Following a successful mediation, parties usually prepare a formal agreement to record what was agreed.  In some situations, the parties may initially prepare a less formal document, sometimes called a ‘heads of agreement’.  Whether a heads of agreement is enforceable depends on whether the parties intended to be legally bound by its terms.  An important factor in ascertaining the parties’ intentions will be how precisely the terms are drafted and whether the agreement contains any wording suggesting that the terms are merely agreed ‘in principle’.

A recent Australian case in the Supreme Court of New South Wales is a timely reminder that, before leaving a mediation, parties should ensure that the drafting of any heads of agreement accurately reflects their intentions as to whether they will be immediately legally bound by its terms. 

In Boardman v Boardman[1], a heads of agreement was signed by the parties and their solicitors at the conclusion of a court-ordered mediation. The heads of agreement stated that the parties would later sign a consent order for the court to record the settlement in greater detail but without material variation. The consent orders were to replace the heads of agreement. The plaintiff subsequently prevaricated signing the consent orders and disputed whether he had agreed to the resolution reached during the mediation.

The defendant brought a motion to enforce the heads of agreement. The plaintiff argued that he had never intended to sign the consent orders and that that the heads of agreement was merely an “agreement in principle” because it required the parties to agree to consent orders that would require approval from the Court.

Despite acknowledging that the plaintiff may genuinely have signed the heads of agreement with a mental reservation or subjective intention that he would not sign the consent orders, the NSW Supreme Court held that he was prevented from characterising the heads of agreement as a mere “agreement in principle” because it did not contain those identifying words and because clause 2 of the heads of agreement in fact stated that the parties intended to be immediately bound by its terms. In those circumstances, the Court held that the heads of agreement was enforceable, given that the plaintiff had freely and voluntarily executed the heads of agreement in the context of a formal mediation at which he and the defendant were both represented by lawyers.

Interestingly, the fact that the heads of agreement was subject to the approval of the Court did not mean that the agreement was not a contract and not enforceable.  On the contrary, the parties may instead be regarded as havinghad a further contractual obligation to apply for the court’s approval[2].

The leading Australian authority on the enforceability of heads of agreement is Masters v Cameron[3] where the High Court of Australia identified the following possible outcomes of a negotiated agreement:

  1. The parties reach finality in arranging all the terms of their bargain and intend to be immediately bound to the performance of those terms, but at the same time propose to have the terms restated in a form which will be fuller or more precise but not different in effect.
  2. The parties completely agree upon all the terms of their bargain and intend no departure from or addition to their agreed terms, express or implied, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document.
  3. The parties do not intend to make a concluded bargain at all.

The High Court concluded that, in the case of the first two, there is a binding contract, but cases in the third class are not intended to have, and therefore do not have, any binding effect of their own.[4]

The case of Cacace v Bayside Operations (Cacace)[5]highlights that courts will defer to both the explicit terms of a heads of agreement and to other evidence of the parties’ intentions.  The Supreme Court of NSW held that a heads of agreement was not binding because some clauses were drafted such that they would not commence until “the date of exchange”. The Court also took into account a conversation that occurred between the parties whilst drafting the heads of agreement which included the statement “[l]et’s prepare a handwritten minute of what has been agreed in principle to form the basis of a formal deed which can be prepared and finalised over the next week”.

The judge observed that “although no general rule can be stated about the phrase ‘agreed in principle’, I think it can be said that it is a phrase often used by lawyers to indicate that, although consensus on a matter has apparently been reached, there is not yet a final agreement”. Simply characterising a heads of agreement as an agreement “in principle” will therefore usually capture the parties’ intentions that they do not intend to be legally bound by its terms.

In the recent New South Wales Court of Appeal case of Malago Pty Ltd v AW Ellis Engineering Pty Ltd[6], the parties entered into a heads of agreement but subsequently attempted to agree to a more formal document. Those negotiations fell apart and the respondents sought a declaration that a binding agreement existed, requesting specific performance and seeking damages. The primary judge, with whom the Court of Appeal agreed, considered that the following words in the heads of agreement revealed that the parties intended to be bound by its terms: “Without affecting the binding nature of these heads of agreement, the parties within seven days [must] execute a formal document or documents as agreed between their respective solicitors to carry out and express in more formal terms and additional terms as these heads of agreement.” Because the parties did not use the phrase “in principle” in the agreement, the parties were bound immediately by its terms.

If a client is contemplating entering a heads of agreement following a mediation, lawyers would be wise to advise them to use very precise language and to be explicit in documenting their intentions as to whether the agreement is made only “in principle” or whether they intend that the terms of the heads of agreement be immediately binding.