Heads of Terms, Letters of Intent: they refer to the same thing. They serve the same purpose.
In business, they also go by the names of "term sheets", "memorandum of understanding", "letters of understanding", "heads of agreement", "letters of interest" and "term sheets". In the construction industry, heads of terms are often wrapped up and packaged as letters of intent or “LOIs” for short.
They’re usually exchanged by the 2 businesses in draft form before they’re finalised – to reach what businesses call “commercial agreement” - to distinguish from the sort of agreement which is legally binding. (we've included 3 templates below: the non-legally binding variety, contractual form and a Letter of Intent)
Once you have commercial agreement on the Heads of Terms, businesses prepare the formal contract documentation, which will be legally binding when signed.
What are Heads of Terms?
They’re a document:
- to reduce a preliminary agreement to writing
- without being legally binding
- before the formal legal documentation is prepared.
- which supports the pre-contract negotiation process.
Formal, legally binding agreements are intended to follow agreement to the heads of terms.
That’s when the legally binding relationship is usually intended to start.
It’s when the intending contracting parties change their relationship intentionally or unintentionally that heads of terms and letters of intent become binding.
What about Letters of Intent?
They’re the same thing as heads of terms, presented in a different format: as a letter.
They’re the same thing from a legal perspective. That's because the law prefers the substance of things over form or presentation.
The form of the document and what it's titled is far less important that what it does from a legal perspective.
So like a document entitled "Heads of Terms" which isn't a contract (or hasn't become a contract since it was signed), a letter of intent isn't - usually - intended to be legally binding.
More on that below.
When are they Best used?
LOIs/Heads of Terms can be used:
- in the run up to set up the framework for a joint venture
- to progress negotiations for settlement agreements in employer / employee disputes
- set up the commercial agreement which will lead to settlement of contractual disputes
- to preface exclusivity arrangements for intellectual property rights
- to flesh out the structure of a merger, acquisition of shares and sales of businesses
- to lay the groundwork for what will be expected in the contractual terms for supply of materials for construction work
- in property transactions, such as leases and commercial premises
Really, they can used as a lead-in to any business agreement.
If they’re used, and negotiations break down and the parties are no worse off, because you don’t have a legally binding contract.
But often businesses go further and use them for purposes beyond that.
Which can create problems.
They can become legally binding, even if they weren't when they were agreed.
What are the Benefits of Heads of Terms?
Negotiations and discussions can get quite complicated. Negotiating the final terms of a contract can get even more complicated.
When they do, the situation ripens for misunderstandings. If misunderstandings mature at the time the contractual documentation is exchanged, it can waste your time, and obviously money.
That’s that Heads of Terms and LOIs serve a real purpose: they minimise the chances that misunderstandings mature at a late stage.
You’re trying to reduce complexity at an early stage to reach a commercial agreement. The final terms of contract follow in turn.
When you use Heads of Terms or an LOI, they can:
- make you focus on the really important parts of the deal being negotiated
- show up gaps in other matters that should be discussed.
The sort that get in the way when the formal contracts are prepared – for example, limitations of liability or indemnities
- make it harder to renege on something which has already been agreed in Heads of Terms
- serve as an agreed guide for what is needed in the formal documentation if you're going to ask a lawyer to prepare the documentation
- help others that come into the negotiations late. They have document to read to know the status of the negotiations and the points of difference
- speed up the contractual drafting. They save time and money
You can also run it by your lawyer to make sure you haven’t dealt with something that you should, during the negotiations. Saves you from going back to your counterpart at a later date after commercial agreement has been reached.
Finally, proposed commercial arrangements when discussed may not be as straightforward from a legal perspective as they sound from a commercial perspective.
Heads of terms draw that out. And you can address that at an early stage.
If you're trying to fit your commercial agreement into a legal framework, the deal might be re-structured from a legal perspective to make the formal documentation more straightforward to prepare.
How are Heads of Terms used ... Properly?
They’re a means to agree in a written form a non-legally binding agreement.
Here’s a process on how heads of terms might be used in your business:
- negotiate with your counterpart - in calls, email and meetings
- prepare draft heads of terms to send to your counterpart, once you’ve the basics are in place
- send the draft to your counterpart to ask if it a fair reflection of the discussions
- If they’re not, invite them to amend them and send them back
- If negotiations continue the heads of terms can be updated and changed to reflect the commercial agreement.
