The question of whether heads of terms (also called letters of intent) are legally binding is one that often comes up. However, there is no set response, as it will depend on the details of the heads of terms, as well as what the intentions of the parties were at the time.
How do you know when you’re dealing with heads of terms?
Heads of terms tend to be the stage of agreement before a legally binding contract. They are not designed by their nature to be binding. However, heads of terms can be binding under some circumstances, for example they can act as a preliminary agreement to cover work that needs to take place before the contract is entered into.
If heads of terms aren’t usually binding, why use them?
The main purpose of heads of terms is to establish an agreement in principle on some of the more substantial commercial issues that will make up the main body of the contract. Doing this can help to simplify the negotiations later required for the contract and provide an indication of what both parties agree on. The key with heads of terms that are not meant to be binding is to ensure they are drafted by a solicitor to avoid any confusion. With legal advice, you’ll be able to make sure that no implied contractual relationship is created.
How do you avoid an implied contractual relationship?
Case law provides some clear indications of how to avoid an implied contractual relationship being established when it comes to agreeing heads of terms.
- Include an express statement that the heads of terms are not intended to be binding
- Follow up with the binding legal documents as quickly as possible after heads of terms have been signed
- Bear in mind that taking any steps to implement what is in the heads of terms could be viewed as an indication of intention for them to be binding
You can also make use of the phrase “subject to contract,” as this is a clear indication that the binding legal document is to follow and is not the heads of terms. However, if the obligations in the heads of terms are then performed before contracts are signed this could be an indication of an intention that those terms be binding, regardless of stating that the terms are subject to contract.
Where heads of terms are intended to be binding
- State this intention in the document
- Ensure that, where only some terms are designed to be binding, and others not, this is also clearly stated
- Ensure that terms are certain and well defined enough to be enforceable
- Make sure that all the requirements for a binding legal contract are in place, such as consideration moving from the benefitting party, and that those who are signing the heads of terms have the authority to enter into a contract on behalf of the parties.
Heads of terms can be a useful tool in business agreements and, as long as they are tightly drafted, should leave no room for ambiguity with respect to whether or not they are binding.