Heads of terms are used in a variety of commercial transactions including property sales, purchases and leases, corporate business sales, purchases and mergers, joint ventures and more.
This blog will focus on the role of heads of terms in commercial property transactions such as the sale or purchase of freehold/leasehold property, a tenant entering into a lease or a landlord granting a lease.
What are heads of terms?
Heads of terms are also known as letters of intent, memoranda of understanding, notice of sale and term sheets. Basically, a document which sets out the heads of terms (whatever it is referred to as) generally sets out all of the terms of a commercial transaction that are agreed in principle between all of the parties.
Headline terms and legal obligations
There will usually have been some negotiations between the parties before the heads of terms are drawn up to enable the parties to agree on certain ‘headline’ terms.
Although heads of terms are not usually legally binding, it's important to state this specifically in the heads of terms to avoid misunderstandings. If it is not expressly mentioned, then the heads of terms could be taken as being legally binding.
Whilst the majority of parties ensure the heads of terms are not legally binding, they often create some moral obligations on the parties and they encourage parties at the outset to think through certain terms that will need to be agreed at some point.
Why use heads of terms?
Agreeing these terms at the beginning (which is when heads of terms are entered into) helps to determine an accurate purchase price/rent and prevents delays or any time being wasted further down the line once the parties have already committed lots of time and incurred significant professional fees.
If there is an issue that needs to be negotiated that may create a stalemate between the parties then the heads of terms negotiations can ensure this is either resolved or the transaction is called off at an early stage.
How much detail should be included in heads of terms?
There can be varying levels of detail contained in different heads of terms – the amount of detail heads of terms contain will generally depend on the size of the transaction and the parties involved.
If an agent draws up the heads of terms then usually they will contain lots of information. However, in some cases parties will draw up heads of terms themselves which may just contain the most basic information necessary.
Generally, heads of terms should always contain at least the following information:
- Property details – including address, whether freehold or leasehold, whether it is a transfer/lease of part or whole.
- Parties – names, emails, addresses and telephone numbers including whether it is being sold/purchased by a limited company or an individual as this can make a difference on tax planning, etc.
- Parties’ professional advisers – which may include their solicitors, accountants and agents.
- The rent/purchase price – this should also specify whether VAT is chargeable and whether things like the service charge, utilities, rates etc. are included. The deposit amount should also be noted.
- Term – if the transaction is a lease, then the heads of terms should specify how long the lease is to be for and whether it is to be ‘contracted out of the 1954 act’ or not.
More detailed heads of terms would also contain information such as:
- Permitted use – where a lease is being granted, the heads of terms could specify what the tenant is allowed to use the property for, i.e. offices, shop, warehouse.
- Conditions to the contract – such as whether the contract is conditional on planning permission being granted, surveys being undertaken, works being carried out or other matters.
- Assignment/subletting provisions – again with a lease, the heads of terms may explain what the conditions of assignment will be and any specific landlord’s requirements in relation to any future assignment or sublease of the property.
- Costs – whether each party are to bear their own costs or not.
- Exclusivity Period – whether the seller can or cannot enter into negotiations with any third parties for a set amount of time.
- Rent/rent review – further details could be provided such as the rent payment dates, the method in which it should be paid, also whether there are to be any rent reviews within the term of the lease and how these rent reviews will operate (market rent, RPI or fixed increase).
- Timescales – how long the parties expect the transaction to take and some may add in a longstop date to prevent the matter being open ended – this can also help to focus the parties’ minds if things are becoming drawn out.
Different people use heads of terms in different ways and as you can see above they can contain very differing levels of information.
It is important that there is a balance between having too much detail, which means overly detailed negotiations become long running and no progress is made, but enough detail to ensure the heads of terms are a worthwhile document that provide a ‘road map’ of the transaction going forward.
If you are about to enter into a commercial property transaction and would like further information or advice then please do not hesitate to contact one of Burnetts’ commercial property experts here.