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Commercial Question

Going Head to Head

updated on 26 February 2008


Lawyers and negotiating heads: burden or benefit?


In large and complex corporate transactions such as company mergers and acquisitions, heads of terms are often a standard piece of equipment. Although there is no set form, heads of terms, also known as letters of intent or memoranda of understanding, will normally be a short document outlining the essential terms and conditions of a deal, made prior to embarking on any detailed due diligence and drafting of documents. They aim to be a road map to assist in helping parties getting to grips with the deal structure, and to isolate key elements and requirements at an early stage.

The process of negotiating heads often gives rise to criticism, particularly from businesses and investors looking for quick progress. As heads of terms are not intended to force parties into legally reaching an agreement, it is often suggested that they can be an unnecessary burden and time delay purely assisting to increase costs. There are also claims that negotiating heads can lead parties to having heated arguments on the finer points of a deal prematurely and on issues that may ultimately prove redundant.

While there is some validity in many of these claims, there are still considerable advantages to having agreed heads. Traditionally, lawyers have not always figured prominently at the early stages of a deal where heads are negotiated. There is also perhaps a common business assumption that given the general and sometimes informal arrangement adopted by heads of terms, lawyers are not essential until finalizing the deal becomes a realistic prospect. However, it can also be a time where important terms and concessions are made or agreed and the benefit of a lawyer's insight and assistance should not be taken for granted. What are some of the ways lawyers can contribute to negotiating effective heads of terms and the success of a deal?

Law firms assisting to produce clear and well defined heads can help mitigate the chances of encountering any unexpected 'deal frustrators' or assist in airing potentially contentious issues at the outset.

Although heads of terms will normally not be legally binding in the United Kingdom, they are still likely to contain legally binding agreements within them such as exclusivity and confidentiality provisions. Extra caution is also required when negotiating on some international transactions where the legal status and enforcement of heads of terms can be considerably different, particularly in some EU jurisdictions. In any event, regardless of whether it is going to be binding on a party, any provisions agreed to unnecessarily or recklessly will still carry a kind of 'moral commitment' between parties. From a business and commercial perspective, these may be difficult to back down from or re-negotiate at a later stage. Appropriate advice and assessment from lawyers is therefore essential even at the outset of potential deals.

Exclusivity and lock-outs often form part of heads of terms and will provide some breathing room for deals to be completed without having to worry constantly about other competitors moving in with rival bids. Taking into account the forever increasing level of detail and cost of due diligence undertaken by potential investors, ensuring that exclusivity is given sufficient consideration can be fundamental. It is easy for businesses to underestimate the amount of time needed to fulfill all the necessary legal and other requirements for completion. Problems can arise where exclusivity periods lapse prematurely forcing purchasers to wrap up matters hastily on less favourable terms. These risks can be alleviated by having lawyers ensure that adequate protection and safeguards have been adopted, such as options to extend the exclusivity period or for failure costs to be covered.

Failure costs will sometimes be provided for as compensation to ward against parties pulling out prematurely or changing the stakes significantly further down the line. They also act as a general deal completion incentive. The difficulty, however, often lies in effectively defining and providing for the circumstances where such contributions and fault for failure would lie, and this is where the detailed drafting of lawyers can be fundamental.

Another important matter for consideration is likely to be the stance on key conditions and warranties such as providing for keyman insurance, which is particularly important with smaller private companies where the prospects of the business can be heavily dependant on the roles of certain individuals. Valuation is also a notoriously difficult and risky affair in the private company arena and it is sensible to obtain some well devised legal assurances in relation to the business plan and due diligence enquiries.

A law firm's contribution can be crucial when negotiating heads by uncovering and isolating any potentially critical issues, and seeking appropriate resolutions early on. Producing a clear plan, getting any contentious issues aired and identifying what can sensibly be left until later can be an invaluable aspect of negotiating effective heads. When done in a commercially practical manner, well advised heads should help keep all parties on track.

Amerigo Holthouse is a trainee solicitor in Weightmans' corporate team.