Purpose of an MOUAn MOU can facilitate commercial transactions by providing a framework within which the parties can negotiate the conditions of the final contract. It may also be used to demonstrate to third parties, such as financiers, that the parties have reached agreement on the fundamental terms of the deal.
In addition, MOUs may address legal issues that effect the parties in the pre-contractual stages of their relationship, including, for example, confidentiality requirements, public announcements, exclusivity, due diligence arrangements and governing law and jurisdiction.
However, a detailed MOU that is legally binding may prematurely limit a party's flexibility in future negotiations or undermine that party's bargaining power. Alternatively, if it is intended that a party will perform some of its obligations based on the terms of the MOU, it is essential that the MOU be sufficiently comprehensive so as to protect that party’s interests.
Binding or non-binding?
Whether an MOU is binding is a question of general contract law1. However, two key issues that are particularly problematic in the context of MOUs are:
- Did the parties intend at the time of signing the MOU to be bound by its terms?
- Are the essential terms detailed in the MOU sufficiently clear and certain?
It is important to be aware that some people will presume the terminology used to describe the preliminary agreement (for example, MOU, heads of agreement, letter of intent) demonstrates their intention to be bound, while others will presume the exact opposite.
To determine if a party intended to be bound by the MOU, the courts will apply an objective approach and ask if an intention to be bound can be reasonably inferred in the circumstances.
Unquestionably, the best way to avoid uncertainty as to intention is to include a clear and unambiguous clause in the MOU that sets out whether or not the MOU is intended to be binding on the parties and, if so, whether it is intended to be binding in whole or in part.
The following provision (or a variation) might be seen in an MOU that is intended to be binding on the parties:
"This MOU creates legally binding relations between the parties":
On the other hand, if the parties intend that the MOU will not be binding (or perhaps binding only in part) the parties may include a clause similar to the following:
"The parties acknowledge and agree that this MOU, excluding [refer to any provisions which are meant to be binding, eg confidentiality, announcements, due diligence,etc] reflects their intention to conduct further negotiations in good faith and its contents are not legally binding."
In addition to demonstrating clearly that the parties intend to be bound by its terms, in order to be binding, the fundamental terms of the MOU must be sufficiently clear and certain. Terms such as “usual terms” and “fair and equitable price” for example, may be too vague to be meaningful and the courts may refuse to enforce them.
A party may be held liable pursuant to the MOU, notwithstanding that the MOU does not constitute a binding contract. Specifically, a party may be stopped from denying that the MOU is legally binding as a result of that party’s conduct. Furthermore, a party may infringe statutory provisions precluding misleading and deceptive conduct.
Irrespective of whether the MOU purports to be legally binding, parties should also consider their tax position prior to entering into the MOU. A party’s tax liability may be assessed on the basis of the transaction evidenced in the MOU, notwithstanding that the actual transaction is eventually structured differently. The date of the MOU may also be taken as the date of the transaction for tax purposes.
Agreements in relation to the negotiation process
MOUs often contain a statement to the effect that the parties undertake to negotiate in good faith, with a view to finalising the terms of a formal agreement to be entered into between them.
Traditionally, the common law will not recognise an attempt to impose an obligation to negotiate in good faith as a binding contract, as it lacks sufficient certainty. Similarly, it is generally accepted that a court will not enforce a mere agreement to agree.
An alternative is a “lock-out” clause, which generally provides that the party bound by the clause agrees not to negotiate with third parties. It does not, however, oblige either party to complete the transaction. In order for a lock-out clause to be effective, the following two essential elements must be satisfied:
- There must be consideration; and
- The length of lock-out must be restricted to a definite period of time.
A lock-out clause may, however, be unenforceable if the lock-out period is, in the circumstances, so long it is unreasonable and, accordingly, constitutes a breach of the restraint of trade doctrine.
The following is an example of a lock-out clause:
“From the date of this MOU until [date or event] or such other date as is agreed in writing by the parties:
(a)[party X] must not, without the prior written consent of [party Y], conduct negotiations of a similar nature to those contemplated by this MOU with any third party or enter into an agreement with any third party in respect of [subject of negotiations] or any matter similar to the subject of this MOU; and
(b)[party Y] must not, without the prior written consent of [party X], conduct negotiations of a similar nature to those contemplated by this MOU with any third party or enter into an agreement with any third party in respect of [subject of negotiations] or any matter similar to the subject of this MOU;”
Clearly, MOUs are an effective tool in commercial transactions to further the negotiation process. Advisers need to be particularly aware, however, of the extent to which MOUs are legally binding on the parties.
1 That is, there must be offer, acceptance, intention to be legally bound and consideration.