Are heads of terms or letters of intent legally binding?

1 February, 2018

words of a typed letterWe’re often asked by clients whether heads of terms or letters of intent they’ve already agreed with another party are binding.  This ultimately comes down to what has been agreed, what the parties’ intentions were and whether the terms are sufficiently certain to be legally enforceable.

What are heads of terms?

Heads of terms (also known as letters of intent) are usually entered into when parties are not yet in a position to sign a detailed contract.  They can be used to set out the parties’ agreement in principle on the key commercial issues at an early stage of a transaction and are not intended to be binding.  They may however also be used as a binding preliminary agreement to cover any immediate work before a full contract is signed.

If not carefully drafted, there can be uncertainty and doubts over whether or not the parties intended to be legally bound by all or some of the terms.   

No intention to be legally bound

An agreement made on the basis that the parties don’t intend to be legally bound until they enter into a more formal contract, is not itself usually legally binding but it can create a strong moral commitment which it might be difficult to later move away from. 

To ensure that no implied contractual relationship is created, case law shows the importance of:

  • Expressly stating that the terms are not intended to be binding;
  • Ensuring that any further documents envisaged by heads of terms are drafted and executed as quickly as possible; and
  • The parties carefully considering whether to take any action to implement the heads of terms as doing so might suggest that they intend to be bound.

 

‘Subject to contract’

The use of the phrase “subject to contract” in commercial negotiations creates a strong presumption that the parties do not wish to be bound, particularly if this is understood from usage in the industry, however, again, if the parties start to perform the contract envisaged by the heads of terms, beware that this presumption will not always apply.

Binding agreements

If the whole agreement or some of the provisions are intended to be binding by the parties, this should ideally be clearly stated.  Further, the legal requirements for creating a valid contract must be satisfied:

  • The terms must be sufficiently certain to be enforceable;
  • All essential terms crucial to the existence of a binding contract must have been agreed;
  • Unless the heads of terms are executed under seal or as a deed, there must be consideration moving from the party benefiting from the agreement to the other party. In practice this is usually a promise, payment or action, or a delay in enforcing a legal right; and
  • The parties handling the negotiations must have authority to enter into the agreement.

 

As is usually the case, the key to avoiding uncertainty is careful drafting in the first place.