Drafting heads of terms - a cautionary tale
In the recent case of Kennedy & Others v Ward, a group of family members entered into an agreement (the Binding Heads of Terms (BHOT)) as mediated settlement of a dispute. The BHOT, signed late at night, provided that the plaintiffs would transfer their shares in the family business to the defendant in return for cash consideration (totalling €31.5m), which was to be paid in instalments on certain dates. The BHOT provided that, in the event that payment was not made in accordance with the agreed terms, the defendant would consent to summary judgment in respect of the outstanding balance.
The plaintiffs claimed that the consideration was not paid in accordance with the terms of the agreement and applied for summary judgment against the defendant. They argued that the defendant's use of cash reserves from the target companies to fund the share purchase was contrary to what had been agreed.
In response, the defendant maintained that the BHOT was merely an "agreement to procure an agreement" and therefore not a binding agreement. He further argued that, under the terms of the BHOT, he was entitled to pay for the shares using the cash reserves of the target companies.
The High Court dismissed the defendant's arguments and found for the plaintiffs. The Court held that:
- the agreement was binding and it was not the court's place to infer intentions or read clauses into the agreement; it is up to the parties to negotiate and expressly agree on the terms of an agreement
- the defendant was not entitled to use the cash reserves of target companies to fund the acquisition of their shares, as this could have exposed the plaintiffs to higher rates of tax and was beyond the scope of the "tax efficiency" clause in the BHOT
This case is a good example of the risks associated with entering into a high level agreement without including more detailed provisions on how the agreement is intended to operate.
In commercial negotiations, parties intending to contract may reach agreement on initial terms with a view to further discussion. This is often documented in an outline agreement covering the key points and which indicates that further negotiations are contemplated.
In this instance, the defendant argued that the first clause in the BHOT, which set out the dates for the various payments, amounted to an agreement to procure an agreement. The Court disagreed – the document was clearly labelled as 'binding' and there was nothing in the BHOT to contradict this.
While certain clauses in the BHOT indicated that it was "clearly envisaged that further work and professional advice would be undertaken to complete the transaction", the Court placed emphasis on the fact that the BHOT was "the outcome of a mediated settlement at which both parties had the benefit of legal advice".
The Court further stated that, "If the defendant had intended to render the performance of his obligations under the BHOT conditional on securing finance from external sources or the completion of other transactions such as the sale of shares in Casino [Cinemas Ltd], he had every opportunity to do so when negotiating the BHOT."
This demonstrates the Court's reluctance to infer terms in an express agreement, particularly in circumstances where legal advice was taken by the parties.
The BHOT provided that the plaintiffs would facilitate the transfer of shares in the companies being acquired by the defendant "or his nominee(s)". The defendant argued that this phrase – "or his nominee(s)" – allowed him to unilaterally nominate the target companies and use these nominee companies' cash reserves to fund the transaction. In other words, the defendant sought to utilise funds from the very companies he was acquiring in order to acquire them.
The Court disagreed with this "novel proposition". If this had been the intention of the parties, the Court said, then this should have been provided for in the BHOT. The Court held that it could not interpret the clause as extending to such a proposition, or interpret the facility to identify a nominee as permitting such a series of steps.
Tax efficiency clauses
The BHOT contained a clause stating that all sums to be paid to the plaintiffs would be structured in a "tax efficient way" for the parties. This is standard language in many settlement agreements. On the defendant's interpretation, this permitted him to use the cash reserves of the target companies to fund payment of all or part of the consideration.
The Court rejected this interpretation of the tax efficiency clause. The Court acknowledged that the use of target company funds in transactions of this nature may commonly form part of the "flow of funds" sourced for payment of the consideration. However, if the defendant intended that the consideration would, in whole or in part, be sourced from reserves in the companies, then such an important facility amounted to more than tax planning – it related to the "very sourcing of the consideration" and should have been specifically set out in the BHOT.
Parties wishing to use a tax efficiency clause in a contract would be best advised to set out the precise parameters of its intended scope in the contract. In particular, if a party wishes to rely on such a clause to set out a particular approach to a transaction, this should be expressly provided for in the agreement.
This case is a reminder of the risks associated with entering into a contract without comprehensive agreement on all the issues and without express provisions detailing how the agreement is intended to operate. Where the parties don't intend a document to be the final say on the matter and contemplate further negotiations to conclude the agreement, this should be clearly signposted (for example, by the use of labels such as “subject to contract” or “contract denied”).
For further information on the issues in this case, please contact Michelle McLoughlin or Liam Murphy.
Date published: 20 May 2022