What purpose do they serve?

Heads of terms (also known as letters of intent, memoranda of understanding or heads of agreement) will set out the main terms of a proposed agreement. They can be binding or non-binding, so careful consideration should be given to the parties' intentions in that respect and to appropriate drafting.

What are the advantages and disadvantages?

Moral commitment. Heads confirm a moral commitment on both sides to observe the terms that have been agreed within them. This can therefore be anadvantage or disadvantage depending on the circumstances. They can limit room for manoeuvre in subsequent negotiations so treat them with care

Focus. Heads can focus the negotiations and by highlighting major issues at an early stage, prevent the parties wasting time and money if those issues cannot be resolved at that stage.

Time and costs. The parties should ensure that the time taken to agree heads is not disproportionate to the benefit. You do not want to end up effectively negotiating the main agreement twice.

Binding commitments. Even, heads which are intended to be non-binding generally can usefully include binding provisions such as exclusivity and confidentiality provisions.

Assisting advisers. Heads are useful for advisers as they can serve as a starting point for drafting and a trigger to ask further questions about the deal, enabling advisers to highlight issues that may not previously have been considered.

Inadvertent binding commitments. If incorrectly drafted or if subject to some non-UK jurisdictions, heads can create legally binding commitments that may not have been intended. Care and appropriate legal advice should always be taken in relation to heads.
 

What should the heads include?

Heads for commercial agreements typically include:

Non-exhaustive provision. An acknowledgement that the heads are not exhaustive. This leaves the opportunity to raise future points whilst ensuring this initial stage keeps moving.

Legal effect statement. A clear statement as to which terms in the heads are to have binding legal effect. Often the commercial terms are stated to be non-binding whereas confidentiality undertakings and provisions for exclusivity would usually be stated to be binding.

Non-binding provisions. These may include summaries of:

• Term of the Agreement
• Services/goods to be provde
• Pricing and pricing term
• Specific warranties and indemnities and any caps on liability
• Management restrictions (e.g. non-compete, non-poaching)
• Employment provisions (e.g. considerations under TUPE)
• Allocation of Risk

Binding provisions. These may include:

• Exclusivity: preventing the company from negotiating with other parties for a limited period
• Confidentiality: Protecting the confidentiality of the information disclosed by the parties and the fact of the negotiations themselves
• Applicable law and jurisdiction (e.g. English law and the Courts of England and Wales)
   

Summary

Although there are some disadvantages of using heads they generally facilitate a more efficient process and ensure everyone is focused from the outset.

Negotiate and agree heads with care as they may be inadvertently binding if not drafted correctly. Even if they are not binding it is psychologically more difficult to renege on earlier commitments set out in formal heads of terms.