WHY PRODUCE HEADS OF TERMS?
Heads of terms give the parties to a transaction the opportunity to get all the important points agreed before any expense is incurred on solicitors. They should provide an outline of all the main commercial issues, covering everything that is essential to the deal or specific to the property. As solicitors, we base the first draft of our documents on the information provided in the heads of terms. The more complete they are, the more quickly we will be able to draft and finalise the deal and the lower our costs will be.
THE STATUS OF HEADS OF TERMS
Heads of terms are not meant to form a legally binding contract: they simply set out the basis on which the parties intend to enter into the deal. To ensure that you don’t inadvertently enter into a contract, you should expressly state that the document is “subject to contract”. Whilst this wording is not conclusive proof that no contract has been created, it does amount to extremely persuasive evidence. The words “without prejudice” are meaningless at the top of heads of terms and should not be used.
Even though properly prepared heads of terms are not legally binding, and neither party can sue on them, they do have a certain amount of moral force. A party which attempts to change its position once heads of terms have been agreed and whilst the documentation is being negotiated will find itself in a weak negotiating position. It is therefore important to make sure that all your requirements are included within the final heads of terms.
You will often see a statement that the heads of terms are confidential to the parties and their advisors. Whilst this has moral force it will probably not be legally binding when it is included in the heads of terms in the absence of any express wording to the contrary. If you do want to make a confidentiality requirement (or any other arrangement, such as exclusivity) legally binding it is preferable to deal with this in a separate, binding, document rather than trying to make some parts of the heads of terms binding.
WHAT SHOULD THE TERMS COVER?
This will be different for every type of transaction, but from a property perspective the ones we see most often, and which most often have gaps in them, are heads of terms for leases. Here are some of the key points to think about:
- Who are the parties? Provide full names and, where possible, company numbers. Check you’ve got the correct group company and that the landlord is in fact the owner of the property. Make sure the landlord is happy with the proposed tenant and any proposed guarantors. Where relevant, find out who the superior landlord is. If you are aware that any of the parties aren’t based in the UK, tell us this. If required, make it clear that the heads of terms are subject to the approval of the board of the relevant company.
- What is the property? If possible, provide a plan at this stage. If the lease will be registrable, try and get a plan that complies with the Land Registry requirements as it will save time later. Make it clear whether the lease will be of the whole or only a part of the building; if it’s of part only, be clear about what’s included and what’s not. Think about any other rights that the tenant might need, for example to use toilets or car parking spaces. Include these on the plan if possible.
- What is the term? You should specify not only the length of the term but also when the term will start: will it be the date on which the lease is granted or some other date (such as the previous quarter day)? Where you’re taking an underlease make sure that the term is shorter than the headlease term and think about whether you want to link it to the terms of any other leases in the same building. Consider and specify whether the tenant will have security of tenure, and set out the terms of any break clauses or renewal rights.
- What will the property be used for? Think about this carefully and avoid being overly restrictive (it’s generally not in either party’s interest). Where it’s an underlease check what the headlease permits. Consider specifying use classes, but be aware that some uses fall outside of these. Agree whether changes of use will be allowed and be clear on any opening restrictions or requirements.
- How much rent is payable? If possible, specify the exact amount of the initial rent and be clear as to what this includes. Where there is a price per square foot, agree how this will be measured. Note whether VAT will be charged on the rent (and whether the tenant requires a commitment not to charge VAT). Give details of any rent-free periods and reverse premiums. Agree whether any rent deposit or bank guarantee is required.
- Is the rent subject to review? If so, on what basis (open market, RPI increases, turnover rent), how often will reviews occur and are there any unusual assumptions and disregards?
- Can the tenant deal with the lease? Is assignment permitted (of whole or part) and is the landlord’s consent required? If so, will an AGA be required on assignment? Specify whether underletting is permitted, and any requirements as to underletting rent. Make it clear whether there is anyone that the tenant can share occupation with (eg group companies).
- What alterations can the tenant make? Divide this up between external and internal, structural and non-structural. Can the tenant put up signs? If so, how many, how big and where? Must the tenant reinstate at the end of the term? Specify whether any fit-out works are needed and, if so, who will carry them out and who will pay for them.
- Is there a service charge payable? Give details of how this will be calculated (fixed amount or fair proportion?) and specify any unusual services that will be included.
- Who will insure the property? Specify whether the landlord or tenant will be responsible for this. Think about whether terrorism insurance will be included. Agree whether rent will be suspended in the event of damage/destruction and whether this will be insured against. Will the tenant have a right to terminate if the property is not reinstated? If so, in what circumstances?
- Who is responsible for repairs? Will this lie wholly with one or other party or will responsibility be divided? Who will be responsible for repairs where damage is caused by an uninsured risk? Consider a photographic schedule of condition to avoid arguments later. If it’s important to either party, specify how often the property will need to be redecorated.
- Is it an underlease? If so, check it’s permitted by the headlease and think about obtaining superior landlord’s consent at this stage. Agree who will be responsible for the superior landlord’s costs.
- Is any other information required from either party? Does the landlord want to see financial information about the tenant and his guarantor? When does this need to be supplied? What will the landlord be providing (eg EPC, service charge history, insurance)?
Where you are involved in a lot of transactions on very similar terms it will save a lot of time and effort if you come up with a set of precedent terms which contain all the usual provisions that you require, and remind you of the transaction specific things that you need to think about every time. It is, of course, possible to just use and adapt heads of terms from a previous transaction but this creates a risk that you will leave out something that is significant to the current transaction but was not relevant to the previous one.
Whilst solicitors will generally not be involved in preparing the heads of terms for transactions, it is advisable to get your solicitor involved in drafting precedent terms as they will be able to make sure that you cover all the points which may be relevant.