[EP 014] The Risks in Using Heads of Agreements and How to Keep Safe with Elizabeth Lee

Joanna: Hi, Its Joanna Oakey here, welcome back to The Deal Room Podcast.Today we have the fabulous Liz Lee with us again and we are talking specifically about heads of agreements, memorandum of understandings, the kinds of documents that might be used at the beginning of a transaction to set out the commercial terms that the parties have agreed and the extent to which these are legally binding. Thanks for coming along Liz to talk about such an exciting topic today.

Liz: Hi Jo. Thanks for having me along.

What are we talking about here?

Joanna: Great. Being very clear for everyone, today we’re talking about heads of agreements, letters of intent, memorandum of understanding, commercial terms, any document that sets out the commercial terms between a party. Issue in particular is how is it that we make these documents enforceable if we want them to be or if we don’t want them to be enforceable, what’s the things that we need to be careful of? We’ve got some really interesting cases here I think you’ve got to talk about today Liz. Maybe tell us a bit about the case of Mulago.

The Case of Mulago

Liz: Yes, so the case of Mulago was about a purchaser wanting to take over a company in order to control the Marina business in the Rozelle Bay and they entered into a Heads of Agreement to try to formalise the deal.

Joanna: So we’ve got a heads of agreement here that’s setting out some of the terms that relate to a buyer buying a seller selling the Rozelle Bay Marina business.

Liz: Yes essentially. And there was a requirement to execute a formal agreement as agreed between the parties’ solicitors.

Joanna: So within this agreement, we see this a lot, effectively a clause where the parties agree to agree in the future. So essentially we say “OK we agree to sell this business to the buyer on terms that we agree to in the future between our solicitors.”

Liz: Yes. So the parties weren’t able to agree on the long form agreement and so it was argued by the seller that there were certain terms that were unclear or not properly defined and therefore the agreement to agree couldn’t be enforced.

Joanna: And that’s the issue with these heads of agreements or whatever we’re calling these documents. Usually, by their very nature, they’re an outline of the commercial terms without all of the depth of the detail that we would usually see in the end transaction documents. I guess it’s clear that’s why these issues occur. So maybe it’s useful if you read out for us the clause that is the bones of the issue which talks about whether or not the agreement is binding and to what extent it is.

Liz: Yes. So the relevant clause that was included in the heads of agreement said “Without affecting the binding nature of these heads that agreement, the parties within seven days, are to execute a formal document or documents as agreed between their respective solicitors to carry out and express in more formal terms and additional terms as these heads of agreement.”

Joanna: So what happened? It sounds like one of the parties decided that they wanted to pull out or didn’t like the terms.

How the court resolved a case of ambiguity

Liz: Yes, that’s right. Didn’t like the terms and cited two issues that were undefined. Firstly, the area of the marina, as in specifically which parts of the marina. Cause even though the heads of agreement stated very clearly as to the percentage that would be taken the heads of agreement didn’t identify the actual location of the marina. But in that instance the court felt that such a clause wasn’t completely devoid of meaning and the court, after due consideration, sort of came to the conclusion that it was sufficiently clear and it was up to the purchaser to determine which area it was entitled to purchase.

Joanna: Right. So I guess the issue here and you can see it play out often in these heads of agreement documents that only contain a skeleton of the detail that really is required to ensure that both parties are absolutely clear about what they’re agreeing. So the court here says well even though it’s ambiguous, the fact that it isn’t completely devoid of meaning means that that’s not sufficient reason for us to say that you haven’t entered into a binding agreement.

Liz: Yes, that’s correct. And even though income is referred to in this agreement was not sufficiently defined, the court resolved it by looking at the surrounding circumstances and background of the party’s knowledge of how the business operates in their industry and gave it meaning.

Joanna: And so I always find this an interesting sort of issue when a court is left to come to its own conclusion about the meaning of an ambiguous clause. Often it’s very hard to predict what the outcome will be. Obviously both parties get to court in the first place because they both think that they have a chance of their interpretation being the succeeding interpretation, but of course we don’t know what a court will decide at the end of the day so that’s the real risk with having a lack of detail and ambiguous clauses.

It's hard to predict the outcome when the court is left to interpret an ambiguous clause. Share on X

Uncertainty vs Ambiguity

Liz: Yes. There’s a distinction between uncertainty and ambiguity. The court would give meaning to ambiguous clauses whereas if it’s uncertain it wouldn’t be enforceable. It’s a fine line I think.

