As conversation swells around a commercial property deal, it’s very easy to get lost in the ever-increasing details and paperwork.
To avoid any issues and nasty surprises in the contract, a Heads of Terms document allows all relevant parties to work from the same page.
The Heads of Terms is agreement-in-principle and are not strictly designed to be legally binding, but specific steps must be taken to maintain the pre-contractual status of the document.
The Heads of Terms (HOTs) somewhat bridge the gap between telephone and email conversations and legal contracts.
After all, talk is cheap – the HOTs is an excellent way to progress a deal from theory to practice.
Heads of Terms are pre-contractual documents, also known as Heads of Agreements, Memorandum of Understanding and Letters of Interests.
In commercial property, Heads of Terms and Heads of Agreements are the standard terms.
In their most basic form, the Heads of Terms (HOTs) is a pre-contract memorandum, a recall of all previous discussions surrounding a commercial real estate deal.
The HOTs isn’t exclusively used in property and real estate – it can be used in any conveyancing process including the transferral of intellectual property and data, business deals, licences and more.
The Heads of Terms provides a list of details pertaining to the property itself, pre-contractual terms, leases and deposits and other agreements between all relevant parties such as confidentiality and exclusivity.
All parties can be copied into the HOTs, including the buyer and seller, lessor and lessee, surveyors and solicitors.
The HOTs is created after an offer is placed and accepted and is designed to summarise the basic elements of the deal, providing a clear route towards completion.
It will typically also contain a timeline for the deal and the contact details of all relevant parties including solicitors, surveyors, etc.
The HOTs may be relatively simple in the case of a straightforward commercial property lease, or reasonably complex if the deal is large in scale.
The content of a Heads of Terms document varies with the deal in question.
Some typical features of the Heads of Terms include:
Property Details – The HOTs will always include accurate details of the property. For leasehold property, this will usually be listed under ‘Demise’, meaning ‘to transfer the lease of [said property].’ The property’s square-foot space and other technical details will also be listed, e.g. car parking.
Parties – Legal names and addresses will be indicated on the HOTs. These could either be personal or business names.
Transaction and Deposit Details – The cost of rent and when it will be paid as well as the details of ground rent and service charges. The HOTs will also include details of the deposit and when it will need to be paid.
Term of the Lease – The proposed duration of the lease. This may be ‘contracted out of the Landlord and Tenant Act 1954’, meaning the new tenants forego their statutory right to renew the lease at the end of the lease period.
Propositions – If other propositions have been negotiated prior to placing an offer, e.g. that the existing landlord needs to make certain alterations to the property prior to transferring the lease (fit-out works), then these will be indicated on the HOTs. The tenant may also be permitted to make certain alterations to the property during their lease – this can also be specified on the HOTs.
Professional Advisers – Details of solicitors, agents, surveyors and accountants.
Timeline – The HOTs may include a timeline for the completion of various conveyancing, surveying, due diligence and lending tasks prior to completion.
Security, Confidentiality and Exclusivity – Details of any security, exclusivity or confidentiality terms and provisions. Supplementary documents will usually be required here that the HOTs points to.
Many of these details will have been discussed via phone or email, but unless they’re drafted onto a unified document that all parties can access, the information can become lost in translation, forgotten or manipulated.
Below is a very basic Heads of Terms (here called Heads of Agreement) example.
As we can see, the Heads of Terms are reasonably simple, representing a logical progression away from the negotiation and consultation stage towards creating and exchanging contracts and finally, completion.
So what are the advantages and disadvantages of the Heads of Terms?
The advantages of the HOTs primarily relate to how practically useful it is as an intermediary document. It provides a clear path forward, often speeding up the conveyance process.
1: Unifies the Pre-Contract Process
The Heads of Terms pull together any information discussed prior to or after an offer is placed.
Numerous telephone and email consultations may have uncovered details about the transaction, these should be summarised in the HOTs.
The HOTs should present a clear picture of what both parties have agreed. For the sake of property details, rent and deposits, this is fairly rudimental. However, any other pre-contractually agreed terms such as fit-out work for the new occupants, confidentiality agreements and penalty costs or exit terms should be clearly presented in the HOTs.
The HOTs has moral weight in this regard, and though the document should be marked as strictly non-binding, it can still be used in the process of rectification. A court can still use the HOTs as a pre-legal expression of the deal – it is not totally legally inconsequential.
2: Speeds Up the Conveyance Process
The HOTs is a convenient way to speed up the transaction. It provides a quick and efficient reference for both parties to revise prior to completion.
