Heads of Terms — English Law Drafting Reference

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Drafting reference for English-law heads of terms — subject to contract, RTS Flexible Systems v Muller, binding vs non-binding, M&A and VC term sheets.

Heads of terms — sometimes called a “letter of intent”, “memorandum of understanding”, “term sheet”, or “heads of agreement” — is a pre-contractual document setting out the commercial principles of a contemplated transaction. The principal function is to record what the parties have agreed in principle so that the formal definitive documentation can be negotiated against a stable baseline. The legal challenge is to ensure the document operates as a non-binding statement of commercial intent on most matters while binding on a few specific provisions (typically confidentiality, exclusivity, costs allocation, and dispute resolution). This page is the English-law drafting reference for the contract type. Cross-reference English contract law basics for the underlying formation principles, standard clauses for the boilerplate, and NDA for the confidentiality detail that typically accompanies heads of terms.

Function

Heads of terms perform several practical functions:

  • Commercial alignment — confirm that the parties agree on price, structure, and key commercial terms before incurring the cost of full diligence and definitive documentation.
  • Process management — set out the timetable, exclusivity period, and conditions to closing.
  • Allocation of due-diligence access — give the prospective buyer/investor access to confidential information under a defined regime.
  • Risk allocation — set out who bears specified costs (legal, professional, transaction).
  • Internal approval support — provide the document the parties’ boards and investment committees will review when authorising the transaction.

The danger is that, despite the parties’ intention to keep most provisions non-binding, the courts may find that the document is in substance a binding contract — particularly where the parties have begun to perform.

Binding vs. non-binding — RTS Flexible Systems v Müller

The leading authority on the binding/non-binding analysis is RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH & Co KG [2010] UKSC 14 (Lord Clarke). The case concerned a letter of intent under which RTS was to design, manufacture, and install machinery for Müller; the letter said expressly that no contract would arise until execution of formal documentation. RTS performed under the letter and Müller paid; the formal contract was never signed. The Supreme Court held that the parties had reached agreement on essentials, that the “subject to contract” reservation had been displaced by conduct, and that a binding contract had been formed on the agreed terms.

The drafting consequence is direct: the words “subject to contract” or “not legally binding” are not magic — they are an indication of intention that can be displaced by subsequent conduct showing the parties intended to be bound. If the parties begin to perform before formal documentation is signed, a court may infer binding agreement on the terms agreed and to which both have committed.

A second relevant authority is Walford v Miles [1992] 2 AC 128 (HL) — Lord Ackner: a bare agreement to negotiate, or to negotiate in good faith, is unenforceable in English law for want of certainty. The position is different from many civil-law jurisdictions and from US law. The implication for heads of terms is that a clause obliging the parties to “negotiate in good faith to reach a definitive agreement” is, on this authority, of no legal effect — though it has reputational and process value.

A third authority is Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust [2013] EWCA Civ 200 (CA) — express good-faith obligations are enforceable on their terms, but their scope is construed by reference to the contract as a whole; they do not generally override express terms.

Express disclaimer and “Subject to Contract”

The drafting answer is an explicit disclaimer and the use of the “Subject to Contract” header on the document. Best practice:

Non-Binding Nature. Save for the provisions of clauses [X to Y] which the Parties intend to be legally binding, this document records the commercial principles of the proposed Transaction and is not intended to create legal relations between the Parties. No binding contract shall arise between the Parties unless and until they execute formal definitive documentation in respect of the Transaction.

The document should be marked “Subject to Contract” at the head of every page. Subsequent correspondence regarding the transaction should be similarly marked. Performance under the document should be avoided until formal documentation is signed.

Binding carve-outs

A small number of provisions typically are binding. They should be flagged explicitly. The common candidates:

  • Confidentiality — usually backed by a separate NDA (see NDA); if not, included in the heads as a binding obligation.
  • Exclusivity / lock-out — see below.
  • Costs allocation — typically each party bears own legal costs unless transaction completes.
  • Term and termination — binding terms specifying the document’s effective period.
  • Confidentiality of the heads themselves — neither party may disclose the heads’ existence or contents (subject to standard regulatory carve-outs).
  • Governing law and jurisdiction — binding choice for any disputes about the binding provisions.

