It may seem so fundamental and obvious but the question “Are we legally bound?” can be one of the most vexing in a leasing negotiation. Whilst the common assumption is that neither tenant or landlord are legally bound until a lease is signed, recent case law and general commercial practice has reminded us that a contract between the parties may arise prior to the completion of formal documentation.
Heads of Agreement- what’s in a name?
A heads of agreement is commonly signed during initial lease negotiations as a way to set out the fundamental terms of the Lease such as rent, term of the lease, security deposit, outgoings etc. Often, a lease proposal or a heads of agreement is silent as to whether the document is intended to be binding and this can lead to uncertainty. The parties should preferably only be bound once they have had the opportunity to review, negotiate and reach consensus on more comprehensive terms. However, even if a lease proposal or heads of agreement expressly state it is not legally binding, the subsequent conduct of the parties can still have a bearing on when a lease agreement is formed and as such the terms of the heads of agreement can constitute an enforceable lease.
The Courts look to all the circumstances surrounding the heads of agreement and have held that the main principles that are relevant as to whether or not it is legally binding are the intention of the parties at the time of drafting the heads of agreement (which may not just be limited to the written documentation, but also conduct of the parties) and if the heads of agreement has been drafted in sufficient detail to give certainty and meaning to the agreed terms.
As in the case of Michael Lahodiuk v Vincent Pace and Prid Pty Ltd  NSWSC 512, the Court found that the Heads of Agreement were legally enforceable and binding on the parties. Whilst considering the importance of the background of the matter, the Court concluded that the specificity of language used in the Heads of Agreement, the protracted correspondence and negotiations between the parties, the involvement of legal practitioners and the state of mind of the parties at the time the Heads of Agreement was signed amounted to the legal enforceability of a binding lease agreement.
In our experience, to avoid such uncertainty and risk over the enforceability of a Heads of Agreement or lease proposal, we recommend it be expressly stated that there is no binding agreement until a formal lease is signed by both parties and there be appropriate exit arrangements if the transaction does not proceed and this be confirmed in subsequent correspondence. For any further enquiries, please contact a member of our Commercial Team who would be more than happy to assist you.