Heads of Terms documents will reduce the main terms of an intended contract to written form. The exchange between the negotiating parties is a way to reach the “commercial agreement" referred to above.
It’s meant to be a short, succinct, structured summary of the fundamental terms of the contract. Most of the time, they’re not meant to include every last detail, like this.
Contents of Heads of Terms
It’s an agreement in principle.
There’s some subtlety in that last sentence. Heads of terms serve to consolidate understandings.
They’re not as informal as a conversation or as a pre-contract meeting (talk is cheap) and they’re not as formal as a contract (they don’t impose legal commitments). They’re somewhere in between.
It’s a step in between to move in a semi-structured fashion to move towards a legal binding relationship.
They're not meant to include every last detail.
They set out the structure the basics of the transaction to:
- list preconditions or events that must take place before agreement is reached
- confirm the understanding of what the final terms of contract will contain
- set up a process and timetable to reach legally binding agreement, and/or
- list the basics of a sale, licence or acquisition of property
It’s what’s important to you, and what’s important to them to get the deal done, and keep it moving in that direction.
It's the fundamentals of the transaction without descending into nauseating detail which will probably stall discussions and negotiations.
You might include:
- Parties to the intended transaction
- What is to be done by each party
- Price to be paid
- pricing structure or cost
- expenses to be reimbursed
- Timetable for completion
Sometimes it helps to work backwards from a final form of contract to cherry-pick the most important issues, and condense them into your Heads of Terms.
There’s no point kicking something critically important to you down the line.
It can be useful to include matters that are likely to cause contention to draw out the conversation in the terms, early in the negotiations.
If you don't, it just delays the matters and raises the question, “Well, if it was that important to you, why didn’t you raise it earlier?”. Raising it late in the day might cause proposal to disintegrate for reasons which might have been revealed earlier, and waste your time.
You might even test and prod for a reaction: you might get better terms than what you expected because your counterpart doesn’t have the reaction that you expect that they might. Even then you want a business partner that will react maturely.
They can also be a test of trust. If your counterpart agrees to the non-binding Heads of Terms but then reneges on what was commercially agreed late in the day (ie before contracts are signed), you have something tangible to raise with them at a later date for an explanation. And why they didn't tell you about the change of position.
If your counterpart flies off the handle easily - even before a contract has been signed - what will they be like after it has been signed?
You can reassess whether you should be contracting with them at all.
Business is hard enough, without having high maintenance contracting partners.
But the deal might be worth it. Obviously, it's your call.
Examples: Heads of Terms Agreements
Here's some of the sorts of matters which might be covered when you're looking to reach agreement on heads of terms for different sorts of contracts.
Software, Data / Intellectual Property Licences:
- SaaS services to be supplied, and:
- a synopsis of service levels
- limits and exclusions to the services. There always are: such as interfere with the services, user load, disk space, bandwidth.
- Terms of licences to be granted
- exclusive, non-exclusive, worldwide or smaller territory, royalty-free, revocable, perpetual
- Does the term of licence = the term of contract? (they don't necessarily need to be the same)
- An additional period required for wind down?
- Under what conditions can licences be revoked?
- Source code to be contributed
- Are any deliberate consequences of termination to apply?
- Are any quality standards to apply to the data licenses, or conditions to use or re-use?
- Associated services to be provided:
- help desk / code support
- data fixes
- help desk hours,
- proposed response times and resolution times
Sales of Business / Business Purchases
It's pretty obvious that money is usually paid for a business.
What's not so obvious is to specify exactly what is being purchased.
Warranties and indemnities obtained by the purchaser from the vendor should support and maximise the chances that the value of the money paid by the purchaser is transferred to the purchaser with the sale.
