This article is written by Mohammad Khurshid Anwar, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com.

Introduction

Suppose you are running a successful company, a project is coming to a new location where you don’t operate and the project allows joint venture. You start searching for parties with similar project experience, and zeroed down to one potential joint venture partner. You start looking for closure to selected parties’ profiles and initiate communication and meetings. In the process the selected party appears suitable for Joint venture and upon further finding an intention from both sides became clear to go for Joint Venture agreement. Both parties decide on basic joint venture requirements like: purpose of joint venture, JV name, how the joint venture will be controlled, directors, management structure, roles and responsibilities of parties, resource commitments from both parties in terms of no. of manpower, intellectual property licenses, services to be supplied, owner of intellectual properties …., including areas where to compete with each other or not, …..etc. but still obtained details are not sufficient to enter into a full detailed contract. Here both parties can depend on formation of “Head of Terms” or any kind of pre-contractual agreement.  Head of Terms are semi-formal arrangements; which is neither as volatile as verbal commitment; nor as obligatory as binding formal contract. However, the question will arise whether the “Head of Terms” are legally binding or not? This article tries to analyse whether head of terms are legally binding and when they can be used?

Use of head of terms and similar agreement

Head of terms is a pre-contractual agreement, and similar kind of agreement is used by different industries. Other typical names given to pre-contractual agreements in different industries are “letter of intent”, “letter of understanding”, “term sheets”, “memorandum of understanding”, “MOU”, “heads of agreement”, “heads of terms agreement” and “letters of interest”.^[i]

As explained above, for a pre-contractual agreement to come into existence, Two parties should come to a consensus of performing certain functions with reasonable intent. With pre-contractual agreement parties can save time, obtain a trustable platform for negotiations, pursue jointly for the permission and the clearances needed from government or the agencies as the case may be, above all it will serve as the basis of reaching a final binding agreement.

Content of head of terms and similar agreement

Being a pre-contractual arrangement parties to the agreement though show their intent for performing certain function; but in most cases certain requirement to enter into the contract is not fulfilled therefore phrases like “subject to contract”, “agreement in principle”, “condition precedent” finds more use in the head of terms or similar agreement. The content of the head of terms depends on the industry and purpose of the transaction, Letter of Intent is widely used in the construction industry, even up to an extent of commencing work without final agreement. A careful and comprehensive drafting of head of terms is essential, with obligation of parties explicitly mentioned to avoid any misunderstanding or later disputes, therefore a thorough review of head of term draft by each party is recommended, preferably signed pre-contractual agreement will serve better. The case of Letter of intent will be discussed further in this article under examples. Let’s see a typical case of basic letter of intent or heads of terms for the sale of a business, it is expected to include:

• Purpose and Type of sales i.e. share or asset or both.
• Value of transaction.
• If any existing Contracts to be transferred to acquirer.
• Key assets which are getting transferred:

1. Immovable property like land, warehouse, specialized facilities, office building etc.
2. equipment, plant and machinery
3. intellectual property rights

• Exclusion of assets not getting transferred to the acquirer.
• Type and quantity of share getting transferred.
• Key employees getting transferred.
• post-sale/acquisition commitments of the vendor.
• restrictive covenants, like non-competition clauses. 
• Pricing structure.
• Clause relating to circumstances where the purchase price can be affected.
• Condition precedents for formation of binding contract.^[ii]

Legal validity of head of terms

These are usual questions which arise with use of the Head of Terms or any other form of pre-contractual agreement:

• Are Head of Terms legally binding?
• What are legal courses which can be taken if some issues come up and the final contract is not signed?
• Can a party perform some action with the Head of Term or other pre-contractual agreement in place?
• Signing of the Head of Terms necessary by both parties?

