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You've reached agreement on the key terms of a business sale, commercial lease, or partnership arrangement. The other side wants something in writing before final contracts are prepared. You draft a document called "Heads of Agreement" or "Letter of Intent" to record what you've agreed so far. But here's what catches many business owners by surprise: that preliminary document you thought was just an outline might create legally binding obligations.
I work with business owners navigating commercial transactions where understanding what's binding and what's preliminary makes the difference between maintaining negotiating flexibility and being locked into terms you're not ready to finalise. Whether you're selling a business, negotiating a commercial lease, or entering a joint venture, getting your Heads of Agreement right from the start protects your position and keeps your options open.
In this guide, I'll explain what Heads of Agreement actually are, when they become legally enforceable, and how to structure them to match your commercial objectives. Let's look at what you need to know to use these documents effectively.
Invest time in clarifying your objectives before drafting Heads of Agreement - are you creating moral commitment while preserving negotiating flexibility, or finalising a binding arrangement with only documentation remaining? Work with legal counsel to ensure your language matches your intention, particularly around phrases like "subject to contract" or "binding in honour only." Ensure you understand which clauses (if any) should be binding immediately, such as confidentiality, exclusivity periods, or cost sharing arrangements. Review carefully how the document describes what happens next - vague language about "preparing final contracts" can undermine non-binding intent if essential terms are already complete.
A Heads of Agreement (sometimes called Letter of Intent, Memorandum of Understanding, or Term Sheet) is a document that records the key commercial terms parties have agreed before preparing final contracts. It's commonly used in business transactions, commercial property purchases, lease negotiations, partnership formations, and joint venture arrangements.
Business sales and purchases: Documenting agreed purchase price, payment terms, due diligence periods, and completion timing while lawyers prepare detailed sale agreements.
Commercial leasing: Recording rental amount, lease term, fit-out responsibilities, and key lease terms before preparing formal lease documentation, particularly important in retail leasing where disclosure obligations apply.
Partnership and joint venture arrangements: Capturing agreed contributions, profit sharing, management responsibilities, and operational structure before finalising partnership or shareholders agreements.
Commercial property transactions: Setting out purchase price, settlement terms, special conditions, and timing before exchange of contracts.
The fundamental purpose is giving both parties confidence they've reached agreement in principle on material terms, allowing them to invest time and money in due diligence, documentation, and transaction planning. However, this confidence can become problematic when parties have different understandings about whether they're legally committed.
Here's what creates confusion: a Heads of Agreement can be binding, non-binding, or partially binding depending on how it's drafted and how parties behave. There's no automatic rule that preliminary documents are unenforceable. Courts analyse several factors to determine whether parties intended to create legal obligations.
Language used in the document: Phrases like "subject to contract," "subject to execution of formal agreement," or "binding in honour only" indicate non-binding intent. Conversely, language that refers to "the agreement," uses terms like "the parties agree" without qualification, or includes enforcement provisions suggests binding intent.
Completeness of essential terms: If the document contains all terms necessary for a workable contract in that type of transaction - parties, price, subject matter, key obligations, timing - courts are more likely to find it binding even without formal documentation.
Parties' stated intentions: Express statements about whether the document is binding carry significant weight. Clear language like "this document is not legally binding except for clauses 7, 8 and 9" provides strong evidence of intention.
Subsequent conduct: How parties behave after signing matters. If they treat the arrangement as finalised, proceed with performance, or enforce terms against each other, this suggests they considered it binding regardless of what they initially intended.
Many business owners believe including "subject to contract" language automatically prevents a document being binding. While this phrase is helpful, it's not a complete shield. Courts consider the document as a whole. If essential terms are agreed, the parties have started performing, and the only remaining step is formal documentation, "subject to contract" may not be enough to prevent enforceability.
The key is consistency - if you want the Heads of Agreement to be non-binding, the language throughout the document must support this, and your conduct afterward must reflect it.
If you're negotiating a retail lease, the Retail Leases Act 1994 (NSW) creates additional complexity. Under this legislation, even if your Heads of Agreement appears to be a binding lease agreement, it won't be enforceable against a tenant until the tenant has received a Lessor's Disclosure Statement in the required form.
This disclosure statement must be provided before the tenant enters the lease or any agreement to enter the lease. It contains essential information about outgoings, trading hours, refurbishment obligations, and other material lease terms. This statutory requirement means retail landlords can't lock tenants into binding commitments through preliminary agreements without proper disclosure.
However, this protection only applies to retail leases as defined in the Act. Commercial office leases, industrial leases, and other commercial tenancies don't have the same safeguard. In those situations, a binding Heads of Agreement remains enforceable.
A properly structured Heads of Agreement serves your commercial objectives while avoiding unintended legal consequences. Here's what needs to be clear.
Identification of parties: Full legal names and registration details for companies, including ACN/ABN where relevant.
Description of the transaction: Clear statement of what's being negotiated - business sale, lease arrangement, partnership formation, property purchase.
