A ‘heads up’ on Heads of Agreements

Whether you are selling your business, entering into a lease or in the process of pre-contractual negotiations for a transaction – you will more than likely come across a heads of agreement.

Heads of agreements (also referred to as term sheets, memorandums of understanding or letters of intent) are commonly filled with legal jargon and standard terms that can be overwhelming at first glance.

We have prepared this guide to assist in understanding the basics as well providing some important considerations to navigate your way to striking a successful deal.

What is a heads of agreement?

A heads of agreement is a document prepared and signed at the start of a proposed transaction that sets out the key commercial terms agreed in principle by the parties. The document will usually be prepared by the buyer’s lawyers and can be negotiated until each party is satisfied with its contents. The document forms the base of the substantive contract e.g. business sale agreement, lease etc. You should always get legal advice before signing a heads of agreement as it can be difficult to vary terms in the substantive agreement once they’ve been agreed.

Are heads of agreements binding?

Heads of agreements can be binding, non-binding or a combination of both. In most cases, confidentiality, exclusivity, termination and jurisdiction provisions will be binding on both parties. If it is intended by the parties that the heads of agreement is non-binding, this should be clearly expressed.

The recent decision of AMA Group Ltd v ASSK Investments Pty Ltd [2021] NSWCA 45 highlighted that a binding heads of agreement may not always be binding.

In this case, the parties entered into a binding heads of agreement for the purchase of multiple smash repair businesses. The New South Wales Court of Appeal found in favour of the buyer that the binding heads of agreement was validly terminated on the basis that not all of the conditions precedent were satisfied. The particular condition precedent in issue was that the buyer required board approval of the proposed transaction. During due diligence investigations, the buyer concluded that the transaction did not meet the requirements for board approval.

As the condition precedent could not be satisfied and was not waived by the buyer, the buyer validly terminated the binding heads of agreement.

Sellers should proceed with caution when signing a binding heads of agreement with a requirement for the buyer’s board approval, or, where approval is required, request a copy of the approval with the signed heads of agreement.

Common provisions in heads of agreements for business sales

Conditions precedent

A condition precedent is an event that must occur in order for the proposed transaction to be completed.

Common conditions precedent include:

• the buyer obtaining finance for the proposed transaction;
• due diligence investigations;
• shareholder/board approval of the proposed transaction;
• assignment or novation of material contracts;
• third party consents to the proposed transaction;
• key employees accepting employment with the buyer;
• transfer of all intellectual property (including business names, domain names and trade marks); and
• release of all securities or other encumbrances over the business assets.

All conditions precedent must be satisfied or otherwise waived by the relevant party for the transaction to complete.

Due diligence

The benefit of due diligence lies with the buyer in that it allows the buyer to undertake searches, gather information and make inquiries in relation to the target business they are wanting to acquire. This process allows the buyer to gain a better picture of the transaction and any associated risks.

A transaction will usually be subject to due diligence, meaning that you can terminate if you reasonably believe there is an issue that could affect the viability of the business.

It is essential that you build a quality due diligence team so that you can make an informed decision. At Avant, we offer consultations on financing, legal and practice management matters. For further information, please refer to the following webpages:

Avant Law: https://avant.org.au/law/practice-legal-services

Avant Finance: https://avant.org.au/finance/practice-finance

Avant Practice Solutions: https://avant.org.au/practice-solutions

Exclusivity periods

Buyers may request that the seller agrees to an exclusivity period in order to put a halt on competing offers. If the seller agrees, the seller may be restricted from entertaining any other offers to acquire the proposed business until the buyer has completed its due diligence process.

As a seller, caution should be exercised when agreeing to such a provision unless the seller is confident in the quality and the buyer’s commitment to the deal. This is because it may delay the eventual sale of the business if the buyer finds something unfavourable during the course of its due diligence searches. Further, you may miss out on a more favourable deal with another buyer.

Restraints of trade

It is also standard for the buyer to include a restraint of trade clause that restricts the seller from competing with the acquired business after a sale. This restraint is usually limited to a specific radius and for a certain period of time e.g. the seller may not be allowed to operate or work from a competing business that is within a 5-kilometre radius of the acquired business for a period of 3 years after completion of the sale.

The purpose of a restraint of trade is for the buyer to protect the value and future profitability of the business it is acquiring. We recommend considering including a similar clause if you are a buyer in a business sale transaction.

We can help you

If you have any questions, or would like more information about how we can assist you or your practice, please call 1800 867 113, or to organise a confidential discussion at a time that suits you, please click here