Joanna: Yeah. Wow. OK. Well I think the real learning then in that case for our listeners is if you’re thinking of using a heads of agreement then you need to be very clear about whether or not in that instance you want it to be enforceable and if so you need to think about whether or not you have given enough detail and specificity to some of these areas like in this case. Obviously, the definition of the area of the marina and the reference to the income that was being disputed. How then does this tie into, maybe we can also talk then about the second case that you have today that I think is also very interesting, Nurisvan Investment.

The Case of Nurisvan Investment

Liz: That’s right. This is a more recent case. It involved a foreign company wanting to enter into the Australian market, to buy a company locally that had an Australian financial services license so it had an asset. So the seller was a shareholder and between the seller and the buyer, they entered into a heads of agreement for the foreign entity to buy into the Australian market. And after nine months of negotiation of the heads of agreement, the negotiations fell through. So that the heads of agreement specified what the purchase price would be but notwithstanding, the court in that case did not enforce the heads of agreement as a binding agreement.

Joanna: So here we have two parties agreeing to buy and sell a business based in Australia and there is a heads of agreement but then and then they negotiate for nine months about the terms that falls over at the end. And why did it fall over Liz? I always like to know why these things fell over. Who wanted to pull out and why?

How the court resolved a case of uncertainty

Liz: Yes. It turned out that the seller in the end felt that it could get more money out of the deal and then after about nine months decided it wasn’t about legally bound to proceed. And one of the reasons cited too was that the purchaser had not signed the heads of agreement.

Joanna: Wow. OK. So it’s failure to sign the heads of agreement even though they were both acting in accordance with it, it still was raised as an issue.

Liz: Yes it was raised as an issue. That wasn’t the reason why the court didn’t enforce it. The court was still happy to enforce it through the conduct of the parties but it was the fact that they negotiated for nine months and it was apparent to the court that there were so many issues that had left uncertain in the heads of agreement that the court could not see itself to bind the parties to the heads of agreement.

Joanna: I think it’s a really interesting point that you made earlier. It’s interesting that the court acknowledged that even if you don’t sign an agreement, by your conduct you can be taken to have accepted the terms of that agreement. I think that’s a really interesting point that we know as lawyers. But it’s something that out in the public is often forgotten, that even if you haven’t signed on the dotted line you might still be seen to be bound to a document if indeed your conduct is taken to show that you’re acting in accordance with that. So I think that’s a good point to shout out. And so then the underlying issue here was that we have this buyer wanting to come into the Australian market and they’ve just spent you know they’ve probably if they’ve had good advice given to them and done some proper due diligence. So they spent money on doing due diligence and going through this process of nine months of negotiation. And at the end of it they’re left with a seller decides they want more money and walks away. How frustrating!

Liz: Yes, that’s right. And one of the reasons the court concluded that it was merely an agreement to agree it looked at the language that was used within the heads of agreement in the recitals, there was reference to the parties wishing or intending to enter into a share purchase agreement. The reference to when the transaction would complete was referenced to the completion as provided for under the share purchase agreement. That’s sort of all pointed towards the heads of agreement not being a binding agreement on its own. And so I think care needs to be taken if parties wish for that heads of agreement to be a binding document. It needs to have sufficient substance in itself to be enforced as an agreement in itself.

Even an unsigned agreement may be binding if your conduct indicates acceptance of the terms. Share on X

It’s not in the name

Joanna: Well I think this sort of leads on really well to what the action points are then for anyone here who is considering entering into a document like a heads of agreement, memorandum of understanding, letter of intent into the future. Because one of the important things that we haven’t mentioned but I think is particularly important to also mention is that often people say to me well a heads of agreement or a memorandum of understanding isn’t a binding document but the point is it doesn’t matter what you call the document. What matters is whether or not the elements within that document comprise a contract and an obligation that’s enforceable on both parties from a legal perspective. And if you’re using wording within these agreements that satisfies the criteria of a contract enforceability which is offer and acceptance, consideration and an intention to be bound then no matter what you call the document it can potentially be enforceable.

Liz: Yes correct.

Joanna: So let’s talk here then about what the takeaways are for anyone who’s entering into these types of documents if they do or don’t want it to be enforceable. So if we want something to be enforceable what should we be doing?

It doesn't matter what you call the document. Content is what determines enforceability. Share on X

Clarity is key to enforceability

Liz: Have clear words as to the enforceable nature of the document and not only state that it’s legally enforceable but you’ve got to have elements within it that support the enforceability of that document. You can’t have clauses that link it to a different document that is yet to be agreed.

