A Memorandum of Understanding is a formal document that sets out the principles underlying a prospective agreement between two or more parties.
A Memorandum of Understanding is also known as a “letter of intent”. An MOU is frequently used in business settings to establish and record the intention of the parties.
An MOU indicates the parties’ willingness and intent to proceed with a contract and is a pre-contractual document in anticipation of a future contract. As a result, you may want to use an MOU if you:
- do not want to immediately enter into a legally binding agreement
- want to outline a mutually beneficial business relationship
- want to outline the mutual goals of a commercial partnership
A Memorandum of Understanding can be viewed as the starting point for negotiations because it defines the scope and purpose of commercial discussions. An MOU helps the parties to develop understanding and achieve progress in commercial negotiations.
An MOU is similar to a terms sheet or heads of agreement, but is usually more high-level and expressed in more general terms than these kinds of documents.
An MOU that is not legally binding
Generally, parties will enter into a Memorandum of Understanding (or a Letter of Intent) so that they can quickly record the principles of an agreement, without creating a legally binding contract.
In some cases, the fact that an MOU is not legally binding may be a benefit, since neither party is required to fulfil the requirements of the MOU. Instead, they can walk away from the agreed principles or change their intentions.
To ensure a Memorandum of Understanding is not legally binding, an MOU will generally contain a clause that states “This document is not, and all parties intend that it is not a legally binding or legally enforceable document”.
An MOU that is legally binding
What terms are usually included in an MOU?
The process of preparing an MOU often begins with each party offering its own best-case terms. Each party will consider their ideal or preferred outcome, what it believes it has to offer to the other part(ies) and what points may be non-negotiable on its side. This is the starting position for negotiations.
An MOU generally contains the following terms:
- a description of the parties
- the date of the document
- a description of the project under consideration
- the scope of the MOU, and each party’s role and responsibilities
- the document is a statement of intent only
- the document is not legally binding
- an execution clause for the parties to sign
While it is not usually a legally binding document, an MOU is an important step in a commercial relationship. Time and effective drafting skills are required to negotiate and draft an MOU that accurately and appropriately records the commercial agreement of the parties.
To create an MOU, the parties involved must first reach an agreement on the commercial principles. This provides the parties with a road map and visibility of what is important to the other before moving forward with a formal contract.
What is the difference between an MOU and a contract?
The differences between an MOU and a contract include:
- a contract is legally binding, an MOU is (usually) not legally binding
- an MOU expresses an intent to enter into a contract, whereas a contract generally expresses the full extent of the agreement and is not a precursor to something further
- an MOU is a tool to record or negotiate commercial principles, whereas a contract definitively states the commercial arrangement
Memorandums of Understanding can take time to prepare. However, compared to the potential time and effort required to formally document a legally binding agreement, an MOU can be a good place to start and record some general principles that the parties agree to.
For example, a retailer and a manufacturer may enter into a professional business relationship by agreeing to an MOU. The MOU may outline how they will collaborate to achieve mutual commercial goals. They do not necessarily need to have agreed on prices or product standards at this point. They may later enter into a supplier contract outlining the cost and specifications of the products.
Memorandums of Understanding are an important part of doing business. An MOU allows each party to clearly state their goals and expectations of one another in general terms. Drafting an MOU can aid in the resolution of any high-level disagreements before each party enters into a legally binding contract.
Contributors: Farrah Motley (Director of Prosper Law), Nada Saleh (Legal Intern), Hadba Alzammam (Legal Intern) and Ziad Baraja (Legal Intern)
Farrah Motley | Director
M: 1300 003 077
A: Suite No. 99, Level 18, 324 Queen Street, Brisbane, Queensland Australia 4000