That depends. 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. Usually in this situation, the parties start with a basic Memorandum of Understanding or a Heads of Agreement. 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 a diamond ring. It’s like that with a Memorandum of Understanding (MoU). In most cases, they are not necessary from a legal point of view and might even cause you a lot of legal trouble down the track.
Common traps with an MoU or HoA
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 the same way as if you had signed the final agreement. 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 entire arrangement, as the court decides it should be, forced on you.
- You sign an MoU, maybe with a person or business 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. The court decides that the MoU is not a complete 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 must happen before it operates as an agreement. If that specific thing doesn’t happen, the MoU is not worth the paper it’s written on.
- The MoU is perfectly drafted, but the wrong people on either side have signed it. In other words, one or another business has sent people to sign the MoU who do not have the legal authority to sign it. Again, the MoU would not be worth the paper it’s written on.
When is an MoU a contract?
So what are the main features of a deal which make it into a contract? Generally, a legal agreement 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 critical commercial clauses,
- The agreement shows that both sides intended to go into a legally binding contract.
If an MoU lives up to those standards, courts will enforce them and make both sides do what 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. Still, courts look at deals from a great height and assess if there is a proper legal deal based on the words of the MoU and your statements and actions, anything you did already, letters, emails, or even trade customs.
An MoU should 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 shows that the MoU is binding. If that happens, the court may even add clauses to the contract to make the deal work. So it is like any contract case, and if the court sees the outline of an agreement in your MoU, it may well hold you to the deal. In other words, you were sure the MoU was not an entire 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 a lawyer should at least review even an MoU 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 are unsure about their reliability, an MoU can lay down a bit of framework around critical commercial issues and give the unwilling side a bit of comfort that you are in good faith. This may help close the deal.
- An MoU can provide a sound basis and outline for a long and complex negotiation by clarifying the main issues.
Thinking about an MoU or HoA?
If you decide that you do need an MoU and that the benefits outweigh the risks, you should draft very carefully to get the level of commitment 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.
Contact us today for a free no-obligation discussion of your needs in this area.
