30/10/2008

Many of our clients come to us with Heads of Agreement or letters of intent asking us to prepare a formal contract. Many times the critical question is are the Heads of Agreement already binding on the parties?

In many instances a Heads of Agreement or other documents that sets out the terms and conditions of a proposed agreement which the parties intend to have drawn up into a “legal contract”, may already be a binding contract between the parties, even if one or both of the parties did not want it to be.

The problem with binding Heads of Agreement is that they often do not cover all of the issues that are commonly covered in the formal contract, and therefore some of the protections and other rights and remedies that may be addressed in a formal contract are left to common law interpretations and principles. This may leave a party in a legal situation that they did not anticipate.

In Australia there are four recognised classes of these types of documents. They are:

Class 1:   a short-form document which contains all the terms of the agreement;

Class 2:  a short-form document which contains all the critical terms of the agreement but where the performance of certain terms is conditional upon the execution of a formal document;

Class 3:   a document that is entirely subject to a formal document; and

Class 4:  a document to which the parties intend to be immediately bound, but agree to execute a formal contract at a later date.

Some of these documents are legally binding contracts and some are not. Do you know which class of document or documents is not a legally binding contract?

Generally, where a letter of intent or Heads of Agreement has sufficient certainty – that is the material terms of the agreement are clearly stated and there is clear agreement on the consideration to be paid (i.e. an agreed contract sum) – and there is an intention that the parties be legally bound by the terms of the letter of intent or Heads of Agreement, the document can be held to be a legally binding contract. This can be so even if the document says it is subject to the execution of a formal contract.

A party’s intention to be legally bound by a Heads of Agreement will sometimes be evidenced by the actions of the parties. Often times the parties to a Heads of Agreement will commence work or services in relation to the Heads of Agreement with the intention of signing the formal contract at a later date. The parties may believe that they are not bound by contract until such time as they execute the formal document. However, if the Heads of Agreement are sufficiently certain, the actions of the parties may clearly demonstrate the party’s intention to be bound by the Terms of the document, and a legally binding contract may exist.

If you are presented with a Heads of Agreement or other document setting out proposed terms of a contract, consider getting professional advice before you sign the document to ensure you get the contract you want rather than the contract that may be imposed by the Heads of Agreement.

And the answer to our earlier question – only class 3 documents are not legally binding contracts.

Please contact Townsends Business & Corporate Lawyers on (02) 8296 6222 for more information.