Exclusivity / lock-out

An exclusivity (or “lock-out”) clause provides that for a defined period the seller / target / company will not negotiate with, solicit, or accept offers from any third party in respect of the contemplated transaction. The clause is binding (often the only commercially substantive binding clause).

The leading authority is Pitt v PHH Asset Management Ltd [1994] 1 WLR 327 (CA) (Sir Thomas Bingham MR) — confirmed that a lock-out agreement (i.e. a negative obligation not to negotiate with anyone else for a specified period) is enforceable in English law. By contrast, a positive obligation to negotiate with the counterparty is unenforceable under Walford v Miles.

The drafting elements of a robust exclusivity clause:

  • Duration — typically 30–90 days; longer in major M&A diligence.
  • Scope — what is restricted (negotiation, solicitation, acceptance, marketing, providing information).
  • Carve-outs — fiduciary “fiduciary out” for directors of public targets; unsolicited approaches that the directors are obliged to consider.
  • Break fee — typically a fixed sum payable on breach or where the seller withdraws.

The break fee is conceptually distinct from a penalty: it is a liquidated payment on breach, subject to the Cavendish/ParkingEye legitimate-interest test (see standard-clauses liquidated damages).

M&A heads — structure and elements

In M&A practice, the heads of terms typically cover:

  • Parties — buyer, seller, target.
  • Transaction structure — asset purchase vs. share purchase vs. scheme of arrangement (Companies Act 2006 Pt 26 / Pt 26A); see asset purchase agreement.
  • Price — enterprise value, equity value, completion mechanism (locked-box vs. completion accounts), price-adjustment mechanisms, escrow.
  • Consideration mix — cash, paper (shares), earn-out, deferred.
  • Conditions to completion — regulatory clearances (CMA merger control; National Security and Investment Act 2021 review where in scope; sector-specific), shareholder approvals (CA 2006), key contract consents.
  • Due-diligence access — scope; cost-sharing; data-room timetable.
  • Exclusivity — duration; break fee.
  • Confidentiality — separate NDA or binding clause.
  • Completion timetable — target signing/completion dates.
  • Restrictive covenants — vendor non-compete, non-solicit (subject to reasonableness test).
  • Employee matters — TUPE 2006 implications; key-employee retention.
  • Costs — typically borne by each party.
  • Governing law and jurisdiction.

For private-company share sales, drag-along, tag-along, and ROFR principles in the existing shareholders’ agreement should be flagged and addressed where they affect deal feasibility (separate treatment in the shareholders’ agreement).

VC term sheets

In venture capital practice, the heads of terms are typically styled a “term sheet”. The structure is conventional:

  • Pre-money valuation and post-money valuation.
  • Investment amount and tranches.
  • Option pool — typically created pre-investment, diluting founders (e.g. 10–15 % of post-money cap table).
  • Class of shares — preference shares with liquidation preference.
  • Liquidation preference — typically 1x non-participating (preference, no double-dip); 1x participating with cap is more investor-favourable.
  • Anti-dilution — broad-based weighted average is market standard; full ratchet is unusual and investor-favourable.
  • Pre-emption — on issue of new shares; sometimes on transfer.
  • Drag-along — typically triggered by holders of 50–75 % of fully diluted equity.
  • Tag-along — on sale of founder shares above a threshold.
  • Board composition — investor director rights.
  • Information rights — quarterly/monthly reporting; budget approval.
  • Reserved matters — investor consent for major decisions (issue of shares, acquisitions/disposals, indebtedness, key hires, executive remuneration).
  • Founder vesting — typically 4-year vesting with 1-year cliff and accelerated vesting on change of control.
  • Warranties — given by the company and (sometimes) founders; capped (typically at the investment amount or a multiple of founder gross consideration); time-limited.
  • Founder good-leaver / bad-leaver — share-buyback at differential pricing on departure.
  • SEIS/EIS qualification — addressed below.
  • Investor conditions precedent — completion of diligence, board approvals, regulatory clearances, key-employee retention.