Key commercial terms: The material terms you've agreed, such as price, payment terms, timing, conditions precedent, key responsibilities. The level of detail depends on whether you want this binding.
Binding status statement: Explicit language about whether the document creates legal obligations. For example: "This Heads of Agreement is not legally binding except for clauses 8, 9 and 10 which are immediately binding on the parties."
Next steps and timeline: Clear description of what happens next, including who prepares formal contracts, timeframes for due diligence, and target dates for completion.
You can make certain clauses binding while keeping others non-binding. This is common for:
Confidentiality obligations: Protecting commercially sensitive information disclosed during negotiations.
Exclusivity periods: Preventing one party from negotiating with competitors for a specified period.
Cost arrangements: Clarifying who pays for due diligence, legal costs, or other transaction expenses.
Good faith negotiation: Requiring parties to negotiate final contracts in good faith.
These selectively binding provisions should be clearly identified and separated from non-binding commercial terms. This structure gives you protection on critical matters while preserving flexibility on substantive deal terms.
Ambiguous language: Phrases like "we agree to agree" or "the parties will negotiate in good faith" without clear next steps create uncertainty. If commercial terms aren't finalised, say so explicitly.
Mixing intentions: Don't describe commercial terms as "agreed and binding" in one clause then include "subject to contract" language elsewhere. The inconsistency creates risk of dispute.
Vague conditions: If the document is conditional on future events, describe those conditions clearly. "Subject to satisfactory due diligence" is vague. "Subject to purchaser's accountant confirming turnover figures exceed $500,000 for the previous financial year" is clear.
Consider a business sale scenario I've encountered regularly in practice. A buyer and seller negotiate the purchase of a cafe business. They agree on price ($350,000), settlement date (60 days), and key terms like stock at valuation and equipment included. They document this in a Heads of Agreement that states "the parties agree to the following terms" but also includes a clause saying "this agreement is subject to preparation of formal sale contract."
If the buyer proceeds with due diligence, the seller removes the business from the market, and the buyer's lawyer prepares a contract reflecting the agreed terms, have the parties created a binding agreement? The answer depends on whether those terms are sufficiently complete to constitute a workable contract. Price, subject matter, and timing are clear. If other essential terms are also settled, a court might find the agreement binding despite the "subject to contract" language, particularly if both parties behaved as though it was finalised.
Now consider an alternative scenario where the same parties create a Heads of Agreement that explicitly states: "This document records terms agreed in principle. It is not legally binding. The parties will negotiate a formal contract, and neither party is committed unless and until both sign that formal contract." This language, combined with conduct that treats terms as preliminary (continuing to negotiate details, not removing the business from market, acknowledging that terms may change), supports non-binding intent.
The difference between these scenarios is clarity of drafting and consistency between language and conduct.
Before signing any Heads of Agreement:
Red flags that need immediate attention:
When to seek professional guidance:
Getting your Heads of Agreement right from the start protects your negotiating position and prevents costly disputes about what you actually agreed to.
I work with business owners to prepare Heads of Agreement that accurately reflect their commercial understanding while preserving the flexibility they need. Whether you're navigating a business sale, commercial lease, partnership formation, or property transaction, let's ensure your preliminary agreements support your objectives without creating unintended obligations.
Contact Jackie Atchison at LexAlia Property & Commercial Law to discuss how we can structure your Heads of Agreement to match your transaction needs.
"Subject to contract" language supports non-binding intent but doesn't guarantee it. Courts look at the document as a whole, including whether all essential terms are agreed, how the parties described their obligations, and how they behaved afterward. For strongest protection, combine this language with explicit statements that the document isn't binding.
Yes, and this is common practice. You can specify that certain provisions - typically confidentiality, exclusivity, good faith negotiation, and cost-sharing arrangements - are immediately binding, while commercial terms remain non-binding until formal contracts are signed. The key is clearly identifying which clauses are binding.
This creates a dispute that may require court determination. Courts will examine the language used, whether essential terms are complete, evidence of parties' intentions, and how you both behaved after signing. This uncertainty is costly and time-consuming, which is why clear drafting matters.
It depends on the complexity of your transaction and the consequences of getting it wrong. For significant transactions, complex commercial arrangements, or situations where you need certain obligations to be binding, legal guidance ensures your document matches your intentions. The cost of proper drafting is typically far less than the cost of later disputes.
Retail leases in NSW have special protections under the Retail Leases Act 1994. Even if a Heads of Agreement appears to create a binding lease, it won't be enforceable against a tenant unless the tenant has received a properly completed Lessor's Disclosure Statement before entering the agreement.
Use a non-binding Heads of Agreement when you want to preserve flexibility to negotiate and conduct due diligence before committing. Use a binding Heads of Agreement when you've finalised all essential terms and both parties want certainty. Some transactions use partially binding agreements where time-sensitive matters need immediate commitment while commercial terms remain flexible.
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