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Australasian Biotechnology (backfiles)
AusBiotech
ISSN: 1036-7128
Vol. 11, Num. 1, 2001, pp. 29-30
Untitled Document

Australasian Biotechnology, Vol. 11 No. 1, 2001, pp. 29-30

BIOTECH LAW

THE USE OF HEADS OF AGREEMENT IN THE COMMERCIALISATION OF BIOTECHNOLOGY - TO BIND OR NOT TO BIND

Peter Willcocks and Marita Hogan of Lander & Rogers, Lawyers, Melbourne and Sydney

Code Number: au01011

Abstract

Heads of agreement or memoranda of understanding are commonly used in commercialising biotechnology as a prelude to signing a more formal and detailed agreement. Heads of agreement have their own risks arising out of whether they are to legally bind the parties before a formal agreement is executed.

This paper looks at how this issue can be addressed and some elements of drafting heads of agreement.

  Introduction

The commercialisation of biotechnology almost invariably involves, at some stage, the need to prepare heads of agreement or a memorandum of understanding. Indeed, in some cases nothing more than a letter of intent or an exchange of correspondence is used.

In some countries the expression “heads of agreement” is used and in others “memorandum of understanding”. The effect of either is the same. In this paper the expression “heads of agreement” is used to also cover memoranda of understanding.

  Commercialisation

There are many different agreements for commercialising biotechnology. The more common are:

  • licensing;
  • joint ventures;
  • strategic alliances.

These agreements impose a large number of detailed rights and obligations upon each party. In addition, they address how the technology will be commercialised, by whom, within what parameters and what will happen if unanticipated commercial events intervene.

The final agreement between the parties must be largely tailor-made to address the particular circumstances.

  Why use Heads of Agreement?

Despite the advances of technology, most agreements are more effectively negotiated face to face. Globalisation means that one or more parties must travel some distance to conduct negotiations. The pressures of time and travel will mean that the negotiations are conducted within a condensed time frame.

In addition, the development of new technologies and the speed with which markets change mean that agreements must be negotiated and finalised over an ever-diminishing time frame.

It is often not possible to negotiate, draft and agree upon the terms of complex agreements in these time frames.

This leaves negotiators to put in place some form of stopgap arrangement setting out the main commercial issues pending the finalisation of a more detailed agreement.

Heads of agreement exist to do this.

Contents of Heads of Agreement

Heads of agreement address the commercial aspects of the transaction. It is not possible to detail in this paper all the issues which may need to be covered. They will vary from transaction to transaction. More important issues are:

  • the parties;
  • the aims;
  • payments to or by parties;
  • the roles of the parties;
  • performance requirements;
  • ownership of intellectual property and improvements;
  • confidentiality;
  • the outline of the legal structure (i.e. joint venture, licensing etc).
Legal Effect of Heads of Agreement

In general terms heads of agreement can fall into one of four categories, being:

  • non-legally binding heads of agreement where the parties intend to subsequently enter into a detailed legally binding formal agreement;
  • legally binding heads of agreement where the parties do not intend to subsequently enter into a more detailed formal agreement;
  • legally binding heads of agreement where the parties do intend to subsequently enter into a detailed formal agreement but where the heads of agreement are silent on how that occurs;
  • legally binding heads of agreement whereby the parties expressly agree to negotiate a detailed formal agreement in good faith.

It is quite possible for the parties to specify in the heads of agreement which of the above is intended. Commonly they do not.

The risk is that if the parties do not address this in the heads of agreement a party may subsequently find itself legally bound by heads of agreement which it thought were not legally binding. Alternatively it may find the other party not legally bound by heads of agreement which it thought were legally binding.

It is possible to state that some parts of the heads of agreement are intended to be legally binding (such as the confidentiality provisions) and other parts are not intended to be legally binding.

  Non-legally binding Heads of Agreement

The purpose of non-legally binding heads of agreement is to set out in writing the basic commercial terms to which the parties have agreed without the parties being legally bound to proceed further.

The purpose is to ensure that both parties are agreeing to the same thing (which is often not the case in informal negotiations).

The parties must then take the risk that one or the other may back out of the arrangement at some time in the future. There will be nothing legally binding the parties, one to the other, until such time as a formal agreement is executed.

