Basics of Memorandum of Understanding

Understanding an MOU

Have you ever come across a document which is signed by all the parties involved in the transaction but is not legally binding on any of them? This document is known as a Memorandum of Understanding (“MOU”). It consists of the statements of intention of the parties regarding a transaction/ deal. In general, it is a widely recognized alternative to a ‘Gentlemen’s Agreement’.

When the transaction is at a nascent stage and parties only intend to capture their intention in writing rather than instantly entering into a legally binding contract, MOU is the best solution. It works as a ‘negotiation starter’ and gives the parties more time to completely understand all the terms and conditions of one another. Moreover, many times, before spending a huge chunk of money on due-diligence, engaging big law firms, or even commencing the financing process, parties intend to enter into MOUs to reach a conclusion.

MOUs are commonly referred to as ‘agreement to enter into agreement’ because parties prefer to enter into MOU to start negotiations and then give it the shape of a legally binding agreement or move to the next stage and enter into a definitive agreement. This also acts as a shield to protect the parties from a legal commitment in case the deal doesn’t work out.

However, MOUs are not always considered as ‘non-binding’. In certain cases, MOUs are intentionally drafted as legally binding contracts in which legal commitment/ intention of the parties can be easily identified. So, the intention of the parties is the key to find out if the MOU will be ‘binding’ or ‘non-binding’.

Black’s Law Dictionary, 8th edition also defines ‘Memorandum of Understanding’ as “A written statement detailing the preliminary understanding of parties who plan to enter into a contract or some other agreement; a noncommittal writing preliminary to a contract.” It also states that MOU is not meant to be binding and does not hinder the parties from bargaining with a third party. Businesspeople typically mean not to be bound by an MOU, and courts ordinarily do not enforce one; but courts occasionally find that a commitment has been made.

Uses of MOU – Cases when MOU is preferred

You might be wondering why anyone would go through even the tiniest hassle of drafting an MOU considering its not even legally binding. Well, it makes more sense to enter into MOU than entering into agreement in the following situations:

Government corporations prefer entering into MOUs to specify the objectives of the transaction, set targets and evaluate performance at the end.
Ministries, Statutory bodies, government departments also choose MOUs as a safer option than entering directly into contracts with the other party
Universities, schools, trade unions, etc formalize the transactions by way of MOUs
In International arrangements, MOUs are categorized as treaties
Organizing events
Research projects
Collaborations
Situations in which non-financial exchange is involved to benefit a project
Transactions with charitable organisations
To build discussion in the deals involving high stakes

Moreover, below are some real life examples where parties have entered into MOU instead of a definitive agreement.

Latest Real life examples of MOUs

- Flipkart signed an MOU with the Ministry of Rural Development (MoRD) of the Government of India to help empower local businesses and self-help groups (SHGs) – especially those that are led by women – by bringing them into the e-commerce fold. [Source]
- The Indian Institute of Technology, Patna (IIT-P) signed an MOU with United Kingdom-based University of Newcastle for carrying out research projects. [Source]
- Zoglo’s Incredible Food Corp. entered into a binding MOU to acquire a 51% interest in Monday Swiss UK Ltd., a leading European-based developer and manufacturer of innovative plant-based food alternatives. This MOU supersedes the non-binding letter of intent (LOI) to acquire a 50.5% interest. CEO of Zoglo’s said “Following extensive due diligence of Monday Swiss, we feel confident entering into a binding MOU” [Source]
- UltraTech Cement signed a non-binding MOU with Punjab Renewable Energy Systems (PRESPL), India’s largest biomass aggregation and densification company to scale-up use of biomass in its manufacturing operations.
- Axis Bank signed a MOU with the Indian Navy, offering a defence service salary package.[Source]
- Moderna signed MOU to make upto 110 million doses of COVID-19 vaccine available to the African Union. [Source]

