Heads of terms (?Heads?) are usually short documents entered into at the beginning of a transaction that outline the main terms agreed to during the course of negotiating a private company acquisition.

They may also be known as letters of intent, memoranda of understanding or heads of agreement.

Heads demonstrate a serious intent of the parties and have moral force - but they do not legally compel the parties to conclude the acquisition on such terms or even conclude the transaction at all.

Heads may take the form of a simple letter or be a heavily negotiated and drafted document prepared by various advisers to a transaction. The size of the transaction and value of the assets will usually dictate how Heads are prepared although the most common form is to have a simple letter.

Heads can assist the parties to avoid misunderstandings and help focus the parties? minds on the terms that will be included in a formal agreement. However, the flip side of negotiating Heads is that certain issues could be negotiated in unnecessary detail. This could result in the delay of the preparation of the formal documents as well as increasing the costs and length of the deal.

The main reasons for using heads are that they:

Provide written confirmation of the main terms agreed;

Outline the timetable and list the obligations of the parties involved; and

Outline some of the legally binding clauses such as an exclusivity agreement.

Heads also provide a moral commitment to the deal as it is harder for one party to go back on agreed terms once they have been recorded. This, of course, can be disadvantageous in certain circumstances.

It is common for Heads to include a binding exclusivity agreement, confidentiality agreement (if there is no separate side letter) and in some cases to provide for payment of break fees and costs should negotiations between the parties result in failure. The inclusion of the exclusivity period and protection against wasted costs assists the buyer to enter the early stages of the transaction with more assurance.

Heads are also useful for providing third parties with a snap shot of the proposed deal. This could be helpful when the parties proceed to instructing their legal or financial advisers or when the terms of the transaction need approval at a higher level (i.e. board of directors).

Heads are usually prepared at the early stage of a transaction, often before the buyer has had the opportunity to conduct due diligence (the fact finding exercise) on the target. The seller will know a lot more about the business and its worth, which could ultimately be reflected in the Heads. For that reason, Heads should be approached with some degree of caution, particularly on the part of the buyer.

If the seller requires the buyer to enter into Heads the buyer should ensure that key assumptions on which they are relying are inserted into the Heads and certain terms are made subject to due diligence.

In addition an express term should be included to the effect that there is no intention to create legal relations. Language at the top of the heads such as ?Subject to Contract? should always be included.

Such language, however, is not foolproof, as demonstrated by a recent English case where the Court held that an agreement expressed to be ?Subject to Contract? was nonetheless binding. In that instance, pre-contractual negotiations were admitted in evidence for the purpose of identifying the meaning that the parties incorporated into their written agreement.

Heads, therefore, should be approached with some degree of caution. Care must be exercised to ensure that an implied rather than express contractual relationship is not created. It is also important to make sure that further documentation contemplated by the Heads is drafted and executed quickly following the Heads being agreed.

It is crucial that the Heads are clear which terms are to have legal effect. Terms which are not to be legally binding may include the price to be paid (this should be made subject to due diligence), the form of consideration and time of payment (i.e. cash, shares or deferred consideration), conditions (i.e. shareholder approval), warranties and indemnities, the timetable (the buyer should ensure that enough time is provided to conduct in depth due diligence) and responsibility for drafting the documentation.

If in doubt, it is always wise to consult an attorney with experience in the area.

@EDITRULE:

Clive Langley is an Attorney in the Corporate Department of Appleby Spurling Hunter. A copy of Mr. Langley?s column can be obtained on the Appleby Spurling Hunter website at www.applebyglobal.com.

This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer.