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Heads of terms and due diligence

Two very important concepts for a seller or purchaser of a business to understand are heads of terms and due diligence.

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Heads of terms and due diligence

Being commercial solicitors we are however able to advise clients on the heads of terms, and due diligence, and the possible different approaches to take.

What are heads of terms?

Before entering into an agreement to purchase a business it is quite common for the parties to agree a number of key points and these are known as the heads of terms.

Under English law, you cannot have an agreement to agree and therefore the heads of terms are not legally binding on the parties.   However, this does not mean that the parties should not take them seriously.

The heads of terms will normally cover:

  • the purchase price;
  • whether or not the purchase price is to be paid in full on completion or payable in instalments;
  • an approximate timetable to work too;
  • a period of exclusivity under which the seller agrees not to market the business;
  • the buyer’s right to carry out due diligence and a duty of confidentiality between the parties.  The duty of confidentiality and period of exclusivity are legally binding on the parties even if the transaction does not go through.

The heads of terms may also contain a provision which is legally binding on the parties that if the buyer pulls out of the transaction for no good reason, then the buyer shall pay the seller’s costs and expenses which they have incurred to date.   The legal problem with this is the subjective nature of the phrase “good reason” – for a buyer and seller this will mean something different.  As a way of combating this, some buyers will insist that the same clause applies to the seller who if he pulls out without good reason will be liable for the buyer’s costs and expenses.   The bottom line is that whilst the heads of terms are not in general legally binding, this does not prevent legally binding clauses being inserted and caution should, therefore, be taken when negotiating and agreeing on heads of terms.

What is due diligence?

Due diligence is a process used by buyers to raise pre-contractual enquiries with the seller about the business.  They are usually quite lengthy and take the form of a questionnaire and the production of copy documents.  For the seller, it can be seen as a long and laborious process, but the replies to the enquiries can often form a warranty in the Sale Contract as to the accuracy of those replies.  Therefore, if they are not answered truthfully and correctly, not only does it make the buyer very wary but it could enable the buyer to bring a breach of warranty claim and/or a claim for misrepresentation. For the buyer, it flushes out any problems from an early stage and usually forms the basis of the disclosure process for the seller.

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