Heads of Agreement – when are they binding?

A recent judgment in New South Wales has clarified that a Heads of Agreement is generally considered binding if, at the time of entering into the agreement, the parties intended to be immediately bound by it.  This holds true even if the parties intended, and the Heads of Agreement between the parties records, that additional matters are to be agreed and a formal contract executed at a later time.  Further, any dispute about the subject matter of a Heads of Agreement will not affect the binding nature of that agreement.

The case highlights that parties contracting on a preliminary basis should take great care when considering the use of a Heads of Agreement.

Background

In Lahodiuk v Pace [2013] NSWSC 512, Justice Sackar of the New South Wales Supreme Court held that a document styled ‘Heads of Agreement’ entered into between two parties following a mediation was binding – even though a dispute subsequently arose between the parties prior to entry into a more formal contract, as contemplated by the Heads of Agreement. 

The parties entered into the Heads of Agreement following mediation in October 2012 ‘in complete settlement’ of proceedings commenced by Michael Lahodiuk against the Defendants (Vincent Pace and Prid Pty Ltd).  The Heads of Agreement provided that Mr Lahodiuk would purchase Prid Pty Ltd’s interest in a business known as Straightline Auto Repairs and certain equipment used in that business.  The Heads of Agreement contemplated the preparation of additional documentation and the parties’ legal representatives exchanged correspondence about that documentation.

In December 2012, Mr Lahodiuk expressed reluctance to settle, citing concerns with the poor condition of the business and equipment, and offered to settle for a lesser sum than that set out in the Heads of Agreement.  The Defendants applied to the court seeking specific performance of the Heads of Agreement.

In determining whether the parties were bound by the Heads of Agreement, Justice Sackar considered:

• the parties’ intention at the time was the overriding issue, to be determined objectively, having regard to the language of the Heads of Agreement
• if the parties intended to be bound immediately, the Heads of Agreement was binding, even though further documentation was to be prepared
• that the Heads of Agreement must be read in light of the surrounding circumstances including the history and commercial context of the agreement and that the parties were involved in mediation to resolve litigation
• what a reasonable person in the parties’ position would have understood the agreement to mean, and
• it was relevant that the heads of agreement was drafted under the supervision of legal practitioners for both sides, after lengthy negotiation and consideration.

His Honour acknowledged the dispute between the parties on state of the business and its equipment but found this was a separate issue and had no impact on whether the Heads of Agreement was binding.  He also noted that Mr Lahodiuk could have managed this issue by conducting appropriate due diligence or inserting an appropriate clause in the preliminary agreement. 

Implications

The true nature of such an agreement, and whether it is, or is not, intended to constitute a concluded contract, is critical.  The magnitude, subject matter or complexities of the transaction are considerations which should ultimately determine whether the parties record their preliminary agreement by way of Heads of Agreement, or rather, in a formal contract. 

Even if the Heads of Agreement is intended to be binding, the agreement should allow the parties time to complete due diligence and re-negotiate if necessary.  The latter course may ultimately save the parties from expensive and acrimonious court proceedings. 

Suzie Emery, Guy Humble