Heads of Terms are commonly used in a variety of commercial property transactions. This document is created during the pre-contract stage of negotiations, setting out the main terms of a commercial transaction that are agreed in principle. Ashleigh Evans explains more about their importance below.
What are Heads of Terms?
These terms will outline the skeleton terms of the lease, such as its duration and whether it is protected under the Landlord and Tenant Act 1954. They will also encompass the use of the property and define the annual rent with any provisions for it to be reviewed. The Heads of Terms can be quite detailed; however, they are generally not comprehensive enough to cover all particulars that are involved within the legal contract. Recording the key points within the Heads of Terms is an efficient way for both parties to identify all details and lay the foundations of a contract / lease before they are drafted into a formal legal agreement.
Why have them?
Drawing up Heads of Terms at the outset of the transaction will determine a guideline of each parties’ understanding of the agreement and help prevent any misunderstandings that can be easily identified at an early stage before the formal drafting. Heads of Terms can also give evidence that each party intend to enter into a formal agreement. Once the parties have agreed the basic terms of the transaction, they can instruct a solicitor to draft the agreement encompassing the Heads of Terms provided. This will prevent delays or disputes later on within the transaction when the parties have already committed a significant amount of time and legal fees spent drafting a detailed contract / lease.
Are they binding if parties fail to make a formal agreement?
Heads of Terms are not generally legally binding, they are used as an instrument to set out the important terms when drafting a contract / lease and the parties are only legally bound once the formal documents have been signed. Although historically many cases have ruled that Heads of Terms should not be relied on for contractual protection, the recent judgement of Green Deal Marketing Southern Limited (“GDM”) v Economy Energy Trading Limited (EE) found that if a document is sufficiently certain, the parties have acted in a way that demonstrates all other elements necessary for a valid contract are present, it may be enforceable.
Between 2015 and 2017, GDM had acted as an agent for the Defendant, encouraging households to use EE’s gas and electricity, operating under a formal written agreement that was signed in May 2015. In June 2016, the parties renegotiated terms further to the original agreement and intended to form a new legally binding contract, however the parties failed to draft the new Heads of Terms into a contract.
When GDM brought a claim against the Defendant for a breach of contract in 2017, the Claimant sought to rely on the Heads of Terms as a legally binding contract. EE disputed that the heads of terms do not have legal effect and the contract created in 2015 was still valid. The question for the court was whether there is a legally binding contract formed if it can be demonstrated that the parties had intended the Heads of Terms, following their negotiations, to bind them. The court found that a legally binding contract had been entered into when each party signed the Heads of Terms on 29th June 2019. The judge stated that each party’s actions following this date clearly show intention to work under the new provisions stated within the Heads of Terms, and not the original agreement.
This case is a reminder that although Heads of Terms are rarely legally enforceable, if parties show the intention to form a contractual relationship without a formal written agreement, then a signed Heads of Terms document may be relied on for contractual protection in court.
To ensure that there has not been an implied contractual relationship formed, it is important that those drawing up Heads of Terms expressly state that the terms are not intended to be binding. It is also essential that any further documents envisaged by the Heads of Terms are created and executed properly.
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