Heads of Agreement: Risk & Remedy
What is a Heads of Agreement?
A Heads of Agreement (sometimes called “term sheet” or “letter of intent”) is a short document signed before a full contract. Its purpose is to record the key commercial points the parties have agreed on and to guide them through to a formal agreement.
It often sets out:
1. the price or method of calculating it,
2. the assets or shares to be sold,
3. timing for due diligence and completion,
4. who pays for what costs,
5. whether negotiations are exclusive, and
6. confidentiality obligations.
Importantly, not everything in a Heads of Agreement is binding. Unless it is drafted carefully, you may end up with obligations you did not intend, or no protection at all.
The Risks
1. Thinking you are locked in when you’re not
A Heads of Agreement is usually not the final contract. If it says “subject to contract,” it may have no legal force in relation to the sale itself. One party can walk away, even after months of negotiation.
2. Being bound when you didn’t mean to be
On the other hand, if the wording is too definite, a court may decide the parties are already bound. That can trigger tax liabilities, financing obligations, or even a forced sale before you are ready.
3. Uncertainty and disputes
Vague wording such as “a reasonable deposit” or “usual warranties” leaves too much open to interpretation. Disputes often arise about what was meant, which defeats the purpose of recording the deal in the first place.
4. Wasted time and money
If the Heads of Agreement does not cover exclusivity or confidentiality, a party could spend money on due diligence only to find the other side is negotiating elsewhere or disclosing sensitive information.
5. Pressure points
Once something is written down and signed, it is psychologically harder to renegotiate. Even if the clause is non-binding, the other party may treat it as a promise and use it as leverage.
The Remedies
1. Be clear about what is binding
State in plain terms that the document is “not legally binding, except for the following clauses.” Typically, the binding clauses are confidentiality, exclusivity, costs, and governing law. Everything else should be expressly “subject to contract.”
2. Use conditions precedent
Make the deal conditional on key steps being completed, such as due diligence, finance approval, or board consent. That way, you are not locked in until those steps are satisfied.
3. Keep it specific but limited
Record the key commercial terms (price, timing, structure) precisely, but don’t try to draft the entire contract in the Heads. Leave the detailed warranties and conditions for the final agreement.
4. Put a time limit on negotiations
Avoid being stuck in limbo. Include a sunset date: for example, “if a binding agreement is not signed within 60 days, this document expires.”
5. Manage costs and expectations
Say who pays for legal, accounting and due diligence costs during the negotiation period. This avoids later arguments.
6. Get legal advice before signing
Even though a Heads of Agreement is short, it can create major consequences. A lawyer can ensure the right parts are binding and the rest are not, keeping you in control of the process.
Conclusion
A Heads of Agreement is a useful tool to capture the deal at a high level, give confidence to banks or investors, and set the rules for due diligence.
Handled properly, a Heads of Agreement can smooth the path to a final contract. Handled carelessly, it can cause confusion, disputes, and unexpected obligations.
Require assistance?
I help business owners and buyers understand their options and reduce risk. If you’re considering a Heads of Agreement, or any major business deal, get in touch for clear, practical advice.
Buying a business? See Buying a Business in Queensland.
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Joe Kafrouni, Accredited Specialist in Business Law, Kafrouni Law
Disclaimer: This article is general information only and is not legal advice. Before acting on it, get advice on your own circumstances. To the extent the law allows, Kafrouni Law accepts no liability for any loss arising from reliance on it. This article is the copyright of Kafrouni Law.
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