Even a basic letter of intent or heads of terms should include:
- whether it's a sale of shares or assets of the business (they fundamentally different)
- fundamental assumptions of the purchaser underlying the value of the transaction. These find form in warranties and indemnities given by the vendor to the purchaser
- contracts between the target acquisition and customers to be novated
- assets included:
- real property, ie land and buildings
- tangible property such as equipment, plant and machinery included
- intellectual property assets, which might include:
- customer lists and customer information such as purchasing data and patterns
- software source code
- design masters
- website(s) and domain names
- any repository of intellectual capital
- assets not included (if any)
- for a sale of shares, the liabilities of the company
- transfer of employees and named employees (or not)
- post-sale/acquisition commitments of the vendor
- restrictive covenants, aka non-competition clauses to protect the goodwill purchased, and
- price to be paid, and when. Importantly for the purchaser, circumstances where the purchase price can be clawed back. For instance, what if all of the customers or a large percentage of them don't stay with the business after it's sold?
A letter of intent for a business proposal, heads of terms for a partnership agreement, or a joint venture company might mention:
- Background to set the context
- If a joint venture company is to be formed
- name (“NewCo” or “JVC” if not decided)
- ownership of shares in what quantities; types of shares
- internal control of company: appointment of directors, management structure, limitations on incurring expenditure
- Roles & responsibilities of participants: operations / admin / software development / product supplier / service provider / distribution rights /
- Resources to be contributed: money, staff, intellectual property licensed, services to be supplied
- Exclusivity of services, software, business activities
- Ownership of intellectual property: Contributions of IP assets: owners retain ownership? What sort of licence or software licence is granted?
- revenue/profit sharing provisions, payment of expenses by the JVC or the parties
- Terms of Restrictive Covenants
- Exit conditions
There are a whole host of considerations for agreements to settle disputes. For a settlement agreement to manage the exit of a person who owns shares in a company might include:
- Price to be paid for shares / Structure of payments (assuming shares are to be paid for)
- Procedure up to completion
- handover of assets and property
- documents required to be signed as preconditions to completion
- procedure and time commitments
- Statements of service of individuals
- Full and final settlement
- Planned date of completion
- Mutual releases from historical claims
- Restrictive Covenants to apply post-settlement
Checklist of Tips: Heads of Terms
- In most industries and sectors, LOIs and Heads of Terms shouldn't be complicated.
They’re meant to move the transaction along. Not bog parties down into excessive detail.
In the construction industry, heads of terms can get extensive with high value work.
- Think twice if you want them to be drafted formally: is it really necessary?
Is the transaction of sufficient size or importance to justify it? Is your counterpart expecting it?
- They should serve your purpose, whether that’s to:
- speed up negotiations
- clarify complexity to reach a common understanding
- fully reflect the contractual relationship.
- Make sure the Heads of Terms do want you think they will do for your business venture.
Clauses 3 to 5 of the precedent here seem to be the sort of obligations that in the ordinary course, you’d want to be legally binding.
They wouldn't have any legal effect, because they're expressly stated not to be legally binding.
We’ve included some templates for you to start with below.
So are Heads of Terms legally binding?
Heads of Terms (and LOIs) can provide that:
- none of the terms of legally binding
- some terms are legally binding, but others aren’t.
There’s nothing wrong with having legally binding Heads of Terms, provided the terms that you don’t want to be tied to are stated not to be legally binding. Clearly and unambiguously.
Because of the way the law works, after parties have signed the non-binding or even legally binding type, they can by their words and actions make the non-legally binding parts .... legally binding.
Non-Legally Binding Heads of Terms
When all of the elements to form a contract are present, a contract is formed.
There are limited things which prevent a document agreed by two or more parties with a business relationship which would be a contract, becoming a legally binding contract.
Usually, Heads of Terms prevent a contract being formed, by using:
- the words “Subject to Contract”
- the words “Agreement in Principle”
- a contractual precondition.
If and while the precondition hasn’t been satisfied, the condition prevents the contract from being formed.
What does “Subject to Contact” mean?
To form a legally binding contract, the parties must have an intention to create a legally binding agreement.
“Subject to contract” communicates that the parties don’t have the required intention to be legally bound.
Assuming that there is no trading relationship between the parties or anything else that would impute a legally binding relationship - those words "Subject to Contract" remove the intention to create legal relationship.
What’s the meaning of “Agreement in Principle”?
The words “agreement in principle” communicate a meaning that:
- one party believes that it’s only an agreement which has been reached on a broad level
- there is more detail to be agreed before a legally binding contract arises
- the agreement – comprised by an offer and an acceptance – has not been reached, and therefore
- you don't have a final binding contract.
But it could become binding at a later date.
And here's the trap with the words.
