Australia: Is my Heads of Agreement or letter of offer worth the paper it's written on?

This is the question that clients always ask me before they're about to sign a letter of offer or Heads of Agreement (HOA).

What is a HOA or letter of offer?

A HOA or letter of offer is usually the first step in a commercial leasing transaction. It's generally an informal document prepared by a real estate agent or property manager on behalf of a landlord or sometimes a tenant, which sets out the key lease terms and conditions. Some tenants – particularly large organisations with various sites across a large portfolio - may have their own standard HOA.

Once the HOA has been signed and finalised, it's typically the trigger for the landlord to instruct their solicitor to produce lease documentation.

What happens though when this documentation is never produced? Are the parties bound to proceed with the Lease?

Are you bound?

There is a lot of case law published which discusses the issue as to whether a HOA or letter of offer represents a lease, or binding agreement to lease.

Every case is different and it is difficult to generalise but if the document sets out the key terms and conditions of the lease including rent, term, rent review, make good, security required, whether there is to be demolition and relocation, etc - coupled with a statement to the effect that the parties agree that they are bound regardless of whether they enter into any other form of documentation, then it's more likely that they will be bound.

Therefore, I will usually advise my clients that if they don't want to be bound by the HOA or letter of offer that they should, as a minimum, make sure that it contains a statement to the effect that the document is not to be construed as an agreement for lease or lease, and that the parties don't intend to be bound until they enter into lease documentation on terms and conditions acceptable to them.

As a tenant, you also need to make sure that you don't fall for the trap of agreeing to a statement in the documentation that locks you into signing a lease within a certain timeframe, such as 14 or 21 days. Never sign the lease documentation unless you've had an opportunity to read through it!

It is also important that if you are a corporation, that any HOA or letter of offer is subject to final board approval.

The balancing act between clarity upfront vs getting bogged down in negotiations between lawyers

You need to carefully consider the language in the documentation as you don't necessarily want to be bound by it however, it's equally important that you cover off any key special conditions or important terms that could generate lengthy debate or discussion before instructions hit your lawyer's desk.

I have acted on many matters over the years where parties haven't resolved key important terms, resulting in additional legal costs because they didn't consider them from the outset. Some of these showstoppers include conditions of lease and rent commencement, the nature and extent of make good obligations, the ability of the landlord to terminate for demolition, method of rent review, length and longevity of security, and industry specific special conditions.

In this regard, if you operate in the franchising space, you may need to consider key conditions such as the ability to confer automatic occupancy rights on your franchisee, and to pass on key obligations to your franchisee (provision of insurances and security, and payment of rent, etc).

Why does it matter?

The ability to have the flexibility to walk away from a leasing transaction despite signing a heads of agreement or letter of offer can assist you if you haven't completed your due diligence on the premises in question or if you aren't in the position to fully evaluate a cost benefit or to go ahead with the transaction.

For example, you haven't had the opportunity to consider how long it will take to obtain approvals for fit out and use and the impact this may have on when the term and rental obligations will commence, key structural issues may arise following a closer inspection of the premises, you may need to incur additional fit out expenses which you did not contemplate such as installation of key services or fire sprinklers – the list goes on.

If you do get out of jail don't forget...

If you're able to successfully withdraw from lease negotiations - despite signing the HOA or letter of offer, don't forget to position yourself to recover any deposits that you've paid.

Many HOA or letters of offer state that if a proposed tenant doesn't proceed with the lease, they either forfeit their deposit in full or reimburse the landlord for any costs they incur such as lease preparation expenses. I would suggest that you read such provisions carefully so you can limit your liability to the landlord's reasonable costs (and I would even go as far as nominating a set fee).

There are many other issues to consider when signing a HOA and it doesn't matter whether you are proposing to lease a small office or factory unit or having a large facility designed or constructed for you – I implore you to seek legal advice to have this document reviewed in conjunction with your commercial advisors.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.