding clauses, like exclusivity or confidentiality, necessitates careful drafting to ensure they accurately reflect the parties' agreement and are enforceable in the relevant jurisdiction.

What’s Included in the Heads of Terms?

Parties' details: The identification of all involved parties.

Description of the transaction: A clear description of the nature and scope of the transaction.

Key terms: Price, payment terms, and any other commercial terms.

Exclusivity: An exclusive period during which time the seller (usually) cannot be engaged with any other potential buyers, allowing the parties (mainly the buyer) time to undertake due diligence with confidence that the seller is not simultaneously engaged with another potential buyer.

Non-binding provisions: Explicitly stating which clauses are non-binding.

Binding provisions: Explicitly stating which clauses are binding.

Heads of terms help everyone understand the deal's key terms and set the groundwork for detailed legal documents. They're a practical step to make sure all parties are on the same page, saving time and effort by clarifying the deal's direction from the start.