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A memorandum of understanding (MOU), also referred to as a letter of intent, heads of agreement or term sheet, can be an extremely useful commercial tool. Parties use MOUs to quickly and inexpensively set out the commercial terms of a transaction. They do this ahead of entering into a formal contract to get the deal moving. However, is a MOU legally binding? In this article, we outline some indicators that your MOU is legally binding.

Is it a Final Agreement?

Firstly, a court will consider whether the parties have actually come to a final agreement. Often, parties use an MOU when they have commenced a commercial relationship but are still negotiating specific aspects of it.

If it is clear from the document that the parties are still negotiating, a MOU is probably not legally binding. Phrases such as “subject to further negotiation” will likely indicate that the parties have not come to a final agreement. Therefore, you should consider whether your MOU indicates that you have reached an agreement or that negotiations are still ongoing.

Is it a Complete Agreement?

To be legally enforceable, the MOU must contain all the essential terms of the agreement. Often, MOUs are not a complete agreement. Parties can leave several essential terms out because they have not decided on them yet.

Essential terms are the terms that parties must finalise before a court can enforce the agreement. For example, in an agreement between a gym and a client, the parties must agree to the time frame of the contract before the agreement is binding. However, deciding on the brand of the gym equipment is not necessary to enforce the agreement.

Accordingly, consider whether you have finalised the essential aspects of your agreement. Ask yourself whether enough information is present to hold the parties to their promises.

Was There an Exchange of Promises?

For the agreement to be legally binding, each party has to promise something of benefit to the other party, in exchange for something else. For example, in an agreement for the sale of a car, the buyer promises money and, in exchange, the seller promises the car.

Often, MOUs simply outline the common goals and expectations of the parties. They often use language that indicates discretion of performance, such as “Party A may” rather than “Party A will”. When the language suggests that a party can choose whether they hold up their end of the bargain, the MOU is not enforceable. Therefore, consider what the parties have promised each other and how certain those promises are.

Do You Have the Intention to be Legally Bound?

For the MOU to be binding, it must suggest that the parties intend to be legally accountable for their promises. To determine whether this is the case, consider the consequences of a breach.

If there is a lot at stake, it is likely that the parties intend to receive legal protection. In addition, look for clauses that explicitly state whether the parties intend for the law to bind them. Some MOUs expressly include clauses along the lines of “the parties do not intend to be legally bound by the above terms”.

MOUs often fall under the category of preliminary agreements, or “agreements to agree”. There are three categories of intention concerning preliminary agreements, where the parties:

  1. have come to a complete agreement and intend to be bound immediately, but want to rewrite the terms in a detailed document;
  2. have come to a complete agreement but do not intend to perform the agreement until they write a formal document; and
  3. do not intend to be bound by the agreement unless they write a contract.

The first two categories indicate an intention to be legally bound by the terms of the agreement. If the MOU falls into the third category, the law will not bind the parties until there is a formal contract.

Key Takeaways

MOUs and contracts are both tools to map out a commercial relationship between parties. MOUs do so in general and often incomplete terms, suggesting the parties do not intend for the law to bind them. However, when an MOU contains all the elements required for a contract, it will be legally binding, regardless of the title of the document.  If you need assistance creating or enforcing a MOU, contact LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

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