Heads of agreement, letters of intent, memorandums of understanding, and term sheets are pre-contract documents commonly used in commercial property transactions to record the principal commercial terms before the formal contract is drafted. Whether these documents create binding obligations depends critically on the drafting, the parties' intentions, and the jurisdiction. Getting this wrong can produce unintended legal consequences.
This guide covers the typical pre-contract documents used in commercial property, the legal test for whether they bind, the buyer-side approach to drafting and signing them, and the practical purpose each serves.
Pre-contract documents are tools, not contracts. They serve as commercial alignment, not legal commitment. The drafting must reflect this; otherwise, parties end up bound to terms they thought were preliminary.
The Principal Pre-Contract Documents
Heads of agreement (HoA)
The most formal of the pre-contract documents. Records the principal commercial terms (price, settlement date, GST treatment, conditions, special inclusions). Usually contains express provisions stating which terms are binding and which are subject to formal contract.
Letter of intent (LoI)
A letter from one party to the other recording an intention to proceed under stated terms. Less formal than an HoA; often used for less-developed deals or initial expressions of interest.
Memorandum of understanding (MoU)
Similar to an LoI; often used in non-property contexts. In property, MoUs are typically used for joint ventures or development partnerships rather than acquisitions.
Term sheet
A short summary of key deal terms, typically used in development or syndicate transactions rather than direct acquisitions.
1 When Pre-Contract Documents Bind
The general legal test in Australia (consistent with the High Court's decision in Masters v Cameron) is that the parties' intention determines whether the document binds. The High Court identified three main categories:
Category 1: bound immediately, formal contract to follow
The parties have agreed on all terms and intend to be bound immediately. The formal contract is a documentation exercise, not a fresh negotiation. The HoA itself is enforceable.
Category 2: bound to perform, subject to formal contract
The parties have agreed on terms but performance is contingent on execution of a formal contract. If a party refuses to sign the formal contract on the agreed terms, the other can seek specific performance.
Category 3: not bound until formal contract
The HoA is a record of negotiation but does not bind. Either party can walk away until the formal contract is signed.
A fourth category sometimes recognised: the parties are bound to negotiate in good faith but not bound on substantive terms.
2 What Drives the Categorisation
The categorisation depends on multiple factors:
- Express statements. If the HoA says "subject to formal contract" or "non-binding except for clauses X and Y", that intention is respected.
- Completeness. If the HoA covers all material terms, it tends toward Category 1 or 2; if substantial terms remain to be agreed, it tends toward Category 3.
- Conduct. If the parties behave as if bound (deposits paid, possession given, work commenced), this affects the court's view of intention.
- Industry practice. Common practice in the relevant industry shapes the inference.
3 Why Use a Pre-Contract Document
Recording commercial alignment
The parties have reached agreement on principal terms. The HoA records the agreement so neither side resiles. Useful in extended transactions where formal contract drafting will take weeks.
Bridging conditional periods
The buyer needs to conduct due diligence before signing a formal contract; the vendor wants assurance the buyer is genuinely committed. The HoA can hold the deal during DD.
Avoiding "stalking horse" sales
An HoA that commits the vendor to not sell elsewhere while DD progresses prevents the property being sold to a competing bidder during DD.
Lender or board approval
The buyer needs lender or board approval before signing the formal contract. The HoA records the deal pending those approvals.
4 What Should Be Binding
Most well-drafted HoAs make specific provisions binding while leaving the substantive transaction non-binding:
Exclusivity (lock-out)
The vendor agrees not to sell to others during a defined exclusivity period. Binding from signing.
Confidentiality
Information shared during DD is confidential. Binding from signing.
Costs
Each party bears its own costs until formal contract. Binding from signing.
Substantive deal terms
Typically expressed as non-binding intentions, subject to formal contract.
5 Buyer-Side Approach
Define binding vs non-binding clearly
Express provisions stating which clauses bind and which are subject to formal contract. The Masters v Cameron categorisation should not be left to inference.
Solicitor review before signing
Even pre-contract documents have legal effect. The buyer-side solicitor should review the HoA before signing.
Avoid completing all material terms
A complete HoA can become Category 1 (immediately binding) even if labelled "subject to formal contract". Leaving substantive matters for formal contract preserves the non-binding intention.
Limit exclusivity period
Vendor lock-out periods should match the buyer's realistic DD timeline. Overly long exclusivity is unfair to the vendor and rarely necessary.
Track conduct after signing
Parties' conduct can override stated intentions if they behave as if bound. Avoid acts that imply commitment beyond what the HoA intends.
6 Common Pitfalls
Treating HoA as informal
Believing an HoA is "just a handshake on paper" and signing without legal review. The HoA can have substantive legal effect.
Failing to specify binding clauses
An HoA with no clarity on which clauses bind invites later disputes. Express drafting is essential.
Implying agreement on missing terms
If the HoA leaves "settlement details to be agreed" but the parties proceed as if settled, a court may treat the implied terms as binding.
Misalignment with formal contract
The formal contract may have terms inconsistent with the HoA. Where the HoA intended specific outcomes, the formal contract should reflect them.
Frequently Asked Questions
Should I sign an HoA before DD?
For substantial transactions, often yes, to secure exclusivity during DD. The HoA must clearly distinguish binding lock-out provisions from non-binding substantive terms.
Can I withdraw from an HoA?
Depends on the categorisation. Category 3 HoAs allow withdrawal; Category 1 or 2 may not. Solicitor advice is essential before withdrawing.
Is verbal agreement binding?
Property transactions generally require written contracts under state legislation. Verbal agreements on substantive property terms are typically unenforceable; but specific reliance and conduct can create binding obligations in some circumstances.
What if the vendor breaks exclusivity?
If the lock-out provision is binding and the vendor sells elsewhere, the buyer can seek damages (and potentially specific performance in narrow cases). Damages calculation depends on the buyer's loss.