Is your Heads of Agreement certain enough to be enforceable?

A Heads of Agreement (also known as a Memorandum of Understanding (MOU) or Letter of Intent (LOI)) is a document outlining the proposed agreement between the parties to it. There are a number of commercial situations where a Heads of Agreement will be commonly prepared between the parties – for example:

• between landlord and tenant to outline the negotiated terms of the lease, pending the lease documents being prepared; and
• between vendor and purchaser to outline the price and other key terms for the sale of a business, pending the contract for sale of business being prepared.

A crucial consideration for the parties is whether the Heads of Agreement is binding on the parties – will there be consequences for a party to a Heads of Agreement if that party decides not to proceed with the proposed transaction? Or, as recently considered by the Supreme Court, is the Heads of Agreement certain enough to be legally binding and therefore enforceable?

In the matter of Leslie Muir Holdings Pty Limited [2019] NSWSC 1519 (5 November 2019)

The Supreme Court in this instance dealt with issues arising from a Heads of Agreement (“HOA”) signed by the parties at a mediation in May 2018.

The parties had been in dispute since 2017, when the plaintiff sought, amongst other things, a declaration that the family company, LMH, was being conducted in a manner that:

• was contrary to the interests of its members as a whole, or
• was oppressive to or unfairly prejudicial to or unfairly discriminatory against the plaintiff,

and orders for her shares in the company to be purchased, or alternatively, for the winding up of the company.

The terms of the Heads of Agreement

The HOA was signed at a subsequent mediation between the parties, which was held on the basis that:

                “any in-principal agreement reached in the mediation will likely be subject to the parties receiving structuring and taxation advice before the agreement can be finalised.”

The HOA provided for various matters, including the sale of the plaintiff’s shares, and also provided that within 6 weeks of the HOA, the parties would jointly seek tax and structuring advice and, “having regard to that advice, a deed of settlement is to be executed”.

The defendants’ position

The defendants in the case sought to establish that the HOA did not give rise to an enforceable contract, and sought consequential orders and directions to give effect to restitution in respect of any payment made in part performance of the HOA.

Restitution is the law of gain-based recovery – in this instance, it was sought that any payments made be refunded.

Alternatively, they sought declarations as to the terms of the contract, if the HOA gave rise to an enforceable contract, and sought a declaration that, inter alia, it was an implied term of the HOA that the plaintiff would cause any shareholder loan associated with her interest in the company to be assigned to the other shareholder.

The Court’s view of the HOA

Noting the difficulties encountered by the parties in obtaining the tax and structuring advice, including a dispute as to whether the negotiated amounts were pre- or post-tax, the Court noted that:

                “… a substantial difficulty with the [HOA] is that it provides no criteria or mechanism for determining how such difficulties are to be addressed, if they are identified and consensus is not reached between the parties as to how they are to be resolved.”

The Court concluded that whilst a binding agreement was formed by the parties, that agreement was so uncertain, in essential respects, that it is not enforceable. Reference was made to the renowned case of Masters v Cameron [1954] HCA 72 where the High Court identified three categories of case which may exist where parties which have been in negotiation reach agreement upon terms of a contractual nature:

1. where the parties have reached finality and intend to be immediately bound to the performance of the relevant terms, but propose to have the terms restated in a form which will be fuller or more precise, but not different in effect;
2. where the parties have reached complete agreement, but nevertheless have made performance of one or more of the terms conditional upon the execution of a formal document;
3. where the intention of the parties is not to make a concluded bargain unless and until they execute a formal contract.

The Court stated:

“Whether a contract has been formed depends on the objective intention of the parties ascertained from the terms of the relevant document, read in light of the surrounding circumstances, and, if the terms of that document indicate that the parties intended to be bound immediately, then effect must be given to that intention irrespective of the subject matter, magnitude or complexity of the transaction.”

The Court then referred to a number of other judgments in which the binding nature of such agreements has been considered.  In light of this, the plaintiff suggested that the parties fell within the first category of the MvC categories, and that the defendants would need to establish that the intention of the parties, objective ascertained, was not to be immediately bound by the HOA and for there to be no concluded bargain unless and until the Deed of Settlement was executed.

The Court concluded that the HOA was a binding agreement, which contemplated that further documents would be executed and also required the parties to “have regard” to the joint advice of the accountants in executing the further documents contemplated by the agreement.  The HOA in itself did not establish any obligation to transfer property, other than by the mechanism provided in it.

The Court again referred to numerous judgments dealing with the issue of uncertainty in contracts, noting that:

                “A contractual provision will not be void for uncertainty merely because its language may admit more than one possible meaning or because, when construed, the application of the provision may produce more than one result, unless the Court is unable to attribute to the parties any particular contractual intention or to determine its meaning upon the proper application of the principles of construction.”

                “The Court will endeavour to give effect to a contract reached between businesspeople, even if its terms are not fully or well stated, although whether the parties have expressed their agreement carefully is a matter relevant to whether they have entered into an agreement, and the Court should seek to put a fair meaning on a contractual provision unless it is impossible to do so.”

                “The omission of a term of a contract will also not render the contract incomplete and uncertain, and therefore void, unless the term is essential.”

The Court noted that certain clauses in the HOA were too uncertain to be unenforceable, particularly considering that they provided no criteria by which the parties would give effect to the tax and structuring advice after they had “regard to” it.  It noted that the proposed sale of the plaintiff’s interest in the company was less advantageous than, for example, a winding up of the company.  The Court suggested that, for example:

• the HOA should have included the basis to determine what should be included in the deed of settlement in addressing the parties’ potentially different interests as to the structure of the transaction once such an advantage or disadvantage was identified by that advice; and
• the HOA should have included criteria to determine the content of the transaction documents if a dispute arose between the parties, as it did;

The Court responded to the orders sought by the plaintiff, and noted:

• the Court could not order specific performance of the HOA because it is too uncertain to be enforceable;
• the Court could not order specific performance, despite the uncertainty, because its terms do not provide any basis upon which the general provisions of the HOA could be translated into the specific provisions of the particular agreements for which the plaintiff contends, nor those that the defendants contend;
• the Court could not order for advice to be obtained from the tax/structuring experts where there is no evidence that those experts would be prepared to give such advice and numerous discretionary judgments would need to be made in determining the instructions to be given to them.

The Court held that the HOA was not enforceable, and will be considering the other requested orders at a later date.

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It is recommended that if you are proposing to enter into a Heads of Agreement, you obtain legal advice before signing anything – this is to ensure not only that the Heads of Agreement reflects the negotiated terms, but also that the binding (or non-binding) nature of the Heads of Agreement is identified and clarified.