Financial

What are Heads of Terms and are they legally binding?

A Heads of Terms document can ensure a successful negotiation, but is such an agreement required? Hereโ€™s everything you need to know about HoTs.

By Making Moves London

What are heads of terms?

Heads of Terms (often shortened as ‘HoTs’) is a document which sets out the key terms of a lease between two or more parties during the initial stages of negotiations. An essential document in any negotiation, it is most often used as an agreement in principle that is not legally binding but helps to form a bridge between an informal discussion and a more formal or legally binding contractual document.

Heads of Terms may also be known by several other names: Heads of Agreement, Letters of Intent, Term Sheets, Memorandum of Understanding (or MOU), Letters of Understanding, and Letters of Interest, among others. While all these names may be used interchangeably, Heads of Terms is often the most widely used and understood.

In commercial property lease negotiation, the key points that a Heads of Terms document is likely to cover include the parties and premises involved, rent, term, VAT, permitted use, and any additional specific arrangements such as dilapidations/reinstatement, alienation (sublet/assignment), break conditions, service charge caps, exclusivity, and any other details critical to the lease. It will also commonly contain timings, jurisdiction, enforceability, and any further due diligence required. Following the negotiation of a Heads of Terms document, the lease is often progressed to ‘Under Offer’.

As a preliminary step before a formal contract, they can often save a business money by ensuring that any deal breaking issues are smoothed out ahead of any formal dealings, especially those which will require additional legal input or advice.

Draft Heads of Terms are typically issued by the landlord’s advisor and are generally focused on protecting the landlord and can be unfavourable to occupiers. It is the responsibility of the occupier’s advisor to negotiate this document to ensure it is as tenant friendly as possible and excludes any onerous conditions before progressing to the legal stage. The process of negotiating a Heads of Terms typically takes around 1-2 weeks.

The overall aim is to not include detail of the minutiae, and instead outline the salient terms of the terms and lease provisions in a concise document, ahead of a legally binding contract/relationship.

What are the benefits of heads of terms?

The primary purpose of a Heads of Terms is to form an agreement in a non-binding and non-contractual way. They are useful in terms of not being legally binding but still laying out vital details about how a more detailed commercial contract is likely to operate and progress. This gives legal advisors of both parties some clarity and direction to focus on issues which are not yet agreed, such as common big-ticket items like dilapidation or alienation. (not accurate. The dilaps and alienation are usually agreed in HoTs but the wording associated to these provisions are yet to be agreed) If managed well, this can be both time and cost effective, particularly if both parties have already made some agreements prior to drafting a Heads of Terms.

They are also useful for demonstrating a certain level of seriousness or commitment between two parties, and a degree of intent to be contracted in a fully-fledged and legally binding contract. [This could be elaborated to say “to ultimately enter into a legally binding contract” or similar.] This can be helpful for any third parties involved in the negotiations in terms of having a clear overview of the overall theme of the negotiations, for example regulatory bodies or potential investors which may require a top-level view of the proposed deal. This level of commitment can also enable swift and early agreement on the key aspects of a deal. It also provides a level of comfort for parties in knowing when to serve notice for an existing space, as well as a point of inflection for both parties to agree to incur more substantial legal fees towards the next stage of the negotiation.

Another major benefit of a Heads of Terms is that they can enable quicker negotiation by keeping focus of any future negotiations on any points which may be contested, rather than those in which both parties are in partial or near-complete agreement. Additionally, the document can always be referred to at a later date, for example, when a new member of a team takes over a historic client, or at a sticking point during future negotiations.

 

A word of caution around ‘subject to contract’

It is important to remember that although Heads of Terms are often not legally binding, some or even potentially all of the clauses can indeed be legally binding depending on the wording used.

If a business does not want to be legally bound by the Heads of Terms, allowing some ‘wiggle room’ with regards to certain terms or conditions which might require further discussion or negotiation, the document should be headed ‘Subject to Contract’. This helps to indicate that the final lease will be a more detailed breakdown of the specific provisions listed in the HoT and is wording which is subject to change.

Heading a document ‘Subject to Contract’ does not however, provide complete legal freedom, so even though it might cover some presumptions around the Heads of Terms, a legally binding contract may still be formed, depending on prior communications or dealings between the parties.

As is always best, in the event of any uncertainty around the legal implications of a Heads of Terms, please take expert legal advice.ย 

Do I need to sign a heads of terms agreement?

It depends. Given that generally, the purpose of a Heads of Terms is meant to be about reaching a non-legally binding agreement, there is often no need to sign a Heads of Terms document. This is often the preferred route for both parties, particularly ahead of any formal involvement by legal teams.

However, a Heads of Terms can be intentionally legally binding, depending on context and circumstance. It can, for example, be useful to have flexibility and carry both legally binding and non-legally binding elements. If there are elements of the Heads of Terms which are legally binding, then the document should be signed, as these will form part of the contract. In most cases, Heads of Terms should only be signed after seeking expert legal advice, just as one would when signing a comprehensive commercial contract. A signature from both parties can, however, indicate a useful degree of commitment, even if this signature is not intended to be legally binding. At Making Moves, we always seek approval from the client to move to legals via email as a minimum, albeit no physical signature is usually required.

Does a solicitor need to draft heads of terms?

While a solicitor does not need to prepare the Heads of Terms, it can often be beneficial to have this additional layer of protection and comprehension from a legal expert. This can often be more cost-effective in the long-term, as getting a solicitor involved from an early stage can help ensure that any finer details are not missed or overlooked. An additional benefit can be helping to get a ‘foot in the door’ regarding any critical minutiae of the detailed commercial contract, particularly those that are likely to require further negotiation. As often the case with legal documents, the inclusion of professional legal advice can mitigate difficulties and headaches later into any negotiations.