You might see words in a letter or email that say something like, "We're all agreed in principle".
Looks like you're agreed, doesn't it? You're not for the reasons above.
New players read those words (or something similar to it) and think they have a ... legally binding commitment.
Well, odds on, it's not. Something further needs to be done to conclude the contract to reach a legally binding contract.
When do non-binding Heads of Terms become legally binding?
Whether or not a contract has been formed depends on the facts of particular case. It's highly fact sensitive: a small change in the facts can change the outcome.
Commercial negotiations are free flowing exchanges. Proposals and counter-proposals are passed with counterparts.
They can be recorded in Heads of Terms (or not).
But let's say they are, and the Heads of Terms aren't intended to be legally binding.
Is there “no contract”?
Businesses frequently think that “there is no contract”, because:
- nothing (or little) has been written down and/or
- nothing has been signed.
But the law operates differently. When work has been carried out by one business for another, the situation changes.
The commercial character of the relationship changes. Work has been carried out by one side. Odds on, it's a contract of supply.
And if money (or some other consideration) has been paid, the odds lower.
- when businesses are involved, it's a commercial relationship.
- there's a presumption that they intend to create legal relationships (ie contracts) when they do business with one another.
The Supreme Court says that these commercial relationships (as opposed to just negotiating):
will often make it unrealistic to argue that there was no intention to enter into legal relations...
Businesses are seen to have intended to enter into a legally binding relationship. Whether they thought they were or not.
There will almost certainly be a legally binding contracts created on some terms or another.
When it comes to forming contracts, law works on an objective standard: personal intentions aren't a significant factor in the equation when deciding whether a legal relationship has been formed.
In this way, the law of contract deems a contract has been formed when all of the elements of a legally binding contract are satisfied - and the parties' behaviour bear all the hallmarks of a contractual relationship.
Consequences: When Heads of Terms become binding
So, if Heads of Terms or an LOI has been signed, and the parties to the Heads of Terms have stared working together, the binding contract might be:
- the heads of terms
- the Heads of Terms + some other terms.
When parties start working with one another after the heads of terms have been agreed, but before the formal terms of contract have been signed off, there could well be other events (in the real world, rather than just on paper) which form part of the legal relationship: that you weren’t intending.
- some of the terms of the Heads of the Heads of Terms, and some other terms
- nothing like what was recorded in the Heads of Terms or in the process of being agreed in the Heads of Terms.
It depends on what has happened in terms of the conduct of the parties, and the communications passing between the parties.
That’s not to say that businesses can’t use heads of terms intentionally to negotiate and enter legally binding arrangements. It a matter of knowing when they do, and what the legal consequences are.
Specialised Contract Lawyers
Need to structure a deal in a certain way, but can't find the words to say it?
It’s not a false economy to run your situation by a qualified and experienced solicitor to help you avoid pitfalls and traps negotiating a contract at an early stage. Review your contract prior to signing it.
If you have concerns that your Heads of Terms won't work as you want it to, our specialist contract lawyers can help you:
- recover from an undesirable negotiating position and find the right solution for your business
- structure your transaction to make legal enforcement easy
- find the legal words to get your Heads of Terms and contract done right the first time
- spot ominous signs that things might not work out as you expect,
- minimise your exposure to legal risk, and
- avoid pending disasters.
We can also help you prepare your contracts to help you do what you need to do to finalise your deal.
You can avoid pitfalls and traps that others have fallen into.
Sidestep problems and difficult conversations altogether.
You can avoid having to revisit negotiations at a later stage because something has been missed at an early stage.
Call us now on +44 20 7036 9282 to speak with one of our specialist contract lawyers for legal advice.
Here are examples of the some of the different forms of commercial heads of terms and letters of intent in templates:
- Example Heads of Terms Template: Non-binding (and informal) Heads of Terms
- Draft Heads of Terms Template: Heads of Terms Agreement: Contract Form
Once signed, this will be a contract. Parts are not legally binding.
You can see how it's split into the binding and non-binding parts
- Letter of Intent Template: LOI Template: A sample of Letter of Intent for a business venture or proposal.
These are heads of terms restructured as a Letter of Intent.
Includes some suggestions for what might want to cover, for a joint venture, intellectual property licence (software or data), a share purchase or settlement agreement.