This arrangement has many advantages, the most important being that either party can walk away from the arrangement or can seek to re-negotiate it. In addition, the parties will not find themselves bound by an arrangement which they had not fully thought through, having regard to the more detailed terms which would normally be included in a formal agreement and the consequences of those terms.

The obvious disadvantage is that the other party is not legally bound. There is no binding agreement between the parties until such time as the formal agreement is executed.

  Legally Binding Heads of Agreement

Legally binding heads of agreement take a similar form to non-legally binding heads of agreement. However they should contain a clause stating that the parties intend to be legally bound.

The clear advantage of such a document is that from the date of execution of the heads of agreement the parties are legally bound to proceed with the transaction.

The disadvantage is that in those circumstances, from one point of view, there is little point in bringing into existence a more formal detailed agreement as neither party is legally bound to abide by it or to adopt it. Either party can simply take the view that they have already entered into a legally binding agreement and are not obliged to vary the provisions set out in the heads of agreement.

This issue may be overcome by including general clauses in the heads of agreement to provide that the formal agreement will contain such warranties or other terms as are commonly found in such an agreement. These clauses have their own difficulties. In addition, it is not uncommon to find that heads of agreement, negotiated in a short time frame, overlook certain important commercial terms. How are these then to be included if one party or the other will not agree to them?

Agreement to negotiate in good faith

An alternative is to agree legally binding heads of agreement whereby the parties agree not only to the terms set out in the heads of agreement but also agree to negotiate a further formal agreement in good faith.

This issue was considered in Coal Cliff Collieries Pty Ltd v. Sijehama Pty Ltd (1991) 24 NSW LR1.

Prior to this decision it was generally considered (and indeed, may still be considered outside Australia) that a statement in heads of agreement that the parties would proceed in good faith to negotiate a formal agreement was not binding. The courts had considered that such a statement was too vague or uncertain to be enforceable.

Whilst that was the outcome of this decision, it was also clear from the judgments of two judges that a promise to negotiate in good faith, may, in particular circumstances, be enforceable. Enforceability depends on the precise terms as construed from the particular heads of agreement.

Such an approach may adopt the advantages of non-binding heads of agreement together with the advantages of binding heads of agreement. In other words, the parties are legally bound but there is still room to negotiate, provided the parties do so in good faith. However, such a provision needs to be carefully worded.

Drafting the Heads of Agreement

The heads of agreement should contain a clause stating whether or not they are intended to be legally binding.

In particular circumstances it may be decided that the heads of agreement should be silent on whether they are intended to be legally binding. It may be that it is ultimately one of the parties’ intention to leave this matter to be argued in court or otherwise should it become necessary or desirable. This approach should not be taken unless it is a deliberate step and the consequences are calculated.

It is important therefore, at the appropriate stage of the negotiations, to address whether the heads of agreement are to be expressed to be legally binding, non-legally binding or are to be silent on the point. Whilst the beginning of the negotiations is probably not the appropriate time, neither is the end when the other party may have negotiated the heads of agreement on an entirely different understanding as to the effect of the document.

If the heads of agreement are expressed to be legally binding (whether in whole or in part) it is also desirable to state by which law the heads of agreement will be interpreted. This is known as a “governing law” clause and should not be confused with a clause which states which courts have jurisdiction. The governing law clause determines by which law the heads of agreement are to be construed. The jurisdiction clause determines which court will hear any dispute.

Parties are commonly suspicious of another party’s legal system (believing it to be biased against them). From a practical point of view it is desirable for any person travelling overseas to negotiate an agreement to have decided, in advance, what might be an appropriate compromise governing law.

Conclusion

The complexity of many agreements relating to the commercialisation of biotechnology, combined with the need to negotiate agreements outside Australia and operate quickly to achieve certainty between the parties has lead to the rise of the use of heads of agreement.

Prior to finalising heads of agreement it is important for each party to consider whether or not the heads of agreement are intended by that party to be legally binding.

It is fundamental in the negotiation of agreements to commercialise biotechnology that these issues are addressed at an early stage. Failure to do so can expose a party to substantial expenditure or protracted litigation (or both).

  • Peter Willcocks is a partner in the Commercial Department at Lander & Rogers practising primarily in capital raisings, corporate law and commercial contracts in the biotechnology sphere. He can be contacted at: pwillcocks@landers.com.auMarita Hogan is an articled clerk in the Commercial Department of Lander & Rogers. She can be contacted at mhogan@landers.com.au

Copyright 2001 - AusBiotech

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