Answers to these all questions depend upon the intent of parties and the trust they have in each other. In general any pre-contractual agreement is entered into with expectation the agreement will not be legally binding. The purpose of these agreements will guide the next action from parties to the agreement. These actions can be: obtaining more information about each other like area of operation, type of assets each party have, ground procedure followed by each party during their operation; to scrutinize further whether the party serve the objective which is planned through pre-contractual agreements, to touch any area of negotiation which is hard if this non binding agreement is not there, commencement of preliminary work until formal contract between parties are not finalized. All these actions again depend upon the business environment an industry provides. For example in a merger and acquisition both party want any pre-contractual agreement to be non binding to have more flexibility or negotiating power, here parties can walk out if the purpose is not achieved and generally don’t have any obligation, whereas in construction industry a party can ask other party to commence work and due to long standing relationship between parties, the other party commence the work and they are able to do that, generally without any dispute or issues; definitely this arrangement cannot devalue the importance of final binding agreement between the parties. In case any dispute arises for the action taken by the party based on a letter of intent then the matter can be referred to court and resolve can be obtained.

Therefore, to answer above questions objectively:

• Head of Terms are generally not binding but can give recourse through court (refer examples) in case some action based on intention shown through the Head of Term or any other form of pre-contractual agreement is taken by any party.
• However, if both parties want the Head of Term to be legally binding then they can do so, and can later again enter into the formal agreement. However to make Pre-contractual agreement legally binding care shall be taken to cover all related issues and include all possible recourse incase of any dispute.

Examples: cases on letter of intent

Rajasthan Co-operative Dairy … vs. Shri Mahal Laxmi Mingrate … on 17 September, 1996^[iii]

In this case the appellant, M/s Rajasthan Cooperative Dairy Federation Ltd., issued an advertisement inviting applications for selling agents for its various products for the territories of Rajasthan, Punjab, Haryana, Himachal Pradesh and Delhi, on or about 19th of November, 1988. Seventy applications were received by the appellant. Ultimately, on 1st June, 1990, a letter of Intent was issued by the appellant in favor of respondent (M/s Shri Mahal Laxmi Mingrate) for appointing respondent as the selling agent of the appellant for marketing of Saras Brand Dairy Products, inter alia, on the following terms:

• submission of an irrevocable bank guarantee of Rs. 15 lacs by 12th of June, 1990;
• submission to the appellant its profit & loss account and balance-sheet for the past year before the execution of the agreement.

Upon submission of the above document, agreement was supposed to be signed.

Respondent was not able to satisfy both the terms in the allotted deadline as a result appellant revoked the Letter of Intent. The respondent challenged the decision of revoking the Letter of Intent. The court decided the Letter of Intent is merely an expression of interest to enter into a contract. If the conditions stipulated in the Latter of Intent were not fulfilled by respondent then there was no binding legal relationship between the appellant and respondent at this stage and the appellant was entitled to look at the totality of circumstance in deciding whether to enter into a binding contact with respondent or not.

Dresser Rand S.A vs. Bindal Agro Chem Ltd And K. G. … on 12 January, 2006^[iv]

Bindal wanted to invite global tenders for supply of various equipment and materials for its Shahjahanpur Fertilizer Project. For that purpose, it prepared its standard ‘Invitation to Bid’ comprising “Conditions of Purchase for Supply of Equipment and Material under ICB Procedure – Shahjahanpur Fertilizer Project”. Due to change in specifications Annexure’s bid went under changes upto revision 4, so the initial bid didn’t remain as it was invited. In order to expedite the process BINDAL issued a Letter of Intent through KGK (another company) to Dresser Rand (both parties signed), with a condition to issue formal purchase order with General Condition which will be a part of  final binding agreement. The equipment supplied by Dresser Rand raised some dispute and was not acceptable to BINDAL. Dresser Rand requested for arbitration proceeding.

Here the letter of Intent was issued by another party not the party who invited tender, and Letter of Intent said final purchase order will be issued later which had General Condition and General Condition included clause for arbitration. The court decided the letter of Intent issued, though signed by both parties, didn’t include General Condition of purchase, therefore the Letter of Intent can only be used to compensate the party of their expenses but doesn’t give the right to invoke arbitration clause which is a part of purchase order, still pending to be issued.

Above example makes it very clear to what extent a Letter of Intent or any other Pre-contractual agreement can be used and what kind of legal recourse it can provide.

