Why Heads of Terms can fail to give certainty to a relationship

Heads of Terms, Memoranda of Understanding, Letters of Intent, Heads of Agreement – the interchangeability of the names used is largely irrelevant. Principals and agents sometimes agree Heads of Terms to formalise an intention to begin negotiations of a formal agreement and sometimes both parties proceed acting on those terms. But uncertainty can arise as to the terms that govern the relationship between principal and agent when the relationship breaks down before a formal agreement is put in place.

This issue was highlighted in the recent judgment in Green Deal Marketing Southern Limited (“GDM”) v Economy Energy Trading Limited (“EE”).

Heads of Terms had been drawn up to move the relationship of the two parties forward and away from an original Partnering Agreement. At trial GDM sought to rely on these Heads of Terms as a new contract which governed the relationship with EE. In contrast EE contended that the Heads of Terms had no legal effect and that the relationship was still governed by the Partnering Agreement.

For many principals and agents the facts of this case will not come as a surprise. GDM and EE had entered into a Partnering Agreement which commenced in May 2015. Following the success of this agreement EE and GDM sought to create a new contract to solidify and carry the relationship forward.

In order to commence this process EE sent GDM draft Heads of Terms. They set out a general outline of what would be included in the formal agreement. The Heads of Terms were then negotiated between the two parties. During this time both parties began to rely on the provisions contained in the Heads of Terms. For example, GDM started to invoice EE in line with the new pricing structure which was then paid by EE. The Heads of Terms were signed by both parties on the 29 June 2016 after which there was a celebratory party.

Importantly in this case the Heads of Terms set out:

1. that a formal contract would be agreed within 90 days of commencement of the Heads of Terms;

2. a commencement date. But in the final version this was left blank. The judge considered this was in order for the parties to insert a date on the day the Heads of Terms were signed;

3. that the contract would be for a fixed term of 3 years with 6 monthly reviews;

4. that there would be standard termination rights for material breach by GDM or on remediable breach if the breach was not remedied in 10 days. Moreover, EE was also able to terminate the agreement if after the 6 monthly reviews it notified GDM of a breach and that breach was not remedied in 14 days.

5. that GDM would exclusively provide its services to EE for a set number of postcodes for which GDM would be remunerated on a weekly basis;

6. detailed performance targets which GDM would be required to meet; and

7. compliance standards that any agents working for GDM would need to meet.

The judge decided that the Heads of Terms took effect as a valid contract when signed on the 29 June 2016 and were relied on by the parties as the new terms governing their relationship. As a result the judge decided that the parties clearly saw the signing of the Heads of Terms as a major commitment to their future relationship. Furthermore the formality of the document showed that it was more than merely a guide for the lawyers to use to draw up a formal agreement. Indeed, the parties did not instruct lawyers to draw up the final agreement within the timeframe, leading to the opinion that the parties did not feel the need to seek a further agreement as what had already been agreed was sufficient for their purposes.

The judge went on to decide that whilst in the Heads of Terms not all the terms of a contract had been agreed, the matters that had been negotiated were capable of constituting a contract. Where the Heads of Terms were lacking provisions or details which were required to complete the contract, the judge relied on the provisions created by the parties current relationship (under the Partnership Agreement) to infer terms in order for the document to be complete.

Finally the judge decided that both parties had implemented the Heads of Terms from the date that they were signed. The parties actions showed they were working under the belief and understanding that from that point their relationship was governed by the Heads of Terms. Indeed the judge noted that GDM in correspondence with EE had relied on the on the termination provisions in the Heads of Terms and this reliance was not corrected by EE.

What are the take home points from this case?

1. Usually the test for whether a contract has been formed is an objective one. The outward appearance of a contract whether by offer and acceptance or by a signature on a document will be sufficient, regardless of the parties’ intention. In a commercial context where there is an objective agreement supported by a payment or performance of the agreement the intention to create legal relations will generally be presumed.

2. Furthermore it is well established that to prevent the creation of legal relations parties use the term ‘subject to contract’ or a similar variation. However principals and agents should note that the court will read the whole of a contract and not just part. If the rest of the contract indicates a clear intention for legal relations then a judge may decide that the Heads of Terms are legally binding. A way in which Heads of Terms could infer that there was no intention to create legal relations would be by leaving out important points not agreed between the party’s as this would make the agreement insufficiently complete, preventing it from having any contractual effect.

3. Green Deal v EE provides a warning highlighting the uncertainty that agreeing Heads of Terms can bring, especially if they are relied on. Moreover if there is an existing relationship principals and agents should be cautioned that even if the Heads of Terms do not form a complete contract, the courts will be willing to infer from the previous relationship terms which will complete the new contract.

4. Importantly agents and principals should note:

4.1 if both parties formally sign the Heads of Terms it suggests an intention that the document should have legal effect;

4.2 if there is an existing relationship between the parties that has deviated from the original terms this could be taken into consideration when drawing conclusions as to the intention of new Heads of Terms if they leave very little to still be decided;

4.3 in order to prevent legal relations from being presumed the Heads of Terms require more than provisions contemplating a formal contract. The Heads of Terms must specify clearly that there is no intention to create legal relations;

4.4 having a commencement date in the Heads of Terms allows for the inference that the new contractual relationship begins the day the Heads of Terms are signed; and

4.5 even where the parties have made clear in the Heads of Terms that there are still matters which have not yet been agreed, the terms which have been finalised between the parties may cause the document to be legally enforceable. 

In light of this, principals and agents will invariably be in a better position relying on the certainty of an agency agreement rather than on Heads of Terms.

Stephen Sidkin
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Imogen Bull
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