Heads of Terms explained
Reckless negotiation of Heads of Terms on a commercial lease can often lead to parties unintentionally entering into an unfavourable legally binding agreement. It is therefore vital that this stage of the transaction is given careful consideration.
What are Heads of Terms?
When a Landlord intends to lease out their property, they will often instruct their agent or solicitor to prepare “Heads of Terms”. The Heads of Terms will outline the skeleton terms of the lease, such as the parties, rent, term and use of the property. Heads of Terms offer a quick and simple way to identify the basic needs of both the Landlord and Tenant in a commercial property transaction and therefore provide the foundations for any subsequent negotiations.
On any given day a commercial property solicitor can be presented with well-constructed Heads of Terms which detail what has been agreed between a Landlord and Tenant. On the other hand, it is also very common for a commercial property solicitor to be presented with a scrap of paper with the details of the agreement, whilst being told “to iron out the finer points further down the line”.
Parties to a lease are often unaware of the pitfalls that Heads of Terms can create, and therefore it is vital that they take independent legal advice prior to entering into any agreement.
Are Heads of Terms legally binding?
It is key to avoid creating legally binding Heads of Terms, as these will usually only reflect the initial negotiations between the parties rather than the final lease.
Under the Law of Property (Miscellaneous Provisions) Act 1989, the Heads of Terms may be considered legally binding if they:
- Are in writing
- Include the terms expressly agreed between the parties
- Have been signed by all parties
- Include offer, acceptance, consideration and an intention to create a legal relationship.
Given that Heads of Terms may satisfy the above criteria, it is important that they include an express provision as to whether the parties can rely on them being legally binding. Parties often try to avoid Heads of Terms being treated as legally binding by inserting the words “subject to contract”.
Heads of Terms are very much the skeleton of a lease, and therefore, it could be disadvantageous for a party to be bound by these terms.
If the Heads of Terms are “Subject to Contract” can the Tenant move into the property whilst the finer points are negotiated?
If the Heads of Terms are understood to be “Subject to Contract” by both parties, then they will not usually be treated as a legally binding agreement. However, if either party are to carry out any of the obligations under the Heads of Terms, this can undermine the fact that they are “subject to contract”.
If negotiations are likely to take some time, and the Tenant urgently needs to move into the property, then both parties should consider a Tenancy at Will whilst the lease is negotiated.
Can the Heads of Terms still create issues once the lease has been finalised?
Once the final lease has finally been negotiated and agreed, the parties may believe that this is the legally binding document between them. Unfortunately, the Heads of Terms document can often rear its ugly head even at the end of a transaction. If the lease does not reflect the intended agreement that the parties were aiming to reach, then this could potentially open the door to a claim for rectification.
Points to remember when negotiating Heads of Terms:
- Heads of Terms should create a structure for the detailed leave negotiations and contain “in principle” agreement on the key issues and any contentious issues that could otherwise prevent the transaction from moving forward.
- There should be sufficient detail in the Heads of Terms to ensure protracted negotiations are not required, which will only result in delays and higher legal costs.
- If the parties do not intend the Heads of Terms to be legally binding, they must ensure that “Subject to Contract” is clearly stated within the document.
- If the Tenant wishes to move into the property whilst the lease is negotiated, both parties may wish to consider a Tenancy at Will or license as a stop-gap.
- Although Heads of Terms are often drawn up by agents, parties should consider instructing a commercial property solicitor at the inception of the matter. This will ensure that all potential issues can be identified and addressed prior to any detailed lease negotiations.