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Are Heads of Terms legally binding?

Author: Woodfines Solicitors
Published On: 11 May 2023

Heads of Terms are a very useful signpost for your Solicitor, telling us the agreed terms of your corporate or commercial property transaction. For the most part, they are non-binding. Certain clauses such as confidentiality provisions and exclusivity clauses (where the seller agrees to hold the deal open for a set period of time without negotiating with anyone else) need to be legally binding but the terms of the deal itself aren’t. After all, until their Solicitors and other advisors have reported to the buyer on the results of due diligence, how can the buyer know if they’ve agreed to pay a fair price?

However, it’s not unusual to see provisions saying the parties to the proposed transaction will negotiate in good faith to achieve the desired outcome: completion of the deal. A commitment to negotiate can be binding on you.

In one particular case, the two parties had agreed, in principle, to enter into a substantial property development transaction. The Heads of Terms said that they would each “use all reasonable endeavours to enter into a final binding Agreement which captures legally these Heads of Agreement acting in good faith towards each other.”

The seller brought a claim when negotiations dragged and then ground to a halt, and relations deteriorated, saying that there was an agreement to buy. Not surprisingly the Court found that there was no agreement to buy and confirmed that what there was was an agreement to agree, which isn’t binding. That is how Heads of Terms have always been understood.

However, the Court did find that the defendant buyer was in breach of contract for failing to act in good faith and failing to use “all reasonable endeavours” to bring about a binding sale agreement. The damages, which were based on the loss of chance to enter into a contract, were assessed at £13.4 million (although it should be borne in mind that the original claim for enforcement of a purported contract for sale was for £500 million).

The case turned on its facts and those facts included the buyer looking for a better site elsewhere and not even agreeing a final plan. Every case is going to differ factually from the next but what is clear is that the sentence was binding.

The judge gave some guidance on “reasonable endeavours” and “all reasonable endeavours” provisions in this context, saying that following one reasonable path might be sufficient where reasonable endeavours apply but that all reasonable actions must be taken when an obligation to use all reasonable endeavours applies, which involves following every path open to a party. The judge went on to suggest that there may be little difference between an obligation to use all reasonable endeavours and an obligation to use best endeavours in practice, although some best endeavours clauses might require a party to sacrifice some of its own commercial interests, whereas an obligation to use all reasonable endeavours is unlikely to do so.

The judge also discussed the meaning of good faith clauses. He said that the precise nature of the obligation would take colour from the other terms of the agreement. He said that good faith generally requires:

acting honestly as judged by reasonable and honest people;
observing reasonable commercial standards of fair dealing;
fidelity or faithfulness to the common or contractual purpose; and
acting consistently with the justified expectations of the parties.
We always advise that you have any legal document reviewed by a solicitor, including Heads of Terms, but it’s not unusual for them to be signed before a solicitor is instructed. This can lead to terms being agreed that go further than the parties anticipate.

It’s important to be wary of provisions promising to negotiate in good faith. In order to ensure that both parties know where they stand and what is expected of them, it is best to outline the steps expected of both parties, including a timeline for actions. For example the Heads of Terms in this case could have included a requirement that the parties would agree a final plan within a certain time after the grant of planning permission.

It is also particularly important to be wary of provisions obliging you to use reasonable, all reasonable or best endeavours to do the deal. There is, of course, a wider lesson to be learned here: “all reasonable endeavours” clauses in any contract are not a compromise between reasonable endeavours and best endeavours. They are potentially onerous in their own right and should usually be resisted by the party who is going to have to comply with them.

For advice on Heads of Terms in corporate transactions, contact our Corporate and Commercial team.

For advice on Heads of Terms in commercial property transactions, contact our Commercial Property team.

– Gillian Harding, Corporate & Commercial Senior Associate

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