Heads of agreement are widely used as interim documents to record the key terms of an agreed deal as a precursor to entering into a formal legal agreement. The question of whether a heads of agreement is legally binding depends on the intention of the parties. Usually, the intention of the parties is primarily ascertained from the wording of the heads of agreement itself, but courts can and do also have regard to the surrounding circumstances. A recent case highlights the risks of relying on surrounding circumstances and in doing so confirms the importance of including an express clause in any heads of agreement as to whether or not the parties intend it to be legally binding.
Who needs to know?
Anyone who is involved in negotiating or drafting heads of agreements. The same legal principles apply to other interim documents such as term sheets, letters of intent and memoranda of understanding.
Background
The decision of the Supreme Court of New South Wales in Horne v James [2015] NSWSC 465 involved a heads of agreement (HoA) for the sale of a broadacre cropping farm in New South Wales.
The HoA was entered into on 13 May 2013. It was relatively brief. It set out the key terms e.g. described the property to be sold, specified the purchase price and included a few ‘special conditions’. Critically, the HoA contemplated that a formal ‘Contract for Sale’ would be prepared (by the vendor’s lawyer) with settlement to occur in early to mid September 2013.
As it eventuated, the vendor subsequently formed the view that sale price was too low and it refused to proceed with the Contract for Sale. The purchaser argued that the HoA was legally binding such that the vendor could not pull out.
Key Features of the Heads of Agreement
The HoA did not contain an express clause stating whether or not the HoA was intended to be legally binding. However, the HoA contained several salient statements in relation to this issue:
- there was some conditionality e.g. “Subject to the parties entering into the Contract for Sale, [the vendor] has agreed to sell …”;
- the vendor’s lawyer was to prepare the Contract for Sale. This was to include such “appropriate clauses and conditions that are usually contained in contracts for the sale of farming land in the district”. Nevertheless, the Contract for Sale needed to be “approved” by the purchaser before the purchaser would enter into the Contract for Sale i.e. there appeared to be some discretion;
- the HoA expressly stated that pending the Contract for Sale being entered into, the purchaser could enter onto the property for the purposes of preparing and sowing canola and wheat crops. As it happened, the crops were sown on the day before the HoA was signed;
- the HoA expressly dealt with what would happen if the Contract for Sale was not entered into by the purchaser e.g. the purchaser would not be entitled to compensation for works undertaken by the purchaser at the farm in anticipation of settlement. This suggested that the parties actually contemplated and allowed for the Contract for Sale to not eventuate, albeit the purchaser would lose the value of the crops sown in advance if that situation arose; and
- the HoA expressly stated that each of the parties would “do all things required” to give effect to the HoA. It also stated that the HoA “shall be deemed binding” on the executors, administrators and assigns of the respective parties.
Overall, the Court concluded that the HoA was not intended to be legally binding insofar as it related to the sale of the property. It was, however, held to be legally binding in relation to having access to sow the crops.
What about the surrounding circumstances?
Apart from arguing about the meaning of words used in HoA itself, the purchaser also alleged that before the HoA was signed he very clearly told the vendors that he required the HoA to be a “legally binding agreement”. The purchaser argued that this clearly showed that the parties (or at least the purchaser) had intended the HoA to be legally binding.
Unfortunately for the purchaser, the Court considered this evidence to be completely irrelevant.
The Court referred to the following statement by the High Court in Codelfa Constructions Pty Limited v State Rail Authority of New South Wales (1982) 149 CLR 337 at 352:
…insofar as [prior negotiations] consist of statements and actions of the parties which are reflective of their actual intentions and expectations they are not receivable [as evidence]. The point is that such statements and actions reveal the terms of the contract which the parties intended or hoped to make. They are superseded by, and merged in, the contract itself.
Put another way, statements made during the course of negotiations which are indicative of the unilateral intentions of a party are not admissible when it comes to interpreting a contract. Therefore, the unilateral statements by the purchaser that the HoA had to be legally binding were not admissible even if the purchaser truly intended the HoA to be binding. This is a classic example of how contract law applies an ‘objective’, rather than ‘subjective’ approach to interpreting contracts and ascertaining the parties’ intentions.
If there was unequivocal evidence to the effect that the vendor had said statements mutually agreeing with the purchaser that the HoA was intended to be legally binding, the outcome may have been different, particularly if the court considered the terms of the HoA were ambiguous on this point. That said, if a court considers that the terms of a contract are clear, extrinsic evidence such as this probably cannot be used to contradict the clear words of the contract.
The Court summed it up as follows:
What the parties intended to achieve in the Heads of Agreement is a matter to be determined objectively by reference to the words that they used in the document, the mutually known [and admissible] surrounding circumstances and the commercial purpose of objects to be secured by the agreement.
Practical Points to Take Away
- Whenever you are dealing with a HoA or similar document, it is critical to always include an express clause stating whether or not the parties intend the ‘agreement’ to be legally binding.
- The main approach for determining whether a HoA is intended to be legally binding is to interpret the wording of the HoA itself.
- Evidence of ‘surrounding circumstances’ can sometimes be used to shed light on the meaning of the words used in a HoA, but as this case shows, relying on this type of evidence can be high risk. This type of evidence may not be admissible and, even if it is, it may not be overly persuasive in comparison to the express words of the HoA itself.