SEIS and EIS — UK angel and seed investment

The Seed Enterprise Investment Scheme (SEIS) and the Enterprise Investment Scheme (EIS) sit at Income Tax Act 2007 Parts 5 and 5A. They provide income tax and capital gains tax reliefs to qualifying individual investors in qualifying small UK companies. The reliefs are economically substantial — typically 30–50 % of the investment recoverable through income tax relief and CGT exemption on disposal — and most early-stage UK term sheets are structured to preserve SEIS/EIS qualification.

Key qualification requirements (broadly):

  • Company — UK trading company; gross assets ≤£350,000 (SEIS) / £15m (EIS) at investment; ≤25 (SEIS) / ≤250 (EIS) employees; specified ineligible trades excluded.
  • Investment limits — SEIS lifetime cap of £250,000 raised through SEIS; EIS annual £5m / lifetime £12m (with knowledge-intensive variations).
  • Shares — ordinary, fully paid-up, no preferential rights to dividends or to return of capital (preference shares may not qualify).
  • Investor — not connected with the company (≤30 % connected interest); not employed (other than as director).
  • Holding period — three years.

The “no preferential rights” requirement is the most awkward for VC term sheets — investors typically want preference shares with a liquidation preference. The structural answer is a separate EIS-eligible ordinary share for SEIS/EIS investors (often a separate class with limited preference) combined with conventional preference shares for non-relief investors.

HMRC advance assurance is the pre-clearance process. The company submits the proposed investment terms to HMRC’s Small Company Enterprise Centre; HMRC confirms whether the proposed terms would qualify. Advance assurance is not binding on HMRC but reflects HMRC’s view of the submitted facts; investors typically require advance assurance as a condition of investment.

Governing law and jurisdiction

For heads of terms, the governing-law clause is binding (it governs any dispute about the binding provisions, including exclusivity and confidentiality). The English-law election is conventional for UK transactions and is uniformly enforced. See standard-clauses governing law.

Jurisdiction: exclusive English-court jurisdiction is normal; the Hague 2005 Convention applies to exclusive jurisdiction clauses between signatory states (UK, EU, etc.).

Sample heads-of-terms structure

  1. Header — “Subject to Contract”; date; parties.
  2. Recitals — describe the contemplated transaction.
  3. Commercial principles (non-binding) — price, structure, consideration, key terms.
  4. Conditions to definitive agreement — diligence; regulatory clearances; shareholder approvals.
  5. Timetable — target signing/completion dates.
  6. Confidentiality (binding) — or cross-reference to separate NDA.
  7. Exclusivity (binding) — duration; scope; carve-outs; break fee.
  8. Costs (binding) — each party bears own.
  9. Term and termination (binding) — effective period of the heads.
  10. Non-binding status (binding declaratory) — the RTS Flexible Systems disclaimer.
  11. Governing law and jurisdiction (binding).
  12. Signature — by each party’s authorised signatory.

Bibliography

Statutes (legislation.gov.uk)

Case law (bailii.org / supremecourt.uk)

  • RTS Flexible Systems Ltd v Molkerei Alois Müller GmbH [2010] UKSC 14 (subject to contract; binding by conduct)
  • Walford v Miles [1992] 2 AC 128 (agreement to negotiate unenforceable)
  • Pitt v PHH Asset Management Ltd [1994] 1 WLR 327 (lock-out enforceable)
  • Compass Group UK and Ireland Ltd v Mid Essex Hospital Services NHS Trust [2013] EWCA Civ 200 (express good-faith obligations)

HMRC guidance

Cross-references

Disclaimer: This content is informational, not legal advice. Last verified: 2026-05-11. Always consult a solicitor admitted to practise in England and Wales for binding decisions.