A memorandum of understanding (MOU) serves as an essential tool in various business contexts. An MOU has other names, such as ‘heads of terms’, ‘heads of agreement’ or ‘letter of intent’.
Before entering into binding contracts, an MOU helps parties who want to work together outline their intentions and lay the groundwork for a potential contract.
In this blog, we will explore what the purpose of an MOU can be, when it should be used, its key functions and potential benefits.
What is an MOU?
An MOU is a written agreement between two or more parties that outlines their intentions and the general commercial and/or operational terms for a future long form agreement.
From a legal perspective, an MOU can serve as a non-legally binding one-pager setting out the bare bones of a deal between two parties up to a much longer document in which several parties have legally-binding rights and obligations to each other.
Why should you use an MOU?
MOUs are often used when parties wish to put in writing the results of their initial negotiations. Signing an MOU indicates that the parties are serious above moving forward with each other. This may mean that the parties’ lawyers will then start drafting a longer and more formal binding contract or it may mean that the parties move on to another stage such as carrying out due diligence, securing a permit or speaking with potential investors.
Common scenarios include:
- When two parties are exploring a project but need to outline the scope of their cooperation before committing to a formal agreement. For example, a startup and a supplier might use an MOU to define shared goals while awaiting funding.
- An MOU is frequently used in the context of buying and selling businesses. A potential buyer may create an MOU (often called a ‘heads of terms’) which is used to set out various assumptions and conditions on which the buyer is prepared to purchase the business before carrying out full due diligence and then entering into a share purchase agreement.
- MOUs can be used in the context of music or film production. A film studio may want to engage a scriptwriter to develop the script for a new film idea. For example, authors who have written popular books may be offered an ‘option’ by a film studio to turn their book into a film. If the option is exercised, the scriptwriter will be asked to turn the book into a script. Prior to a formal engagement, an MOU would be used to allow the film studio and the scriptwriter to explore the terms (and cost) on which the scriptwriter will develop the script.
- An MOU can be used when a commercial property owner and a potential tenant agree on high-level terms for a lease but need time to finalise details, for example regarding maintenance. The MOU in this case usually addresses key agreements, like rent and lease duration.
- In the context of operating internationally with a state entity, an MOU may be the only document that the state entity is prepared to sign to work with the hopeful supplier.
The structure of an MOU
An MOU can vary in format, but there are basic elements it typically includes, such as:
- Introduction. This section identifies the parties involved and provides a brief background. It usually describes the purpose of the MOU and sets the stage for further discussions.
- Objectives and goals. This section will outline the specific objectives and goals that the parties wish to achieve and how they intend to work together to reach these objectives and goals.
- Roles and responsibilities. Clearly stating each party’s responsibilities is crucial. An MOU should address what each party will contribute to the relationship or project, whether it be resources, expertise, etc.
- Term and duration. An MOU may specify the timeline for the arrangement, outlining how long the understanding will last, any deadlines for future agreements or the period for negotiating the formal contract.
- Confidentiality and non-disclosure. If an MOU involves sensitive information, it may include legally binding confidentiality clauses to protect that information and outline how it can be used or disclosed.
- Dispute resolution. If a dispute arises, an MOU could govern how the parties should or may plan to resolve that dispute.
- Governing law and jurisdiction. If any parts of an MOU are legally binding, it is important to define the jurisdiction that governs the document.
- Signatures. It is useful to have the parties involved sign the document to evidence their agreement to the terms contained in the MOU.
Are MOUs legally binding?
Assessing whether an MOU is legally binding is usually straightforward if the MOU has been drafted properly to make the position clear. If not then examining the point can be a complex.
We have explored previously the requirements to make a valid legal contract that would be binding on all its parties. In determining whether an MOU is legally binding, the key question is whether the parties intended to create legal relations.
If a party does not have the necessary intention to create legal relations, a contract will not be formed. The starting point is that, between two businesses, there is an intention to create legal relations where promises are given and received (to ensure those promises are binding).
So, for the purposes of an MOU, both parties can seek to go against this starting point. This is why it is common for MOUs to contain terms such as ‘subject to contract’, ‘not-legally binding’, ‘subject to board approval’ and so on.
Indeed, the recent case of Sundorne Products (Llanidloes) Ltd v Geminor UK Ltd [2024] EWHC 1666 (Ch) highlighted that just labelling a document an MOU was not sufficient to demonstrate that it was not legally binding.
Importantly, an MOU can contain a mix of non-binding and binding provisions. For instance, confidentiality clauses and exclusivity clauses are often legally enforceable even in otherwise non-binding MOUs. To mitigate ambiguity, precise drafting is essential. The document should explicitly outline which terms are binding and which are not.
Other legal considerations
There are some other legal points to consider:
- Lack of certainty. Another requirement for a contract or contractual term to be enforceable is that it is certain. MOUs will often contain language which amounts to an agreement to agree on something in the future. That obligation, because it is effectively meaningless in isolation, may mean that the term or the wider MOU is non-binding (even if the parties intended to create legal relations).
- Lack of detail. One of the inherent challenges of an MOU is its informal nature, which often results in a lack of detailed terms and conditions typically found in formal contracts. Without precise language, the parties’ responsibilities and expectations remain vague. For example, phrases like ‘the parties will collaborate’ or ‘the parties will explore opportunities’ leave room for interpretation, making it difficult to determine whether either party has met these responsibilities and expectations or not. This can lead to unnecessary disagreements, especially when one party feels like the other has not fulfilled their role as intended. The lack of detail in an MOU may also cause delays or complications when transitioning to a more formal agreement.
- Confidentiality. MOUs often involve the exchange of sensitive information, making confidentiality clauses critical. The issues above apply to confidentiality clauses in an MOU. If the MOU is non-binding, then the confidentiality provisions may not be effective (albeit that a party may have other rights in the law of confidentiality). Likewise, if the confidentiality clause is unclear it may not be sufficiently certain to impose a contractual obligation of confidence. Confidentiality clauses should clearly define what constitutes confidential information, the obligations of each party regarding its use and disclosure and the duration of confidentiality obligations.
FAQs
Does an MOU need to be signed?
Not if the MOU is not legally binding. However, it is useful for parties to sign an MOU as evidence to demonstrate that the parties understood and/or accepted its provisions. However, the signing of an MOU may also serve as evidence that it was intended to be legally binding in which case clear language in the MOU would be needed to state which sections (if any) were legally binding and which sections were not.
Can an MOU be revoked?
That depends on whether the MOU is binding. If an MOU is not binding, then parties will not be legally obliged to adhere to its terms (therefore it is unnecessary for it to be revoked).
If it is binding, then it depends on whether the terms of the MOU allow either party to terminate.
Is an MOU confidential?
An MOU may contain terms stating that the information shared between the parties (or indeed the MOU itself) is confidential. If it is legally binding, those terms will be enforceable.
Even if the MOU is not legally binding, or it doesn’t contain confidentiality clauses, the parties may still be required under common law to keep the contents of the MOU confidential.
Conclusion
An MOU is a valuable tool for parties wishing to outline the essential commercial or operational terms of a potential deal or collaboration before entering into a more formal long form contract.
However, as with any legal document, careful drafting is needed for the reasons given above.
Consulting with a solicitor when drafting an MOU ensures that the document accurately reflects the parties’ intentions and minimises legal risks down the line. If you have any questions about MOUs, please do not hesitate to reach out to one of one our legal experts such as Colin Lambertus or Neil Williamson directly, or contact us here.
