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When parties enter into negotiations, one of the first documents they produce between them is often headed a "heads of agreement" (HOA), "term sheet" or "heads of terms". It is normally drafted by the negotiators themselves since it is often too early in the relationship for either of them to have engaged lawyers.
The document is intended to contain the bare bones of the proposed transaction and quite often refers to supplemental documents to be drafted at a later stage by the parties' lawyers in order to give effect to the terms contained in the HOA. The parties, or at least one of the parties, often presume that this requirement for drafting supplemental documentation means that the HOA/term sheet itself has no legal effect i.e. that it is not a legally binding contract. Such presumptions arise from experience since, as most businessmen will tell you, this is the way it has always been.
As will be noted below, this is not correct and parties – company directors in particular – should be wary of sleep-walking into loose contractual arrangements without the appropriate legal advice and considerations.
The terms of a heads of agreement or term sheet are capable of being legally enforceable if it can be shown that the parties intended them to be so. The document is interpreted in the same way as any other document alleged to be a contract. The issue normally arises where one of the parties acts in a manner inconsistent with the terms in the HOA and the other party issues legal proceedings for specific performance or damages based on breach of contract. The party issuing the proceedings will claim that the terms contained in the HOA represent legally binding and enforceable obligations.
That is the situation which arose before the High Court in Danbywiske v. Donegal Investment Group  IEHC 126. In that case, the plaintiff purported to exercise its right to purchase shares in exercise of a share options agreement. The agreement was contained in a HOA which, the defendant argued, was not a legally binding contract and therefore unenforceable. According to the defendant, the share options agreement contained in the HOA was not intended to have legal effect until it was put into a further document envisaged by the HOA, namely a shareholders' agreement. Since the shareholders' agreement was never drafted, the option agreement remained only an aspiration and could not be exercised by the plaintiff.
The Court considered that the HOA had "many indicia of an agreement" and that it did form a legally enforceable contract between the parties. In reaching that conclusion, the Court adopted the usual tests for contractual interpretation. In particular, the Court considered whether, viewed objectively, it was clear that the parties intended to enter into a legally enforceable agreement at the time of signing the HOA. He noted from the language used in the HOA that it was intended to bind the parties. In that regard, the Court noted the word "agreement" in the heading of the document itself and in other parts of the document, which suggested that the parties had reached consensus. The judge noted that the document was signed by representatives of both parties. He acknowledged that the document did make reference to other documents to be drafted in future but concluded as follows:
"The fact that some of these terms were to be effected by the execution of other formal documents does not mean that the HOA was not, of itself, a binding contract. It is not recorded anywhere in the HOA that it is necessary to record the terms in a further formal contract...
The Court was referred to the case of Rossiter & Ors. v. Miller [1874-80] All ER Rep. 465, where the House of Lords confirmed that a contract has been concluded if the parties have reached agreement on all of the essential terms. Simply because the parties envisage recording those terms in a subsequent formal document does not render the concluded agreement or bargain unenforceable. This decision was adopted in the High Court by Kenny J. in Law & Ors. v. Robert Roberts & Co.  I.R. 292. This judgment was upheld on appeal."
This case is not authority for the proposition that the terms contained in a heads of agreement or term sheet will always be binding on the parties. The case demonstrates that the fact of a document being headed "heads of agreement" or "term sheet" does not automatically exclude it from being interpreted as a binding legal contract. There should, as there too often is, be no presumption to the contrary by those engaged in negotiating legal transactions.
If the intention behind a document is that its terms (or some of them) shall not be binding on the parties then this should be explicitly stated in the HOA. The fact that the document envisages the terms to be set out in a different document which is ultimately never produced does not necessarily have the effect of discharging the parties from those terms. It is suggested that this is all the moiré relevant when one of the parties has acted to its detriment in the expectation that the subsequent document would be produced or there has been a level of informality around the arrangement from which a court can imply that the terms were intended to be enforceable without the subsequent document envisaged in the HOA.
Author: Mahmud Samad BL
Publication date: 9th July 2021