Understanding Heads of Agreement in conveyancing

Understanding Heads of Agreement in conveyancing

A “Heads of Agreement” is a document frequently utilised in pre-contractual negotiations, serving as a framework outlining proposed terms between parties. It can be used in various scenarios, such as business purchases, lease agreements, property purchases and other commercial dealings. It may also be referred to as a letter of intent, memorandum of understanding or  a terms sheet. Its primary purpose is to establish a preliminary understanding between parties before committing to a formal contract.

Key components of Heads of Agreement

The contents of a Heads of Agreement can vary based on the nature of the commercial transaction. However, it typically includes:

1. Details of the parties: Identifying the involved entities in the transaction.
2. Consideration/price: If applicable, specifying the agreed-upon amount.
3. Key terms: Outlining the crucial terms agreed upon by the parties.
4. Intent to cooperate: Expressing the mutual commitment to securing a formal contract.
5. Binding clauses: Identifying which clauses are intended to be legally binding.
6. Conditions: Specifying any prerequisites that must be fulfilled before the final transaction.
7. Rights and obligations: Outlining the responsibilities of each party.
8. Pre-contractual issues: Addressing matters of confidentiality, exclusivity, intellectual property rights, due diligence, etc.

Legal status of Heads of Agreement

A Heads of Agreement is not a legal requirement for entering into a subsequent contract or agreement. Generally, it is not intended to be legally binding, but caution is advised. Certain clauses, such as those related to confidentiality, exclusivity, intellectual property rights, and due diligence, may be legally binding even within a non-binding Heads of Agreement.

The determination of whether a Heads of Agreement is legally binding often hinges on whether the document is deemed to be a contract. The presence of elements such as offer and acceptance, a meeting of the minds, consideration, capacity, and legality is crucial for a contract to be formed.

In the High Court decision of Masters v Cameron (1954) 91 CLR 353 the written memo between the parties read:

“This agreement is made subject to the preparation of a formal contract of sale which shall be acceptable to my [Cameron’s] solicitors on the above terms and conditions”

The Court identified four broad categories of interpretation:

1. Intend immediate binding commitment, expressing a desire to formalise their agreement in a subsequent, more formal document;
2. Intend immediate binding commitment but may opt to delay the operation of a specific clause or term until the creation of a more formal document;
3. Intend to defer the establishment of contractual relations until the execution of a formal contract; or
4. Intend immediate binding by agreed-upon terms, anticipating the subsequent formation of a new contract, with additional terms incorporated by mutual consent.

The Victorian Supreme Court in the recent case of Patel v Sengun Investment Holdings Pty Ltd [2023] VSCA 238 delved into these principles and found that a “Heads of Agreement” for a land sale could be subject to specific performance as a binding contract, characterising it as a “call option for a potential future purchase. At the trial of this matter the judge concluded that the Heads of Agreement fell into the third category where the parties did not intend to create a binding contract until a formal sale contract was executed. Despite this, the judge expressed a willingness to grant specific performance if the document were deemed binding.

On appeal, the Court looked at the characterisation of the “Heads of Agreement” and likened it as a “variant of the second or fourth category of cases” outlined in Masters v Cameron.

Deciphering the Heads of Agreement

Examining the terms, form, and terminology of the Heads of Agreement, the Court found it to contain all essential elements of a land sale agreement. The document referred to the parties as “Vendor” and “Purchaser” and explicitly mentioned an “offer” being “accepted”. The inclusion of crucial details like the identities of the parties, property particulars, purchase price, payment terms, and settlement date pointed towards a binding contract.

Despite certain clauses anticipating the formulation of a sale contract, the Court clarified that this did not negate the standalone binding nature of the Heads of Agreement. The Court’s conclusion was that the document formed a binding contract where the respondent agreed to sell the property, contingent upon the applicant executing a contract consistent with the Heads of Agreement within a specified timeframe. It cited precedent highlighting that the contemplation of a future contract in no way negates the current binding status of the Heads of Agreement. The imposition of a deadline for executing the contract of sale, as noted by the Court, introduced a characteristic reminiscent of a “call option”.

Despite acknowledging that the “call option” characterisation was a variant of the second or fourth category of contracts as outlined in Masters v Cameron, the Court of Appeal refrained from explicitly categorising it. This decision aligned with the Court’s acknowledgment that these categories are not rigidly exclusive formulations of potential agreements between parties.

Specific performance: a valid claim 

Regarding the second key issue raised on appeal—whether the trial judge was accurate in determining that he would have issued orders for the specific performance of the Heads of Agreement had he deemed it a binding contract—the Court of Appeal concluded that such remedy would have been justifiable. The unique characteristics of the land and the applicant’s preference for its purchase over damages were highlighted as factors supporting this relief.

Pros and Cons of Heads of Agreement

Pros:

1. Negotiation framework: Provides a structured platform for parties to negotiate key terms before committing to a formal contract.
2. Flexibility: Allows for the freedom to swiftly reach an agreement or withdraw if contract terms are not finalised, facilitating smoother negotiations.
3. Less disagreement: The lack of intricate details in a Heads of Agreement often results in fewer disagreements and more flexibility in final contract settlements.
4. Time and cost savings: May save time and expenses associated with drafting a detailed and binding contract.
5. Framework for final contract: If parties progress to a final contract, the Heads of Agreement provides a foundational framework.
6. Useful for financing: Useful when presenting to lenders to demonstrate the parties’ commitment to a formal contract, potentially saving time and resources.

Cons:

1. Legal risks: The risk that the Heads of Agreement may inadvertently be legally binding, causing unintended consequences.
2. Non-legal drafting: Often drafted by non-lawyers, leading to potential unintended consequences.
3. Uncertainty: Ambiguity regarding whether the Heads of Agreement is legally binding.
4. Differing commitment levels: Due to its non-binding nature, one party may be more committed than the other, potentially resulting in an uneven commitment to a formal agreement.

Tips:

1. Accurate party details: Ensure correct recording of the parties’ full legal entity and ABN/ACN.
2. Authorised signatures: Confirm that the Heads of Agreement is signed by authorised representatives of the parties.
3. Address essential terms: Cover all essential terms, including consideration and proposed settlement, to avoid ambiguity.
4. Binding language: Clearly state which terms are legally binding and which are not.
5. Seek legal advice: Given the importance of language, seek legal advice on the terms and enforceability of the Heads of Agreement.

While Heads of Agreement can expedite negotiations and provide a useful framework, careful consideration of its legal implications and thorough drafting are essential. For detailed guidance tailored to your specific situation contact Haitch Conveyancing at (03) 8590 8370 . We are a team of experienced property lawyers who can help you understand the implications of all aspect of conveyancing in Melbourne. We are an online property law and conveyancing firm that can assist when buying or selling property.

This update does not constitute legal advice and should not be relied upon as such. It is intended only to provide a summary and general overview on matters of interest and it is not intended to be comprehensive. You should seek legal or other professional advice before acting or relying on any of the content.