Advantages and disadvantages of using heads of terms

Heads of terms are not always useful in the context of negotiating a transaction and can be of more use to one party than the other. This is especially so if one party has not established all the facts it needs to know before it commits to the transaction. However, they can help to avoid misunderstandings and, in some cases, provide a useful road map of the steps to be taken before the formal agreement is signed. On the other hand, if negotiation of the heads of terms stalls over points of unnecessary detail (which in reality should be addressed at a later stage in the process), this can delay preparation of the definitive documents and increase the length and cost of the negotiations. 

The advantages of using heads of terms include the following: 

• They are usually considered to confirm a moral commitment on both sides to observe the terms agreed (which can be an advantage or disadvantage depending on the circumstances). It is psychologically harder for one party to renege on earlier commitments if they are recorded in a formal document, and, therefore, each party can proceed with more confidence.
• Where a transaction is complex, heads of terms can help focus the negotiations, bring out any misunderstandings and, by highlighting major issues at an early stage, prevent the parties wasting time and money if those issues cannot be resolved. In addition, draft heads of terms can sometimes help parties instruct their respective advisers.
• They can provide an opportunity to introduce binding commitments, such as confidentiality obligations (if there is no separate confidentiality agreement), exclusivity (lock-out) undertakings and the treatment of costs (in some cases, heads of terms may provide for payment of costs if the negotiations break down). These commitments may be important at the negotiating stage, even while there is no agreement on the main commercial deal.
• Where a deal has to be explained and sold in advance to people not directly involved in the negotiations, heads of terms can provide a useful statement of the key terms of the proposed deal.
• Where either party has to comply with the requirements of a regulatory body or competition authority, they can spell out the proposed agreement in detail. This can be useful if clearance is required from that body.

Disadvantages of using heads of terms include the following: 

• Heads of terms carry strong moral force, so they can limit flexibility in the subsequent negotiations. This is illustrated by the ill-fated acquisition of PRB (a Belgian company) by Astra Holdings PLC (a UK company) in 1989. PRB went into liquidation a year after the acquisition and the (then) Department of Trade and Industry launched an investigation into the matter. In their report, the inspectors mentioned that Astra had, before taking legal advice, entered into heads of terms that included certain unfavourable terms (the acquisition agreement was to be drafted by the seller's lawyers, governed by Belgian law and was to contain only limited warranties). Although it was not legally binding, it severely tied Astra's hands in the subsequent negotiations.
• They can create a legally binding agreement between the parties even when this is not the parties' intention.
• In international transactions, particular care must be taken to ensure that signing formal heads of terms will not inadvertently create obligations that the parties are not yet ready to undertake.
• Heads of terms (whether binding or non-binding) may fall foul of competition law rules. If they have as their object or effect the restriction, prevention or distortion of competition within the UK or the EU, they may be prohibited by Chapter I of the Competition Act 1998 or Article 101(1) of the Treaty on the Functioning of the European Union (formerly 81(1) of the EC Treaty), respectively.
• The time taken to agree them can be disproportionate to the benefit. Care needs to be taken to avoid effectively negotiating the main agreement twice.
• Heads of terms can expire and leave a contractual vacuum.
• Once the parties have signed the heads of terms and work has commenced, they may become involved in the day-to-day arrangements and forget to finalise the full agreement. This can create its own problems at a later date.

The legal effect of "non-binding" heads of terms is often one of the key concerns of the parties. They do not want the statement of the terms of the commercial legal transaction to be legally binding; but if, as is often the case, they include provisions in the heads of terms document dealing with issues such as confidentiality, exclusivity (lock-out), or costs, they will want those provisions to have legal effect. The cases in this area illustrate that great care must be taken when drafting heads of terms.