When Should a Memorandum of Understanding (MOU) Be Used Instead of a Contract?
A memorandum of understanding (MOU) can be a great asset to contract negotiation. Here are our tips on when to use an MOU, and what to avoid when drafting one.
When entering into business opportunities, understanding the possible impacts the style of agreements may have on your endeavours is important. A memorandum of understanding (MOU) is a valuable tool in the process of negotiating a commercial contract and may prove beneficial in avoiding conflict within business relationships. By understanding what an MOU is, we can then understand when to use it.
What is an MOU?
More formal than a simple handshake agreement, and less formal than a contract, an MOU is an expression from two parties to mark a business relationship.
However, an MOU is NOT a legally binding contract. It is just a way to establish some basic understanding between parties prior to formal negotiations.
Often used in commercial partnerships, it will likely take the form of a document.
How to make sure it’s not a contract
The contents of an MOU may include:
- The goal and purpose of the partnership.
- The roles of the parties.
- Some basic deadlines of the negotiation process.
DO NOT include specific terms and conditions regarding things like payments, standards or any promises to the other party.
Including terms that state you want to eventually agree to something, rather than agreeing to it within the document, is key here.
Be careful; otherwise, you might accidentally form a legally binding contract.
Intent is the basis of legally binding contracts. Both parties must sign a contract intending it to be binding for it to be enforceable. Intent is formed at the point both parties agree to the terms of the document. Hence, provided there is no intention for the MOU to be a legally binding contract, it will not become one.
This is why it is important to be clear on what you’re including within the MOU. Terms that appear to show an intention to be bound should be avoided. For example, don’t state specifics like what will be exchanged between the two parties.
Include a term stating that neither party intends for the agreement to be legally binding to avoid these issues.
Certain and Complete
Under contract law, an agreement is only binding when it is certain and complete; meaning that no further negotiations will take place as all the terms and conditions are included within the contract.
Under the various fields of contract law, certain terms and elements need to be included to consider the contract complete; such as prices, obligations etc.
An MOU is a tool in the process of negotiating, and so won’t ever be certain and complete in this sense.
So what are the benefits of an MOU?
As any business mogul will tell you, making sure that every party is on the same page is the only way you’ll progress in forming a deal. While it’s easier said than done, an MOU is a great tool to use in achieving this. Particularly if the intended project is long or complex, aligning your values and setting expectations during initial negotiations may help avoid conflict later down the track.
Forming open and honest business relationships promote mutually beneficial outcomes without binding your or the other party to any legal obligations. Think of it as a formalised handshake where you both make it clear to each other that you want this relationship to succeed.
Likewise, an MOU is particularly beneficial where you remain sceptical of certain ideas from the other party. As you are not legally bound, it has the benefit of not exposing you legally or requiring formal termination if negotiations break down.
Still, you should consider what is best for your situation. In situations of high risk or where you want to leave nothing to chance, to create a formal contract earlier rather than later may prove to be the better option.
Often underutilised amongst small business, an MOU is a strong tool in negotiation practices to avoid negative business relationships. While it, of course, doesn’t guarantee against these, it provides a simple way to at least promote open and friendly business relationships. Hence, when to use one will depend on what you wish to achieve from your agreement. Ask yourself, do you want to establish a relationship, or do you want to bind someone to an agreement legally?
Daniel is a Legal Tech Intern at Lawpath. He is currently studying a Bachelor of Laws/Bachelor of Business at the University of Technology Sydney. His principal fields of interest are in commercial, corporate and intellectual property law.