Home » What are commercial term sheets & heads of agreement – when are they used?

What are commercial term sheets & heads of agreement – when are they used?

Posted by Allison Anthony | 10 February 2018 | Corporate & Commercial

Have you ever got half way through negotiations for a transaction and wondered why the process is taking so much time, effort and money, at the same time asking yourself whether the transaction could have been documented more effectively? Alternatively, have you ever wholly or partially negotiated a detailed Heads of Agreement only for the parties to walk away and not proceed with the deal?

More often than not, at the start of a transaction it is highly worthwhile for parties to take the time to discuss the most appropriate strategy for documenting the transaction (regardless of whether that transaction be a lease or licence arrangement, complex sale of land or business transaction, property development deal, corporate re-structure or financing transaction).

These discussions should include whether or not a Commercial Term Sheet and/or Heads of Agreement should be utilised from the outset to identify the core agreed terms of the transaction and (hopefully) minimise the time and cost of negotiating and documenting the transaction.

What is a Commercial Term Sheet and how does it work?
A Commercial Term Sheet (which can also be called an Outline of Commercial Terms or more simply, a Term Sheet) is a document usually presented in bullet point or tabular format, which in the most basic form outlines the material terms and conditions of the transaction, it is worked up between the parties and once finalised guides the detailed negotiations and drafting of the transaction documentation.Whilst Commercial Term Sheets can be legally binding (if carefully drafted in sufficient detail, and the parties agree for it to be so), in most cases they are not legally binding, but rather are updated as the negotiations for the transaction progress.It is a very useful tool, and if used effectively, can significantly reduce time and costs associated with the transaction.

What is a Heads of Agreement, and importantly, is it legally binding?
A Heads of Agreement (which is sometimes also called a Memorandum of Understanding) (HOA) is a document that is usually more detailed and lengthy than a Commercial Term Sheet which sets out (usually in clause or paragraph format) the agreed terms of the proposed transaction in addition to containing usual agreement provisions relating to confidentiality, costs, exclusivity and dispute resolution. Given the detail ordinarily required in HOAs, they take greater time to document than Commercial Term Sheets and therefore are more appropriate where complex negotiations or stages in a transaction are contemplated.

Careful consideration needs to be given whether or not a HOA is appropriate in addition to, or instead of, a Commercial Terms Sheet.  This is particularly relevant where the proposed terms of the transactions are highly uncertain, conditional or speculative and the parties are yet to agree on core commercial terms.  In such circumstance, documentation of a Commercial Terms Sheet rather than using a HOA would be beneficial in the long run – particularly if the transaction does not proceed.  One of the main issues that arises in connection with HOAs is whether or not they are legally enforceable and binding. In the past, this issue has often become a matter of dispute between parties leading to the Courts being asked to determine the matter (more recently in Michael Lahodiuk v Vincent Pace and Prid Pty Ltd [2013] NSWSC 512 (9 May 2013)).

The Courts look to all the circumstances surrounding the HOA and have held that the main principles that are relevant as to whether or not a HOA is legally binding are:
1. What was the intention of the parties at the time of drafting the HOA (which is not limited to written documentation, but also conduct of the parties)?
2. Has the HOA been drafted in sufficient detail to give certainty and meaning to the agreed terms?

These matters need to be carefully addressed when the HOA is drafted if the parties intend for it to be (partly or wholly) legally binding and enforceable.
Before a HOA is entered into other matters should be considered including possible tax implications that might arise upon its execution (if you have any doubts in this regard, we recommend that specific tax advice be sought prior to documenting a HOA) and the appropriate exit arrangements if the transaction does not proceed.
HOAs certainly have benefits, but the potential disadvantages relevant to the specific circumstances should be weighed up and assessed (in conjunction with seeking legal advice, if required) prior to a HOA being used as part of a transaction documentation strategy.

For further information contact Nexus Group Principal, Alison Anthony on +612 4961 0002 or ala@nexuslawyers.com.au.

 

This publication is © Nexus Lawyers Pty Ltd and is for general guidance only.  Legal advice should be sought before taking action in relation to any specific issues.

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