Heads of terms and entire agreement clauses

When interpreting a contract, the court will look at the presumed intention of the parties. What would an objective third party - with all the background knowledge reasonably available to the parties at the time the contract was entered into - understand the contract to mean? That background knowledge is referred to as the factual matrix and it can include a broad range of factual material. Deciding what is and what is not included in the factual matrix is an important but difficult question.

In Matchbet Ltd v Openbet Retail Ltd the High Court decided that the heads of terms on which an agreement was based did not form part of the factual matrix for the purposes of interpreting that agreement. The legally binding parts of the heads of terms were superseded by the entire agreement clause contained in the final agreement. The non-binding parts were inadmissible, like any other non-binding pre-contractual negotiations.

The facts

A software developer brought a claim for damages against a technology supplier for breach of a software licensing and development agreement. The development agreement was based on written heads of terms, which were not legally binding except for a few clauses, and it contained an entire agreement clause which provided that it was “the entire agreement and understanding between the parties” and was to supersede “all proposals and prior agreements, arrangements and understandings between the parties relating to its subject matter”.

The developer claimed that the supplier had failed to satisfy certain obligations relating to the integration and marketing of the development product. The supplier’s defence was that it was not actually obliged to do any of those things under the development agreement in the form that was finally agreed. The developer argued that the heads of terms formed part of the factual matrix and that the court should interpret the development agreement to include, whether expressly or by implication, all matters contemplated by the heads of terms.

The decision

The developer’s claim was dismissed. The court decided that the heads of terms could not be considered part of the factual matrix, so no recourse could be made to them when interpreting the development agreement. Central to this decision were the following conclusions:

• To the extent that the heads of terms were not contractually binding, they were no more than steps in the pre-contractual negotiations between the parties and, like any other pre-contractual negotiations, were inadmissible for the purposes of interpreting the final agreement.
• To the extent that the heads of terms had contractual force, they remained binding on the parties unless and until superseded by the final agreement. In this case, because the development agreement contained an entire agreement clause, the binding provisions of the heads of terms were superseded when that agreement came into effect, after which the position for the future was governed exclusively by that agreement and not the heads of terms. The court reiterated that the whole point of an entire agreement clause was to ensure that the parties’ rights and obligations are ascertained by reference to the single agreement that contains the entire agreement clause. The development agreement would still have to be construed in its factual matrix, but to include within the matrix any prior agreement between the parties that was set out in the heads of terms would run counter to the very purpose of the entire agreement clause.

Comment

The judgment highlights the importance of ensuring that all the key points that are set out in the heads of terms are captured in the final agreement (to the extent they are still the agreed position). On the other hand, it also highlights the importance of including an entire agreement clause in the final agreement. Otherwise the court may be inclined to look to the heads of terms – which may no longer reflect the agreed position – to interpret the final agreement.