Memorandum of Understanding (MOU): Does Your Business Need One?
What is a Memorandum of Understanding (MOU)?
A Memorandum of Understanding (MOU) is a document that records the general understanding and preliminary plans between parties, prior to entering into a formal contract.
An MOU is also commonly known as a:
- Letter of Intent;
- Letter of Understanding;
- Heads of Agreement;
- Memorandum of Agreement; or
- Term Sheet
When is an MOU Used?
An MOU is typically used at the early stage of negotiations for an intended business transaction between parties.
At this point, parties usually have yet to agree on all the important terms of their transaction, but still wish to set out its broad framework.
What is an MOU Used For?
An MOU may be used to:
- Show the parties’ serious intentions in negotiations to reach a common goal and eventually enter into a contract;
- Ensure that parties are on the same page with regard to certain essential terms;
- Provide assurance to parties by discussing all the key points of the eventual contract;
- Construct a structured framework including the scope and extent of future negotiations;
- Keep all relevant persons updated with the progress of negotiations by recording any negotiations milestones, points discussed and decisions made;
- Make a public announcement that parties are in negotiations and have plans to enter into a contract; and/or
- Provide proof of the future business transaction to any potential investors.
What Happens After the MOU is Signed?
After an MOU is signed and if the parties involved are still committed to undertaking the deal, they typically wait for a formal and final contract to be drafted.
However, if the deal falls through and one party backs out, the question of whether the party is legally bound by the MOU arises.
Is an MOU Legally Binding?
Generally, MOUs are non-binding because they are often incomplete agreements that are subject to a written contract. This incompleteness often indicates parties’ intention not to create legally binding relations until the enforcement of a formal contract or agreement.
However, the court may also interpret an MOU as a binding contract and therefore a legally binding document, depending on the facts at hand.
The Singapore High Court in Bassatne Mohamed v Rifaat El Gohary has held that an MOU was a legally binding contract. The court was not restricted by the document’s label (that an MOU is non-binding), but instead examined the document’s language and surrounding evidence to determine its legal effect.
The court considered the following key factors in its decision:
The MOU’s language and contents
The language of the MOU and details spelt out showed that the parties intended for it to be a binding contract. The MOU contained very specific details, including the price of shares.
The fact that the MOU envisioned signing of an additional agreement later on did not make it any less binding.
Performance of the MOU
The parties performed obligations that were provided in the MOU such as keeping each other posted on all trades conducted and consulting a law firm regarding the drafting of the subsequent agreement.
Party A was also employed by the Party B’s company according to the MOU, and acted as the company’s paid executive director despite not being formally appointed as such.
This showed the parties’ intention for the MOU to be legally binding.
Parties’ subsequent conduct
To determine if the parties’ subsequent conduct proves for the MOU to be legally binding, the court looked at whether the parties had acted on an assumed state of facts or law.
In this case, the parties acted on the basis that the MOU was operative and in accordance with its terms, thus showing intention for the MOU to be legally binding.
Therefore, although parties may enter into an MOU to nullify any intention to be legally bound by a contract, the court may disregard the document’s label as an MOU to determine its exact nature.
What are Some of the Clauses that MOUs should Contain and Their Objectives?
MOUs generally contain, but are not limited to, the following essential terms:
1. Details of parties
This is important to identify the parties undertaking the MOU. Some details include parties’:
- Full names;
- Identification numbers;
- Contact numbers; and
- Registered addresses.
If companies are involved, some details to be included are:
- Companies’ registration numbers;
- Contact numbers; and
- Registered addresses.
2. Purpose of the MOU to take legal effect or otherwise
Setting out the purpose of the MOU is essential to record the goals of negotiations and ensure that all relevant persons are on the same page. From the outset, parties should clearly state the intended legal effect of the MOU.
If parties do not intend for the MOU to be legally binding, it should be explicitly stated that:
- The contents of the MOU is subject to a formal and final contract; and
- Parties would not have any outstanding obligations to each other for failure to agree on a formal and final contract.
3. Responsibilities of parties
Since an MOU is meant to set out the general framework of the initial phases of negotiations, it should contain the scope of work of parties.
For example, frequency and timing of meetings for negotiations, and any other responsibilities specific to the transaction.
4. Essential details of the transaction
Useful terms to be included are the general overview of the transaction, and other key points. For example, industries, prices, any third-parties involved, and deadlines to be met.
5. Duration and termination of the MOU
The MOU should contain the beginning and end dates of the MOU, and how the MOU may be terminated should the need arises i.e. notice period and mode of termination.
In the event that negotiations fail, parties should include confidentiality, non-disclosure and good faith clauses in the MOU, to protect themselves in case either parties have the intention to act dishonestly. For example, disclosing the other party’s information.
7. Signatures with dates
Finally, once the MOU is agreed upon, it should be signed and dated by the parties or any authorised representatives of the companies involved.
Once signed and dated as such, the MOU will then take effect.
Since it is uncertain when a court may interpret an MOU to be legally binding, it is important to exercise care and caution in drafting an MOU.
If parties did not intend for the MOU to be legally binding, problems may arise when parties did not explicitly state so in the MOU, which may lead the court to interpret the MOU as a legally binding contract instead.
Therefore, especially in complex commercial transactions, you may want to seek advice from a corporate lawyer when you need to draft an MOU.
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