Benefits of MOU

Kick off negotiations: By entering into MOUs, parties get a headstart for undertaking the transaction, redefining the terms and conditions and negotiating on crucial matters.
Solidifies intentions of parties: It is paramount to fully understand the intention of the other party for effective communication and closure of a deal. The intention of the parties towards the transaction becomes transpicuous once they enter into a non-binding MOU and it leads to closure of the deal by either converting into a contract or nullifying the MOU.
Reduce Uncertainty: Written communication is the best way of reducing uncertainty among the parties and achieving Consensus ad idem, or meeting of the minds. MOU is an easy way to put together terms in writing without having any legal commitment.
Time to reach to conclusion: By entering into an MOU, parties get sufficient time to conclude whether they want to make this intention a legally binding commitment or not.
Foundation of a definitive contract: The parties put together their intention for undertaking a deal with the purpose and their responsibilities so that MOU can serve as the foundation for future definitive contract which shall be legally binding.
Safer Alternative: Government corporations generally consider MOUs as a safer alternative especially when major deals are in the planning stage.
Ease of exit: Another reason to enter into MOU is the convenient way of terminating the transaction/deal.

Disadvantages of MOUs

Not legally binding: The fact that an MOU is not legally binding grants the freedom to conveniently exit to parties who are not willing to live up to their part of responsibilities.The other party cannot even claim damages if it fails to prove that the MOU was legally binding.
Prone to False claims: There’s a loophole in the concept of MOU that may make it binding or non-binding, which is the intention of the parties. For instance, it is clearly written in the MOU that it is a non-binding MOU, and one party fulfils its part of obligation and claims that it is legally binding while the other party considers it just statements of their intention to enter into a deal. In such a case, courts may or may not enforce it after considering the language of the MOU. Hence, an MOU is highly prone to different claims with respect to its binding nature.
Greater chance of litigation: Due to its confusing nature, it may lead to disputes between the parties and even litigation if disputes are not solved amongst them.

Mandatory clauses in MOU

An MOU is basically an expression of intention of the parties with respect to a particular deal/ transaction/ goal. It is of utmost importance that the intention is crystal clear in the MOU. Following clauses should be carefully drafted in the MOU which will make the intention of the parties extremely easy to understand:

- Parties: Name and details of all the parties such as identification proof, address, authorised signatories etc.
- Recitals: Purpose of the MOU and background/ brief of the parties.
- Intention to make MOU legally binding: The parties may choose to highlight the intention in the beginning itself to make things absolutely clear regarding the binding nature of MOU.
- Scope of work: The Parties shall limit the scope of the MOU to the particular transaction only so that there is no scope of ambiguity left.
- Roles and responsibilities: Clearly define the agreed roles and responsibilities of each of the parties to ensure what each party is expected to do or not to do. The roles and responsibilities should align with the purpose of the MOU, scope of work and achieving set goals.
- Term and Termination: Parties shall mention the term of this MOU. They may mention that it may be extended or renewed after expiry of the duration of this MOU. They shall also mention the events in which they have the right to terminate the MOU such as (i) bankruptcy/ liquidation; (ii) non-performance of MOU; etc.
- Consideration: There may or may not be any monetary consideration for either of the parties, however, if there is any consideration involved, Parties shall mention how consideration will be paid to both the parties. Whether it will be on commission basis or fixed amount. Details regarding tax liability of both parties shall also be made clear.
- Confidentiality: Since both parties will be disclosing critical information without even making the MOU legally binding, confidentiality is the supreme aspect for all the parties. This clause must be carefully drafted to keep the crucial information confidential.
- Exclusivity: Generally this clause is not mentioned in MOUs and it is left at the option of the parties whether they wish to come into agreement with other parties as well. However, in case the parties decide to prevent any party from soliciting offers or negotiating with the competitors of one party for a specific period, they may include an exclusivity clause.
- Dispute Resolution: There are chances of disputes, controversy or breach, therefore, it is advisable to include this clause to settle such disputes promptly through negotiation.
- Signature: The MOU must be signed by all the parties and the Signatories, in case of organizations, must be officially authorized to sign on behalf of the organization.