Overview
A Memorandum of Understanding or MOU is a formal agreement between two or more parties who wish to enter into a business relationship to fulfill a common goal. Though it is an agreement entered between parties before actually preparing and signing the final contract, it is more of an understanding between the parties to initiate matters for negotiation with a promise to keep the matters confidential or prohibit from breach of any of the terms and conditions as mentioned in an MoU.
It is obvious to understand that business negotiations could be very long driven, it is necessary to chunk out the final points that are finally sorted out by the parties mutually. When the parties finally reach a consensus then they further indulge in negotiations and discussions through the MOU, which later acts as the guiding document for the preparation of the final document. Therefore, an MOU includes all the key points of an agreement as discussed & decided by the parties involved in the negotiation of the contract and could be seen as the starting point for negotiations as it outlines their intentions and expectations in pursuance of the business relationship.
A Memorandum of Understanding is governed under the provisions of the Indian Contract Act, 1872, and the Specific Relief Act, 1963 is responsible for the enforcement of MOU through the doctrine of estoppel. However, to enforce estoppel through the Specific Relief Act 1963, it is important to keep in mind that the conditions for enforcement of a contract must be fulfilled under the provisions of the Indian Contract Act 1872. However, if the parties fail to fulfill the conditions under the Contract Act, they can still approach the court of law based on the principle of promissory estoppel and equity. Thus, an MoU is not legally binding unless mutually agreed by parties to make it binding, but indicates the inclination of the parties to move forward together in the business relationship. Such memoranda are typically used in business agreements, principal contracts, in international treaty negotiations but also may be used in high-stakes business dealings such as business acquisitions & mergers.
Essentials of a valid Memorandum of Understanding
Though an MoU is not legally enforceable in a court of law until the agreement is signed or ratified between the parties or two nations. However, in cases where it satisfies all three essentials of Section 10 of the Indian Contract Act, 1872, it is then said to be legally valid. Furthermore, certain other essentials need to be kept in mind to make an MoU legally binding if so decided y the parties, which include-
- First and foremost, it is important to identify the intent of the parties who wish to agree. Though there could be more than two parties to an MoU, there must be at least two parties to enter into an MoU.
- There must be a specific date mentioned on the effective term of the MoU including the date of its effective date of initiation.
- The MoU must clarify the roles & responsibilities of all the parties. It must provide clearance for the terms of payments or any consideration involved.
- A MoU should specify the clauses relating to risk allocation and indemnification in case of conflict of interest arises between parties or any legal injury and further specify the party liable to make up for losses.
- An MoU should also provide for the events leading to the termination of an agreement wherein any of the parties could terminate the agreement at a given point in time.
What are the Objectives of a Memorandum of Understanding?
Provided below are the aims & objectives of creating a Memorandum of Understanding between the parties-
i. Sets out the Intention of the Parties-
One of the key purposes of drawing an MOU is helping the parties to get a better mutual understanding’s intentions & expectations from the business relationship during the negotiations without any risks of creating a legally binding document unless the parties agree to create one. Business negotiations may take a longer time and entering directly into a legally enforceable contract without observing its legal implications could be risky and time-consuming.
ii. Highlights the work being carried out-
The MOU defines the work being carried out in pursuance of the agreement between the parties to the MOU including the aims & objectives behind undertaking the work.
iii. No Legal Guidance is Mandatory
Since an MOU is not legally binding, it could be drafted in points & bullets in simple and clear language with a minimal amount of legal support.
iv. Encourages better decisions with Negotiation-
The MOU allows the parties to negotiate business terms and conditions freely without having to worry about its legal enforceability. It encourages the parties to specify their intentions and negotiate their interests in the contract.
Who uses a Memorandum of Understanding (MoU)?
