Heads of Agreement (HOAs) are often used in business transactions to record the principal terms agreed between parties before a formal contract is signed. Although they can be useful in progressing negotiations, they may create unexpected legal obligations or significant legal risks if they are not drafted clearly and carefully.
A primary risk of a Heads of Agreement (HOA) is uncertainty about whether it, or parts of it, are legally binding. Enforceability depends on whether the parties objectively intended to create legal relations, having regard to the language of the document, the conduct of the parties, and the surrounding circumstances. Simply calling a document a HOA does not determine its legal effect. The critical issue is whether the parties intended to be immediately bound or only intended to be bound upon execution of a formal agreement. Failure to clearly express that intention can result in costly disputes and litigation.
Another common risk is leaving out important terms or using unclear language. A HOA may not be enforceable if key terms are uncertain or still subject to future agreement. It is also important to clearly identify which clauses are intended to be binding, such as confidentiality, exclusivity, costs, or dispute resolution. The phrase “subject to contract” usually indicates that the parties do not intend to be legally bound until a formal agreement is signed. However, unclear drafting or the parties’ conduct may lead a court to find that some or all of the HOA is legally enforceable.
The decision in Coal Cliff Collieries Pty Ltd v Sijehama Pty Ltd (1991) 24 NSWLR 1 shows the importance of determining whether a document is simply an “agreement to agree” or creates legally enforceable obligations. Australian courts generally consider agreements to agree to be unenforceable because they lack certainty. However, an obligation to negotiate in good faith may be enforceable if it is clearly drafted, sufficiently detailed, and supported by consideration.
Parties should also exercise caution before acting on an HOA. Commencing performance, transferring funds, or otherwise acting in reliance on the document may provide evidence of an intention to be bound and can create enforceable obligations. In AW Ellis Engineering Pty Ltd v Malago Pty Ltd [2012] NSWSC 55, the court ordered the parties to comply with the HOA because the terms and objective intentions of the parties were sufficiently clear.
To minimise risk, parties should clearly state whether the HOA is intended to be legally binding or non-binding. Any clauses that are intended to be enforceable should be clearly identified, and all key terms should be defined as clearly as possible. Any obligation to negotiate or act in good faith should also be carefully articulated. Before signing or relying on a HOA, parties should obtain legal advice, particularly for complex, high-value, or important transactions.
Although HOAs are often viewed as straightforward commercial documents, they can create significant legal consequences. Careful drafting and professional advice are essential to ensure that the document accurately reflects the parties’ intentions and avoids unintended liabilities.
