Sale of Business and Heads of Agreement 18 October 2022
Introduction
To advance discussion concerning the sale or purchase of a business parties will seek to document those agreed terms. Sometimes like when someone purchases a house or a new mobile phone, the contract has been prepared and has been delivered to the purchaser by the seller for review.
When a business is being sold, often a preliminary document attempting to capture the key terms of the deal is promptly prepared and signed by the parties. This preliminary document could be called a Memorandum of Understanding, Term Sheet, Exchange of emails, Indicative Offer Letter or Heads of Agreement. For the purposes of this paper, I will reference an Heads of Agreement.
More often than not, the Heads of Agreement will confirm the parties contemplate the preparation of a long form agreement as well and often will say the parties are not bound to complete the sale of the business until the long form agreement has been prepared, agreed and signed.
Purpose
So why bother preparing a preliminary document such as an Heads of Agreement?
As a lawyer, if the client said that terms have been agreed for the sale of their business and would you please prepare a long form contract, Heads of Agreement serve as a good instructive document as to what terms have been agreed. Ideally, a client’s lawyer should be involved in the preparation or review of the Heads of Agreement as well as the long form agreement because sometimes the preliminary document may intentionally or unintentionally bind the parties.
The Heads of Agreement typically is intended to serve as a list of the key terms that are agreed between the parties.
Key terms
Typically the key terms addressed in a Heads of Agreement include:-
| Term | Comment |
|---|---|
| Parties | Clarifies who the legal entities are that are entering into the agreement and whether there are any other parties involved such as guarantors or multiple sellers or multiple purchasers |
| Definition of what is being sold | Is it a business and asset sale or a share sale or a combination of both and are any particular assets excluded from the sale. |
| Purchase price | How much is the business being sold for and on what terms? Is it all being paid in one lump sum at completion or is there deferred consideration. If there is deferred consideration, what percentage of the purchase price does that equal, how is it calculated, when does the deferred consideration get paid and what conditions are attached that must be achieved. For example, it might say that 20% of the purchase price is payable 12 months after completion provided the business achieves an agreed amount of revenue or EBITDA in those 12 months. It might go on to say if it doesn’t, the 20% is reduced and at a certain point it is lost altogether. |
| When is completion | It might confirm a completion date and it might also confirm a sunset date by which completion must occur or either party can terminate the deal. |
| Exclusive dealing | The purchaser may seek to bind the seller not to be having parallel negotiations and creating documentation with another potential purchaser during the period in which the seller is dealing with this purchaser. |
| Restraints | Who does the purchaser require to be restrained from competing with the business other than the selling entity and what are the terms of the restraint – 2 years, 5 years or more? In Melbourne, in Victoria or Australia? Is it a non-compete (likely), a non-solicit or accept work in competition from a customer (likely), not to poach staff (likely) |
| Conditions precedent | What conditions have been agreed that must be satisfied in order for the deal to be proceed? If it is an overseas purchaser, it might include that FIRB have to consent or if there is a particular licence or authorisation from a third party then the third party’s consent to the sale may be a pre-condition to completion or it may be that certain key personnel important to the business, execute an employment agreement to continuing with the business post-completion for a period of time or it might be subject to the buyer obtaining finance or the parties Board’s approving the deal. |
Are the Heads of Agreement legally binding?
Sometimes they are binding and sometimes they are not and sometimes only parts are binding.
Good Heads of Agreement deal with this issue and specifically say whether the parties intend that the Heads of Agreement should be legally binding on the parties or not.
Sometimes only part of the Heads of Agreement will be binding. An example would be that the parties intend the Heads of Agreement not to be binding and simply to be a confirmation of the terms that have been agreed thus far and subject to many things including approval by the parties’ board of directors and agreement on the long form agreement but terms like the parties keeping the discussion confidential or the purchaser not soliciting the employees of the seller are binding now.
Determining whether a Heads of Agreement is legally binding is not as simple as looking for whether it says it is or not. If it says it isn’t, then most likely it won’t be. If it says it is, it may be. If it is silent on that issue then you may need to ask the following questions:-
1. Is the language in the document suggestive that both parties intended to be legally bound?
2. Have all of the key terms of the agreement been specified and agreed?
Examples:
Stellard & Anor v North Queensland Fuel Pty Ltd [2015] QSC 119
The seller and buyer negotiated by email for the sale of a service station. The terms and price were agreed but the seller’s email contained “subject to contract” and a requirement to immediate acceptance of offer. The buyer accepted the offer. The seller then got a better offer and wanted to disregard the first agreement.
The court held in favour of the buyer confirming that the central terms were agreed and the conduct of the parties at the time suggested an intention to be bound despite the seller using the phrase “subject to contract”.
Bobbi Damcevski v Emilios Demetiou & Ors (2018)
The court had to consider whether a Heads of Agreement which was drafted during the course of a mediation but contemplated the formal execution of a deed of settlement and release was binding. The plaintiff argued that the Heads of Agreement was binding (intention to immediately be bound) the defendant argued that it was merely an agreement to agree and was not enforceable and the court found in favour of the plaintiff.
To be enforceable the parties to the Heads of Agreement:-
1. Should be clearly identified and the document should be signed by a person with due authority.
2. The terms of the Heads of Agreement should be sufficiently certain and complete.
3. All of the key terms of the agreement between the parties must be included (or be capable of being determined by reference to the Heads of Agreement).
There must be consideration given by each party to the other in order for the heads of agreement to be binding.
5. Preferably the agreement should say whether the parties intend for it to be binding or not.
Agreement to agree
Where the document contemplates that important terms are yet to be agreed then its very unlikely that the document will be legally binding. See the case of Masters v Cameron (1954)
So why have a Heads of Agreement?
As mentioned, it provides the drafter of the long form agreement with a very useful instructive document as to the terms agreed.
The party drafting the Heads of Agreement must consider what it thinks has been agreed and the party receiving it must review it and see whether it accords with its understanding of what’s agreed. At that point, there may be dispute and things may not progress further saving the parties the cost of incurring due diligence and devoting significant effort to a proposed transaction that is destined to fail.
It may also be a very useful preliminary document that one party or the other needs to share with its lender, investors, holding company or other stakeholders who can then indicate whether they are supportive of the deal before substantial time and cost is incurred.
A party may want a legally binding Heads of Agreement because they want to know the party is legally committed to proceed with the deal before it agrees to stop dealing with competitors.
So, what would be terms not dealt with in the Heads of Agreement but which would be considered not to affect the enforceability?
Some obvious clauses would not be treated as key terms:
such as whether the document can be signed electronically or via wet ink.
Whether the period for making a warranty claim is 12 months or 14 months. To be clear, if the dispute was 6 months or 4 years that might be considered a key term.
Whether a restraint area is 10 or 12 kilometres. Again, to be clear, if the dispute is between 10 kilometres and the world that might be considered a key term.
Whether a party has to procure individuals waiving moral rights.
Summary
Heads of Agreement are important and useful documents.
Once the Heads of Agreement have been executed delay should be avoided in drafting the long form agreement.
THIS PAPER IS PROVIDED FOR INFORMATION PURPOSES ONLY AND NOT TO BE RELIED UPON AS LEGAL ADVICE.