Parties using Heads of Agreements, term sheets or similar documents in mergers and acquisitions need to take care to ensure that the document adequately reflects their intentions. Failure to do so could lead to unexpected risks and outcomes.
Heads of Agreement (HAs) in mergers and acquisitions are usually relatively concise preliminary documents that set out key matters between parties and guide the long-form documents, such as Share/Business Sale Agreements and Shareholders Agreements. They are commonly used in the acquisitions of, and investments in, businesses for various reasons, including:
- they are generally considered to be, at least, commitments in good faith. They often limit the parties' opportunities to renegotiate and provide the parties with sufficient comfort to proceed with incurring due diligence costs and devoting significant effort to a proposed transaction
- they help identify early key differences between the parties' expectations before substantial costs are incurred, resources are used and significant confidential information is shared
- lenders, indirect investors, holding companies and other stakeholders or participants obtain earlier visibility of the deal terms
- HAs can be used to start regulatory processes, like with the Foreign Investment Review Board (FIRB)
- they provide a great opportunity to set the tone, process and momentum for a transaction.
However, care needs to be taken not to duplicate efforts and costs (especially for an unenforceable document, see below) if the transaction can be quickly and simply documented in the final agreements.
In addition, from a strategic perspective, a party may not wish to accelerate the early negotiation of difficult points before trust has been built and the parties are "invested" in the transaction.
Further, there are legal and tax risks to the parties, including if they expect the HA to be binding and it's not (or vice versa).
Binding vs. non-binding HAs
A party may want an enforceable or "binding" HA to (among other things):
- legally commit another party, including to a deadline (subject to the satisfaction of any conditions precedent)
- prevent competitors from participating in an opportunity
- deal with cost recovery.
A non-binding HA:
- permits flexibility from the terms of the HA
- allows either party not to proceed
- might avoid the need for early approvals or regulatory disclosure, where applicable.
The parties should express in the HA whether it is intended to be legally binding or not. However, this in itself will not determine whether it is enforceable.
To be enforceable:
- the parties to the HA should be clearly identified and the document should be signed by a person with due authority
- the terms of HAs should be sufficiently certain and complete. All of the essential terms of the agreement between the parties must be included (or be capable of being determined by reference to the HA terms)
- financial or other consideration (or value, such as mutual promises) must be given by each party to the other in order for the HA to be binding, unless the HA is executed as a deed.
Also, if the HA is executed as a formal agreement or deed, care should be taken to ensure due signing, exchange and delivery.
Typical terms of HAs include details of:
- an explanation of the transaction
- the consideration, in what form (for example, cash, shares and loans) and the adjustments
- any conditions precedent such as shareholder approval or regulatory approvals, or clearance from ACCC, ASX or FIRB
- the process and timeline
- the scope and extent of the warranties, indemnities and any restraints
- arrangements in respect of exclusivity (to prevent the parties from dealing with others during a specified period), confidentiality and costs.
Commonly, parties agree in HAs that they will carry out further negotiations in "good faith". If such provisions are too vague or uncertain, such commitment may be unenforceable. To assist with enforceability, good faith clauses may benefit from further details. For example, a specific period during which the parties must negotiate in good faith and an obligation to refer disputes to senior executives for resolution may assist.
Often, the outcome is for some (but not all) clauses of the HA to be expressed to be legally binding. For example, the clauses regarding exclusivity, confidentiality and costs are typically binding.
The final, long-form documents should clarify any continuing obligations in the HAs and/or contain an 'entire agreement' clause so that they supersede the HA.
Care needs to be taken to ensure transaction documents adequately record and reflect the parties' intentions. HAs that are prepared with consideration to the above matters can ensure transaction certainty, risk mitigation and a strong relationship between the parties.
This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.