A Heads of Agreement is most often used as part of the process of negotiating a commercial or property transaction, though they could be used in other circumstances. The purpose of a Heads of Agreement is to record the terms the parties consider important, to provide a framework for the negotiations before a final binding contract is entered into, to deal with matters of confidentiality, intellectual property, and due diligence, and to give the parties confidence in a transaction and that further costs in preparing binding, sometimes extensive, written contracts are warranted.
There are some common misunderstandings about a Heads of Agreement and its role in negotiations. To begin with, a Heads of Agreement, when drafted properly is a document setting out the important terms of a proposed agreement between parties. Normally, a Heads of Agreement is not binding on the parties. However, that is not always the case. Problems can arise where parties sign Heads of Agreement that have been drafted to be binding when they didn't mean them to be.
A Heads of Agreement may deal with many items and issues, some of which may not normally be found detailed in a contract. The primary consideration for anyone thinking of using a Heads of Agreement in negotiating a transaction is whether it should be or, will be, binding on the parties. It is a good starting point for the parties to agree on this early in the negotiations.
Whether a Heads of Agreement is binding on the parties or not depends upon how it is drafted. In most cases, the Heads of Agreement won't be binding in relation to the important terms of the transaction set out in the Heads of Agreement but, will be binding in relation to other matters such as confidentiality, intellectual property and due diligence. Disputes can arise when one party assumes the Heads of Agreement are binding and another party assumes that they are not. For that reason alone, discussing the binding or non-binding nature of a Heads of Agreement at the very start of negotiations can save a lot of headaches further down the road.
While many parties negotiating a commercial transaction see a Heads of Agreement as a way of keeping their legal and accounting costs down, there are good reasons to get some legal and accounting advice early. Entering into a binding Heads of Agreement can trigger certain events and liabilities, which if occurring at an unintended time can make for a costly error.
For example, where the terms in a Heads of Agreement are so extensive and certain, a sale of an asset can be found to have taken place even though the formal sale contract was yet to be prepared and signed. Care must be taken to ensure that unintended Capital Gain Tax events and liabilities to pay transfer duty don't arise until intended to. In one case before the Commonwealth Administrative Appeals Tribunal, such an error saw the vendor of a business incur a CGT liability on a capital gain of $700,000. If the vendor had obtained advice on the Heads of Agreement, in that case, his CGT liability may have been $0.
Our Commercial Law team can help with any of your business's legal needs, and recommend you speak to us as early in the negotiation process as possible. We're here to help in Bathurst, Oberon, and Lithgow on 02 6331 2911.
David Killen | Solicitor