Heads of terms set out a broad outline of the parties’ expectations, understanding and agreement of the key terms of the proposed transaction which they have agreed in principle. We set out below some of the key advantages and terms which are normally included in Heads of Terms.
Advantages of using Heads of Terms
• Address key commercial issues early on
• Impose a moral commitment to proceed
• Set a timetable for due diligence and negotiations
• Basis for instructing legal and other advisers
• Summarise the deal to other stakeholders
• Provide a framework for exclusivity and confidentiality commitments
• Tax—avoiding argument that transaction undertaken for tax avoidance purposes
Disadvantages of using heads of terms
• Disproportionate time and cost
• Buyer will be disadvantaged in negotiating without having conducted due diligence
• Risk of creating duty to negotiate in good faith (for international transactions): Many European jurisdictions treat heads of terms as amounting to a binding preliminary agreement with a duty to negotiate in good faith, meaning that they may be used by an aggrieved party as the basis for an action breach of the duty of good faith.
Legal issues to consider in preparing heads of terms
Binding or non-binding: In the UK, heads of terms will normally be expressed to be non-binding and subject to contract.
Consideration, contractual certainty: The requirements for the creation of a valid contract must be fulfilled and will need to be supported by some form of payment, action, provision of information etc. An agreement to agree can be void for uncertainty and will be unenforceable.
Financial promotion: An invitation or inducement to engage in investment activity that is given in the course of business and such communication is not given, or the content of the communication is not approved, by an authorised person. This would not be the case, however, if a financial promotion exemption were to apply.
Pre-contractual statements: Although the heads are usually expressed to be non-binding, the parties will need to ensure that the provisions or terms in the heads of terms, as well as statements made during contractual negotiations, do not amount to misrepresentations that could give rise to an action for damages under the common law or the Misrepresentation Act 1967. The use of an entire agreement clause in the share purchase agreement, if correctly drafted, can ensure that the parties are not liable for statements made prior to entering into the heads of terms which are not fraudulent or dishonest.
Duty to negotiate in good faith (for deals involving other European jurisdictions): There is no legally binding duty to negotiate in good faith under English law. However, many European jurisdictions treat heads of terms as amounting to a binding preliminary agreement with a duty to negotiate in good faith.
Checklist of provisions to include in the heads of terms
• Description of the transaction
• Price (including any assumptions and qualifications)
• How payment will be made
• Pre-completion restructuring
• Due diligence arrangements
• Drafting responsibility
• Protection for the buyer from liabilities
• Proposed timetable
It is common to include in heads of terms for a share or asset purchase transaction certain provisions which are intended to be binding, concerning some or all of the following matters:
• Any restrictive covenants
• Costs: who will be responsible if negotiations break down, for example, will each party bear their own costs or will one party pay the other party’s out-of-pocket expenses?
• Exclusivity: where the buyer is given a certain period of time to conduct its due diligence and enter into negotiations with the seller;
• Confidentiality: provisions to protect the confidentiality of the information concerning the seller/target disclosed to the buyer and also the fact that negotiations are taking place
• Break fees: where one party agrees to pay the other party a break fee if the transaction does not proceed for certain specified reasons
• Non-solicitation: where both parties agree not to solicit key employees from the other party for a defined period after the heads of terms are entered into, in the event that the parties withdraw from the transaction
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