Can Heads of Agreement That Are "Subject to Contract"
Still Bind You?
It is common practice for parties to property and business
transactions (such as sales, purchases and leases) to sign a heads
of agreement once an agreement has been reached in relation to the
key commercial terms of the transaction, but prior to the
preparation and entry into a formal contract. Difficulties can
occur when the parties only intend that a binding agreement arise
upon entry into the formal contract, but the heads of agreement in
fact constitutes a binding agreement.
In Confidential and Commissioner of Taxation  AATA
76, the vendor's agent had prepared a heads of agreement
for the sale of a business based on a pro forma heads of
agreement. The vendor and purchaser signed the heads of agreement
prior to obtaining legal advice. The agent did not intend that the
heads of agreement bind the parties other than in respect of
exclusivity and confidentiality, and understood that a formal
contract would be required if the parties intended to proceed with
The Administrative Appeals Tribunal of Australia (Tribunal)
considered that the relevant question was whether the heads of
agreement operated as a legally binding document between the
parties. It was determined that the agent's intentions in
relation to the effect of the heads of agreement, and the
subjective intention of the parties, were irrelevant.
Despite containing an express provision that the heads of
agreement were "subject to and conditional upon" (among
other things) the vendor and purchaser entering into a formal
contract for sale to be prepared by the agent, the Tribunal found
that the heads of agreement:
clearly indicated that the parties had agreed to the sale of
contained the essential terms of the sale of the business
expressly stated that the parties intended to be bound by the
heads of agreement
operated as a binding legal document in respect of the sale of
the business and not just in respect of exclusivity and
The Tribunal's finding had a significant adverse impact on
the vendor's taxation position.
"Subject to Contract" Clause
In this matter, the Tribunal found that the inclusion of a
"subject to contract" clause in the heads of agreement
did not negate a binding agreement arising before the parties
entered into a formal contract because:
there can be an informal binding agreement with the expectation
that other terms will be negotiated and agreed, and by consent
included in a formal contract
the formal contract was simply intended to restate the terms
set out in the heads of agreement in a fuller and more precise form
but not different in effect, and the parties had intended to
substitute the formal contract for the heads of agreement.
The heads of agreement fell within the well-established legal
categories of agreements that, although being stated to be
"subject to contract", were nevertheless binding.
Heads of agreement should clearly state whether they are
intended to be binding on the parties.
There are traps in using pro forma documents and it is
always prudent to have such agreements legally reviewed before
If the intent of the parties is to provide a prospective
purchaser with a due diligence exclusivity period, then it might be
sufficient to simply document that arrangement by a confidentiality
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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On 12th November 2016, new laws will commence to protect small businesses from unfair terms in standard form contracts.
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