Joanna: Yeah, absolutely. And so here we are talking about I guess keeping the document simple, clear, but also having enough information within it that it can stand on its own in terms of enabling enforceability of the elements that you want to be enforceable because sometimes in these documents we don’t intend for the whole document to be enforceable. Sometimes we just intend for parts of it to be enforceable.

Liz: That’s true. Sometimes parties are very I suppose careful about protecting their confidential information, making sure they have an exclusive period to negotiate the deal so provisions such as confidentiality and exclusivity can sometimes be made clear that they are provisions that are enforceable within the heads of agreement.

How much detail is enough?

Joanna: Absolutely. I guess the next question for people is if they’re using these sorts of documents do they want to make the deal that they are talking about enforceable or not and are they prepared to accept the risk that goes with that, which is if you make or you attempt to make a document that relates to a deal where you intend to have the further details of the deal described later on or agreed to later on, are you happy to be bound to that deal even if you don’t have those extra details to enter now. I guess this is always the tension between making an enforceable document relating to a future deal vs. only making elements of it enforceable.

Liz: Yes that’s very well said Joanna, because in a typical transaction for sale and purchase of business there are sometimes quite complex issues regarding risks that need to be dealt with, such as what warranties are going to be given by the vendor and what remedies the purchaser has should there be breaches of warranties and these are sort of left uncertain in a heads of agreement. And yet the parties want to enforce it. There is a fine balance as to how much detail you put in there because people want it to be enforceable as a standalone. You’ve got to have some meat on it.

Joanna: Absolutely. these two cases are a really good offset to each other, because we have a similar sort of circumstances in that we have a heads of agreement in which we have an agreement to agree in the future for the sale and purchase of a business in each of these cases. In one instance the court was happy to fill in the extra details themselves and enforce the agreement on the basis of its own construction of what the parties essentially meant by the lack of detail they had in the document. Whereas in the second case with our foreign company trying to buy the company based in Australia we had the flip side where the court wasn’t content to enforce the heads of agreements so we have courts in this instance taking different views. And it just shows how difficult this area is and the importance of getting the right advice and understanding what you’re doing when you’re creating these documents I think.

Liz: Yes, I agree.

Legal advice is important

Joanna: Because one of the issues is quite often you might have parties thinking that heads of agreements are not the time when they need to involve a solicitor because they’re really setting out the commercial terms. I guess that’s another thing to bear in mind isn’t it? For organisations to be aware of when they’re creating a risk element and need to make sure they’ve crossed off that legal advice component.

Liz: Yes, I agree. often users of this type of document might think that well this is not legally binding so doesn’t matter what I put in it, but you know you might inadvertently put in something and get the parties to sign a document that might be enforceable too.

Joanna: Yeah, yeah absolutely.

Liz: It’s the flipside.

Quick Recap

Joanna: Yeah absolutely. Okay great. Well look I think that’s a pretty good overview of the many tensions in this area of dealing with heads of agreements and memorandums of understanding. So just as a quick recap the action points from this episode if you’re thinking of dealing with a heads of agreement document is to be aware of the risks that relate to the element of enforceability. So think clearly about whether or not you want the agreement to be enforceable and if you do, are you trying to create the situation where the end deal that the document discusses can be enforced against both parties even though you don’t have the full details? Or are you only trying to make certain elements of the document enforceable? Say for example confidentiality and exclusive rights to negotiate for a particular period of time.

Make sure you’re clear about whether there’s enforceability on all or elements of it and you use clear wordings so that there’s no ambiguity in that. And if you’re creating an enforceable document that requires later detail to be added, just be aware of the risk of creating that situation for yourself if indeed you were not able to agree on those further details later on down the line. Great. All right. Wonderful. So if you’d like more information about this topic please head over to our website at talkinglaw.com.au. Through that website, you’ll also be able to download a transcript of this podcast episode if you’d like to read it in more detail. You’ll also there be able to find details of how to contact our lawyers at Aspect Legal if you’d like help with any of the items we covered today. And finally if you enjoyed what you heard today please pop over to iTunes and leave us a review.

Thanks for coming on board Liz! We look forward to having you again on the next one.

Liz: Thanks for having me, Joanna.

Joanna: Thanks again for listening in – You have been listening to the Joanna Oakey on the Deal Room Podcast. See you next time!