Introduction to this document


Heads of terms

You’ll often find documents are created to set out the terms of a commercial transaction agreed in principle with a view to then creating a formal contract at a later date. Three of the many terms for such documents are “heads of terms, “letter of intent” and memorandum of understanding.


What are they?

These terms basically refer to a document that sets out how negotiations are progressing and what’s been agreed so far, before a full contract is drawn up. However, if their limitations and dangers are not fully understood, trouble may follow, so they must always be used with caution.


Can these documents have their uses?

Sometimes, yes. For example, heads of terms can be very useful as meeting agendas, or for minuting what was agreed - and not agreed - during a negotiation. They can set out the basis of the proposed agreement in skeleton form, which can later be used to help draft the contract, as well as highlighting those areas that require further negotiation.


But what if the full contract never appears?

A major risk with this kind of document is that it can divert the parties’ attention from completing the contract towards starting the work - and the negotiation process can fall by the wayside as a result.

And if something then goes wrong, the heads of terms are unlikely to offer much, if any, protection.


Does heading it Subject to contract solve everything?

Generally, where heads of terms are clearly understood by both parties to be subject to contract, or if they don’t contain enough detail on key areas such as pricing, then no contract will be formed. That’s all well and good - unless or until the project actually starts.

If a contractor begins work with the other party’s consent, then a contract will exist between them. This may only cover the basics, such as reasonable payment for the work done. It may not include any other provisions from the heads of terms, which means the parties may not have any of the protections that they’d begun negotiating.

Again, the main issue here is a lack of mutual understanding. One party believes it’s bound and protected by the heads of terms - even though they’re subject to contract - and the other knows it’s not, and simply sees them as part of the negotiation process.


How can we avoid getting into difficulties?


Use heads of terms as agendas and minutes only. Always mark them subject to contract or make it clear in your correspondence that you don’t intend to be bound by their contents. And never sign anything you don’t intend to be bound by.

If you have to start work before the main contract is ready, break the project into stages. Your ongoing negotiations will probably concern something later on in the process, so try to agree terms for the initial stage separately, before the work begins.

Don’t relax because you’ve agreed heads of terms. This is merely an optional step along the way to hopefully entering into a formal contract. 

As always, clarity is key. If you want to avoid arguments over whether or not you or the other party made a commitment, then spell it out.