Having a solicitor involved at this stage can enable a stronger final contract document, whether it be from a commercial, legal, tax, or accountancy perspective. The input of a solicitor from both parties at the earliest stage possible can also be more cost effective in terms of legal fees, as solicitors can start the process at a point of some mutual agreement, and do not need to then negotiate from scratch.

When should heads of terms be created?

In short, a Heads of Terms agreement should be drawn up as soon as is feasible at the beginning of a contract lifecycle. By beginning this process as soon as possible, it ensures there is adequate time to iron out the finer details of any agreement before legally binding agreements are negotiated. This can avoid costly mistakes further into negotiations, such as either party withdrawing before a formal contract is signed due to unforeseen or deal breaking issues, or any uncertainties surfacing at the last minute.

Generally, a Heads of Terms will be created once the most salient terms of the commercial deal are agreed (pricing, terms, incentives, time periods, etc.), however as negotiations develop, they can of course be updated, as long as both parties agree. This can make a Heads of Terms document useful as a fixed point of reference for both parties as negotiations develop.

What should be included in heads of terms?

Although a Heads of Terms is meant to be a succinct document drafted ahead of any legally binding contract, it is still important to ensure it contains the core terms of a future agreement, particularly those which are at all unusual or likely to require any further detail or discussion at a later stage.ย 

Generally, a Heads of Terms agreement should include (at least) the following:

    • The fundamental purpose of the contract proposed
      An outline of the key points of the deal, and the most vital details and obligations of both parties to ensure maximum clarity and transparency from the outset.
    • The most important headline terms
      These can vary depending on the nature of the proposed contract, but in a commercial lease can include anticipated timescales, price, pre-conditions, and an explanation of key commercial terms. It also makes sense to cover deposit details, use class of office, landlord contributions such as floor box and flooring allowance, incentive structures (rent free/capital contribution), and other standard items such as: alienation, alterations, dilapidations, service charge, service charge cap, insurance provisions, break conditions, repair conditions, technical conditions i.e. early access for mechanical and electrical validations, whether landlord is to maintain HVAC, potentially pandemic clauses, what type of lease (FRI lease), exclusivity, confidentiality, subject to contract, inside or outside the Landlord and Tenant Act 1954.
  • Unusual provisions relating to the terms (see below)

Details of any likely major issues or differences between the parties which requires further negotiation or discussion. A Heads of Terms can be an excellent starting point for the negotiation of any such issues, as well as anything outside of the ordinary which needs specific provision.

  • Clauses
    A description of the most important details involved within, not limited to, but including:
    • The parties involved
    • Confidentiality agreements/clauses
    • Enforceability (as ‘subject to contract’ above)
    • Due diligence required
    • A statement of the key terms as listed above
    • Jurisdiction of governing laws
    • Occasionally a ‘lock-out’ clause
  • Failed transaction details/next steps
    Information on any further protection available for either party in case of a failed transaction.

Top tips when drawing up heads of terms

Often easy to overlook, it is worth spending the time to ensure that a Heads of Terms document is as strong as it can be, to maximise the chance of future success of a final contract. With that in mind, here are some tips to strengthen a HoTs agreement:

  • Set out clear objectives
    Given that its general purpose is to set out the basics for a future contract, ensure that a Heads of Terms document does exactly what is needed by setting out clear and not overly complex or ambiguous objectives from the outset. It may sound obvious, but these documents can become bloated, so ensure that any key points are comprehensible, and try to ensure that a HoTs is as simple and straightforward as it can be.
  • Establish realistic timeframes It is advisable to include clear and realistic timeframes within the Heads of Terms, such as deadlines for receiving the legal pack, responding to initial documents, and arranging meetings to address final queries. This fosters a structured and efficient negotiation process.
  • Raise key points at this early stage
    If there are contentious issues which are likely to require further negotiation, a Heads of Terms agreement can be a good place to ‘set the scene’ for these, or raise any thorny points early in the discussion.
  • Ensure clarity
    Without a clear understanding from both parties about what is already agreed, and what needs further negotiation, any Heads of Terms document is less likely to succeed. Ensuring absolute clarity will increase the likelihood of a future successful contract.
  • Take the opportunity to state the unusual
    By addressing any unusual or potential sticking points at an early stage, any risk of these becoming larger issues can mitigate the chance of any negotiations breaking down. Highlight any ‘out of the ordinary’ points and ensure both parties understand these.
  • Ensure the document is kept up to date
    As negotiations ebb and flow, a Heads of Terms document can be a handy reference point for all parties. But as negotiations progress, keeping the document up to date can save time, money and any potential frustration from any involved party.
  • Never sign a Heads of Terms without legal advice
    Tempting though it can be to save on the legal fees at this early stage, ensuring total comprehension from a legal standpoint can ensure a positive outcome for all parties.

Summary

While it is easy to overlook the importance of a Heads of Terms agreement in any negotiations, it should be remembered that a Heads of Terms can save all parties involved both resources and money in the long term and help to foster a successful working relationship.ย 

Make sure any Heads of Terms agreement does its job by making it clear what the key terms are, that any document is drafted early on in the negotiation process, and that any legal assistance has been sought where necessary. Above all, by giving the document sufficient effort and due care, it is significantly more likely to conclude in all parties getting the best out of the final contract and ensuring a successful negotiation process which is after all, the desired outcome for all.

If youโ€™re in the market for a new office, or are looking for consultancy for an office relocation, get in touch and one of our team would be happy to help.

 

Additional Sources
https://uk.practicallaw.thomsonreuters.com/0-107-6683?transitionType=Default&contextData=(sc.Default)&firstPage=true

https://www.brachers.co.uk/insights/heads-of-terms-explained

https://harperjames.co.uk/article/heads-of-terms-and-letters-of-intent/#section-4