A Heads of Agreement, properly drafted, is a non-binding document which sets out the key terms of a proposed agreement between parties.
It is commonly used as part of the process of negotiating commercial transactions for example, the purchase of a business.
The idea is that the parties sign the Heads of Agreement at the pre-contractual stage of negotiations, with the intention of the parties continuing negotiations with the involvement of lawyers and accountants, and ultimately entering into a binding contract.
In general, an Heads of Agreement can be effective to provide:
evidence of a party’s commitment for the benefit of third parties such as banks or potential investors;
a mechanism for dealing with pre-contractual issues such as exclusivity, confidentiality, due diligence and intellectual property;
a degree of confidence that a deal is probable before the parties incur further expense.
Is a Heads of Agreement legally binding?
Some people immediately assume that a Heads of Agreement is legally binding, while others assume it is not.
The reality is that a Heads of Agreement could be either binding or not. However, generally the intention is that the Heads of Agreement is not binding in relation to the “key terms of a proposed agreement between parties”, but is binding in relation to such matters as “exclusivity, confidentiality, due diligence and intellectual property”.
Are there any risks associated with entering into a Heads of Agreement?
Yes. The most obvious and common risk is that the Heads of Agreement, though not meant to be binding, is drafted in such a way that it is binding. This can have significant adverse consequences. Click here to read my article about a business owner who incurred a $700,000 Capital Gains Tax liability because a Heads of Agreement was binding and triggered a sale of the business before the end of the financial year.