Are they legally binding?
For a document to be legally binding in English law it must be sufficiently ‘certain’ (ie clearly set out the key intentions of the parties, eg the object of the transaction, price, term etc), and it must not merely be an "agreement to agree".
Heads of agreement would not normally be legally binding as they would usually not be sufficiently "certain". This is because in general a heads of agreement will not set out in full all the terms of the transaction, will state items that require further discussion and will not contain sufficient agreement or precise terms to be considered certain. However, it should be borne in mind that a document which contains extensive detail as to a transaction and its terms may (at least in the absence of specific provisions stating its non legally binding status) constitute a legally binding agreement.
There are also circumstances where an agreement to agree can be enforceable, at least in so far as requiring the parties to it to use their best endeavours to come to an agreement (although they would not actually be required to enter into a specific agreement).
Therefore, in order to reduce the possibility of a heads of agreement being held to be binding, it should clearly state that it is subject to contract and include a clause which states that it is not intended to be legally binding.
In rare cases the courts have found Heads of Terms to be legally binding. In order to mitigate the risk of binding agreements arising out of pre-contractual negotiations, the parties are advised to ensure that (a) the Heads of Terms do not include the final or material terms, but contain a clear statement that the parties do not intend to be legally bound (except where expressly provided) and (b) neither party says or does anything during the course of negotiations that could be construed as demonstrating an intention to create legal relations eg performance of their obligations prior to execution of the full agreement.
Where heads of agreement contain confidentiality and/or exclusivity arrangements or arrangements with respect to costs (eg break fees), it is usual to state that only these particular clauses (and any governing law/jurisdiction clause) are intended to be legally binding.
Impact on third party rights
Heads of agreement may in some instances provide a useful statement to third parties of the key terms of the proposed deal. If the terms of the heads of agreement are certain and held to be legally binding, then under the Contracts (Rights of Third Parties) Act 1999, if a term expressly provides that a third party has the right to enforce the term, or if such term purports to confer a benefit on a third party, then the third party may have a right to enforce the term.
If the parties do not intent to grant a right to any third parties, then they should expressly exclude this Act.
What are the consequences of breach?
In the event that a party breaches the terms of a legally binding heads of agreement, the other party may be entitled to damages to compensate him, provided he can show loss caused by the breach, in the same way as for any other breach of contract.
Can heads of agreement have any tax implications?
Heads of agreement serve a valuable purpose of setting out the commercial reasons for the transaction, especially those that are tax driven. This might assist the parties in avoiding any potential tax avoidance challenges.
The signing of heads of agreement may sometimes be considered as amounting to an "arrangement" for the disposal of the target company under the UK tax laws. This would prevent the seller from taking advantage of relieving the tax losses by surrendering such losses to or from the seller’s group companies.