Prism Corporate Broking

What’s the Point of Non-Binding Heads of Terms?
Article by Paul Whittingham, Ashton Graham Solicitors

This is an apparently fair question. What is the purpose of spending time and effort producing a document recording the proposed terms of a sale if it does not commit either party to proceed with the sale or to do so on the stated terms?
In fact, there are several clear advantages to having a Heads of Terms. First of all, if the whole document was intended to be binding, then it would actually constitute the sale document if all the relevant terms were set out with reasonable certainty. The parties do not normally wish this to happen at the stage of reaching an initial agreement or “handshake”. In particular, the buyer will want to undertake due diligence and will need proper sale documentation to be drawn up to put the “flesh on the bones” of the terms briefly outlined in the Heads of Terms.

A Heads of Terms, therefore, states that the sale will not be concluded until proper legal documentation has been prepared, negotiated and signed, including the appropriate warranties and indemnities for a transaction of that kind. The buyer needs to reserve the right to pull out of the transaction at any stage if, for example, they were to discover skeletons in the cupboard.

Another useful purpose of Heads of Terms is their moral, rather than legal effect. Sometimes during the course of the evolution of a deal, one of the parties will introduce a new term or try to vary the deal in some way or another. It is then useful to be able to wave the Heads of Terms under their nose to remind them of what they have agreed. The other party may then say that if certain terms are going to be changed, they may also want to revisit other terms, such as the price, for example. In this way, Heads of Terms provide a practical way to prevent a party from moving the goal posts.

A clearly drafted Heads of Terms also saves time, effort and cost in the preparation of the sale documentation. In deals where the parties have not bothered with the Heads of Terms but have concluded arrangements either verbally or in a lengthy exchange of emails, it can be very difficult to ascertain precisely what the terms of the deal are. This can make it extremely difficult to draft a purchase agreement that accurately reflects what the parties had in mind.

Although people readily refer to “non-binding Heads of Terms”, in fact most Heads of Terms are expressed to be binding in relation to certain clauses. For example, the Heads of Terms will normally contain a confidentiality clause concerning information exchanged between the parties and indeed the existence of the negotiations themselves. It will be expressly stated that this clause is legally binding and enforceable, even if the clauses setting out the terms of the purchase are not.

It is also common for buyers to include an exclusive dealing period in a Heads of Terms document. This will specify a period of weeks or months in which the seller agrees not to conclude a deal or even have negotiations with any other prospective purchaser. These clauses cannot force the seller to negotiate or to conclude a sale with the buyer, but they can give recourse to a potential buyer if the seller concludes a sale during what was supposed to be an exclusive dealing period. Therefore, the exclusivity clause will need to be expressed to be legally binding if it is to have any effect at all.

In deals with complicated provisions, such as elaborate earn outs or net asset warranties it can take quite a long time to agree and sign off a set of Heads of Terms. This sometimes alarms buyers or sellers who think that if it has taken so much effort to produce a non-binding Heads of Terms, the sale process itself will be a nightmare. In reality however, the time spent thrashing out the more elaborate concepts at the Heads of Terms stage saves a lot of time and cost later on. It therefore usually proves to be a good investment.

Paul Whittingham – Ashton Graham Solicitors

This article is for general information purposes only and does not constitute legal or other professional advice. We would advise you to seek professional advice before acting on this information. Ashton Graham is authorised and regulated by the Financial Services Authority. Ashton Graham solicitors are regulated by the Solicitors Regulation Authority, No. 50075.