Conclusion

Head of Terms or any other Pre-contractual agreements are entered when there is intent by parties to pursue common function and complete details or information or related legal requirements (licenses or authorization, etc.) are not available to form a final legal binding agreement.  These agreements can be non-binding or binding depending upon parties’ intentions. If the intended purpose is not achieved by the pre-contractual agreements then the party is free to walk out of the agreement, without any liability, subject to all the obligations required by the pre-contractual agreements are fulfilled or non apply.

However, these pre-contractual agreements come in force and do provide legal recourse through courts, if some actions are taken by the party or parties to the agreement without having a final binding agreement in place. This will be the case irrespective of parties’ initial intent of entering into binding or non-binding pre-contractual agreement. Its other thing, the recourse provided by these agreements is limited and a final binding agreement provides complete legal option for smooth functioning of the contract.

Annexure 1 – template for head of terms

Heads of Terms

[with legally binding parts]

THIS AGREEMENT IS MADE AT  ………………. [INSERT DATE]

BETWEEN

1. [COMPANY NAME] LIMITED, a company registered under Indian Companies Act 1956 having CIN [.] and registered offices situated at [address] (“the Company ”); 
2. [SUPPLIER NAME] LIMITED, , a company registered under Indian Companies Act 1956 having CIN [.] and registered offices situated at [address] (“the Supplier”),

each a “Party” and together the “Parties”.

BACKGROUND

1. The Parties are considering entering into an agreement to [describe].
2. The Parties have agreed to these heads of terms to further progress negotiations with a view to preparing legally binding contractual documentation whereby the Company will [describe] and the Supplier will [describe].

NOW IT IS HEREBY AGREED

• Preliminaries 

1. 1. Clause [4] and the following clauses are legally binding upon the Parties. 
   2. Other than clause [4] and the following clauses, this Agreement will not be legally binding upon the Parties.

• Definitions and Interpretation

1. 1. The following terms are defined for convenience. They are not to be taken in account when interpreting the legally binding parts of this Agreement:
      1. […]
      2. […]

• Heads of Terms

1. 1. 1. The Parties are considering entering into an agreement which provides as follows.
      2. […]
      3. The Supplier will:
         1. […]
      4. The Company will:
         1. […]

• Confidentiality 

1. 1. The Parties will keep secret and treat as confidential all information obtained from any other Party which marked confidential or is reasonably considered confidential (“Confidential Information”), including the existence and terms of this Agreement. 
   2. Confidential Information received by a Party may only be used for the purposes of the negotiations described above. 
   3. This clause does not extend to information which is public knowledge, trivial or obvious. 
   4. Each Party shall return or destroy the Confidential Information of the other promptly upon a request made in writing by the disclosing Party.

• General

1. 1. Unless otherwise stated, references to clauses are references to the clauses of this Agreement.
   2. This Agreement constitutes the entire understanding and agreement between the Parties in respect of the resolution of the Claims. 
   3. Each Party acknowledges that it has not entered into this Agreement in reliance of any statement made by or on behalf of the other Party (whether orally or in writing) other than as expressly set out in the Recitals [4] or clause and onwards.
   4. This Agreement may be executed in any number of counterparts, each of which is an original and which together have the same effect as if each Party had signed the same document.
   5. The Parties agree that the terms of this Agreement are not enforceable by any person under the Indian Contract Act 1872.
   6. This Agreement shall be governed by the India Law and the Parties submit to the exclusive jurisdiction of the Indian  Courts, and in each case including non-contractual claims and disputes.

Agreed on the day first mentioned 

Signed for and on behalf of)

[COMPANY NAME] LIMITED )

………………………………………

[Director Name]

………………………………………

Date

Signed for and on behalf of)

[SUPPLIER NAME] LIMITED )

………………………………………

[Director Name] 

………………………………………

Date

References

^[i] https://hallellis.co.uk/heads-terms-agreements-meaning/

^[ii] https://hallellis.co.uk/heads-terms-agreements-meaning/

^[iii] https://indiankanoon.org/docfragment/58638390/?formInput=letter%20of%20intent

^[iv] https://indiankanoon.org/docfragment/1159642/?formInput=letter%20of%20intent

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