By combining disparate paperwork and information into the HOTs, both parties have a pre-legal checklist that helps move the process towards completion.
This is especially true when a more complex timeline is in place including the rough times and dates for final surveys to be completed, etc, though these are usually carried out pre-HOTs unless issues are raised.
3: Points to Pre-Contractual Legally Binding Agreements
Whilst the HOTs for the most part is not a traditionally legally binding document, it may still have legally binding features, or may point to separate agreements.
This mostly revolves around exclusivity, security or confidentiality agreements that must always be raised pre-contract. The HOTs is useful for highlighting these agreements and keeping them in view.
However, this can add to the murky legal status of the HOTs – which is its primary disadvantage.
The HOTs has a rather tricky legal status. Whilst the HOTs is rarely intended to be legally binding, it is not legally irrelevant either.
Simply calling the HOTs a non-legally binding pre-contractual document is not enough to class it as such by the rule of law.
1: Legal Status
The name of the document does not indicate its legal status, nor will simply entitling a document as ‘Heads of Terms’ have any legal ramification without further clarification.
It’s well-established that the HOTs is not intended to be legally binding – but intention alone is not legally robust.
To expressly declare the Heads of Terms as non-legally binding, one must add the phrase ‘subject to contract’ to the document. Further adding the phrase ‘These provisions are not intended to be legally binding’ can help clarify this.
‘Without prejudice’ is another frequently used phrase, but this is much vaguer than ‘subject to contract’.
However, even when a document is marked ‘subject to contract,’ it can still be viewed as legally binding on some level.
Namely, the HOTs can be legally consequential if:
- It includes the framework required to create a legal relationship. This means the HOTs has the hallmarks of a contract, including the offer, acceptance, consideration and intention to progress with the deal.
- If it meets section 2 of the Law of Property (Miscellaneous Provisions) Act 1989 the HOTs may be contractually binding. The law suggests a contract for land must be in writing, containing agreed terms and be signed by both parties. If this is the case, then the HOTs may form a legal document.
These situations can create issues in the (albeit unlikely) dispute that involves the HOTs.
Moreover, after completing the transaction, the HOTs can still have legal ramifications and may be used as evidence in the process of rectification. The HOTs can be used as evidence of the intended transaction and relationship between the parties, showing that the final deal did not respect the original terms agreed.
This situation would be rare and when exercising correct due diligence throughout the process, it will be avoided in the vast majority of situations.
Nevertheless, it highlights the need to take the HOTs seriously, despite its pre-contractual intention.
The final point worth considering here is that, if the HOTs points towards pre-contractual legal conditions, e.g. exclusivity and confidentiality, then these terms should be detailed in their own separate documents. Pre-contractual legally binding terms should be dealt with outside of the HOTs, but the HOTs should point to them. This keeps the HOTs non-legally binding whilst allowing other terms to remain legally binding in their own right.
2: Time and Resources
Though the HOTs is a relatively compact document of fewer than 10 to 15 pages typically, it still takes some time and resources to complete. In the case of a quickly executed deal, it may be tempting to overlook and skip the HOTs.
Furthermore, if the terms of a deal change sometime after the HOTs is written then the HOTs will no longer be relevant. This could also cause legal issues, say if the terms are changed over the phone or email but not reflected in the HOTs.
Even a basic HOTs is better than none at all.
Pulling together key information on the deal shouldn’t take long and is well worth it, even in small commercial real estate transactions.
3: Expiry of the Heads of Terms
The Heads of Terms will typically expire after some time, if a Heads of Terms was produced early in a transaction that has been delayed, it may no longer be relevant to the deal. If terms are changed post-HOTs, then the HOTs may expire or no longer be useful or relevant to the transaction.
If the HOTs does expire or otherwise becomes redundant, this can create a contractual vacuum between the two parties. The HOTs is an important document to sandwich between the offer and contract to ensure a clear pathway towards completion.
It is therefore important to agree on what will happen to the HOTs in the event of any delay or changes to the transaction.
The Heads of Terms, also known as the Heads of Agreements, is an important pre-contractual document that summaries the key terms of a deal prior to the exchange of contracts and completion.
The HOTs is reasonably straightforward and is not a major hassle to complete. Both parties benefit from the HOTs – it avoids nasty surprises and comebacks later on in the deal.
The key disadvantage of the HOTs is their murky legal status.
Marking the document as ‘subject to contact’ and ‘this document is not intended to be legally binding’ are the best precautions to take.
Lastly, other confidentiality and exclusivity contracts should be drawn up separately from the HOTs, but the HOTs can summarise and point to these documents.