That depends really. If two businesses or organisations are entering into big or complicated projects or relationships, sometimes people on either side like the idea of a symbol of commitment before the final contract. Maybe there’s pressure from the bank or other outside stakeholders. It’s like an engagement, something you do to show each other and the world that you are committed to each other and will marry in due course, before the big day of the final legal contract.
I don’t need to remind anybody that not all engagements end happily with a yard and 2.4 kids! Or that courts may force you to give back the diamond ring. It’s like that with a Memorandum of Understanding (MoU). In most cases they are not really necessary from a legal point of view, and might even cause you a lot of legal trouble down the track. Here are four common traps you can fall into with an MoU, Heads of Agreement (HoA), Letter of Intent, Letter of Comfort, or Term Sheet:
- You sign an MoU before you feel that negotiations with the other side have been finalised, the project derails, you end up in court, and the judge decides that the MoU is as good as a contract. The court then issues orders forcing you to carry out your part of the deal in exactly the same way as if you had signed the final contract. If it decides there is a contract, the court may even ‘fill in the gaps’ in the deal to make it operate. If you don’t know how to draft an MoU so that it’s only a first step and not the whole deal, you could end up having the whole deal, as the court decides it should be, forced on you.
- You sign an MoU, maybe with a person or business that you are unsure about, thinking that if the project falls apart you will at least be able to enforce the MoU, and it does fall apart and the court decides that the MoU is not a full contract and is only an ‘agreement to agree’. You may then be stuck with a dead loss.
- The MoU is all legal and up to the standard of a contract, but it’s written so that a particular thing has to happen before it operates as an agreement. If that particular thing doesn’t happen, the MoU is not worth the paper it’s written on.
- The MoU is all perfectly drafted, but it has been signed by the wrong people on either side. In other words, one or other business has sent people to sign the MoU who do not actually have legal authority to sign it. Again, the MoU would not be worth the paper it’s written on.
So what are the main features of a deal which make it into a contract? Generally, a legal contract requires:
- One or other side to make an offer and the other side to accept that offer either in writing or by their words or actions.
- A price for the deal, either in money or goods and services.
- Enough certainty and clarity in the key commercial clauses.
- That the whole agreement shows that both sides intended to go into a legally binding agreement.
If an MoU lives up to those standards, courts will enforce them and make both sides do the things they promised to do.
But here’s where it can get tricky. You may not feel like you intended to go into a legal agreement, but courts look at deals from a great height and assess if there is a proper legal deal based on, not only the words of the MoU, but also your statements and actions, anything you did already, letters, emails, or even trade customs.
An MoU should definitely state whether it is fully binding or not, but even a statement that it is not binding is not the last word on the matter. The court may decide that everything else in the situation shows that the MoU is binding. If that happens, the court may even add clauses to the contract which will make the deal work. So it is like any contract case, and if the court sees the outline of a contract in your MoU it may well hold you to the deal. In other words, you were sure the MoU was not a full contract, but the court decides it is. You are then stuck with a lame horse.
WHAT ARE THE REASONS YOU MIGHT CONSIDER SIGNING AN MoU?
Some people think an MoU will do the job and save them legal bills for drafting a contract. That is very short-sighted, because even an MoU should be at least reviewed by a lawyer, for all the reasons outlined before.
However, an MoU may be a good idea for the following reasons:
- To get the ball rolling on parts of the deal that should start straight away, so that revenue can start flowing.
- Where you are dealing with a reluctant party, or you are unsure about their reliability, an MoU can lay down a bit of framework around key commercial issues and give the reluctant side a bit of comfort that you are in good faith. This may help close the deal.
- An MoU can provide a good basis and outline for a long and complex negotiation, by giving clarity about the main issues.
THINKING ABOUT AN MoU or HoA?
If you do decide that you really do need an MoU, and that the benefits outweigh the risks, you should draft very carefully so that you get the level of commitment that you need, and no more or no less. Professional legal advice is the best course to take, and should not break the bank for a straightforward MoU.