Most of the persons concerned prefer to sign an MoU due to their benefits in the initial negotiation process. Provided below are the persons who generally agree to and sign an MoU in the general course of their business-
i. Countries- Where countries intend to enter into any bilateral arrangements or multilateral arrangements, they employ MOUs in the initial stages. Further, the aims & objectives to enter into such a legal arrangement are also specified in the MoU.
ii. Non-Governmental Organisations (NGOs) – Most the NGOs collaborate with business corporations or government agencies against any specific aim or objective through
iii. Memorandum of Understanding. The MoU so signed describes the aims & objective of the arrangement and the key roles & responsibilities of each party concerned
iv. Business Organizations – In key business partnerships or collaborations or agreements changing the structure of the business (investments, acquisitions, or mergers), the companies sign an MoU which is typically in the form of a term sheet. Processes like merger clearance or FIRB approvals are done only after an MOU is entered into.
v. Financial Institutions- Financial and other accounting institutions generally enter into MOUs with other organizations to carry out commercial partnerships.
vi. Government Agencies- Government agencies frequently enter into MoUs with other state governments or countries to ensure that specific standards are maintained always.
What are the different categories of Memorandum of Understanding?
There are two types of MoUs entered between the parties that have been provided below-
i. Exclusive MOU–
An exclusive MOU is arranged where parties wish to prohibit the parties to the MoU to enter into a similar relationship until the termination or expiry of the MoU.
ii. Non-Exclusive MOU–
A Non-exclusive MoU is one that does not have any form of exclusivity and is all-inclusive. The parties to the agreement under a non-exclusive are free and could enter into any similar MoU with any other parties. It allows the parties the freedom to enter any number of similar business relationships without any breach of the terms of the agreement.
How to draft an effective MOU?
Provided below is the step-by-step process of drafting an MOU-
i. Choose a Topic and title- Since there are various forms of MoUs used for every business relationship such as Joint venture, service MoU, term sheet, etc. Therefore, it is necessary to choose a topic & title of the agreement to disclose the type of MoU being used.
ii. Parties involved –Next, the MoU should disclose the details of the parties involved such as their names, father’s/spouse’s name (in case of an individual), and address of residence.
iii. Agreement initiation and termination details – Further, the effective date of the commencement of the agreement, including the date to start work/project, the events under which the MoU would get terminated, and in case the agreement is a one-time contract for a fixed timeline, the MoU must contain the date of its termination.
iv. Aims, Objectives & Responsibilities of each party – The MoU so entered between the parties must include a detailed description of the work/project undertaken to be fulfilled, deadlines for work completion, milestones and obligations of each party, etc.
v. Scope of the Project – Next, the MoU should specify the scope of the work/project along with the principles of the business organizations to offer a thorough understanding of the long-term use of the project and their partnership.
vi. Mention Important stakeholders– Declare the key stakeholders in the work/project committed to the work as collaborators, sponsors, investors or partnerships should also be stated in the MoU.
vii. Put Important Timelines – In case of contracts/projects involving deadlines, the MoU shall provide the important deadlines for deliverables. These deadlines should be cited in the MoU to replicate that all parties have agreed to and abide by the terms of the deadlines.
viii. Provide Other Terms and conditions– A MoU could also include any specific requirements or any terms such as representation & warranties, indemnities, etc. then these should be added to the MoU.
ix. Signatures– Finally put the date & sign of all parties involved in the MoU to represent their mutual agreement & understanding.
What are the contents of a Memorandum of Understanding between the Parties?
Though every MOU is specific to each work/project undertaken by the parties, there are some common terms in each MoU, that include-
i. Identification of Parties -The first clause is to recognize the parties agreeing concerning the work/project. This may include all the details of the parties entering the MOUs such as the names, addresses, and other contact information.
ii. Purpose of MoU- A MoU should describe the purpose of the agreement. It also lays down the obligations and responsibilities, important timelines, and significant dates for the work/project being discoursed.
iii. Legally Binding or Non-Legally Binding – It is important to specify whether the MoU is legally binding or not.
iv. Terms & Conditions- It is important to state the terms & conditions required for the completion and indicate the key commercial terms.
v. Due Diligence –The parties may desire to conduct due diligence and related processes of the other parties concerned.
vi. Deliverables- Recognition of the deliverables and their timelines associated with the project;
vii. Confidentiality clause-It would be necessary for the parties to protect the confidential information received by the parties in accordance with the terms and conditions of the project.
viii. Cost Allocation- The parties may already decide the allocation of costs and expenses related to various projects in cases where the agreement is binding.
ix. Governing Law & Jurisdiction – Finally, the parties may decide upon the governing laws and jurisdiction with respect to the terms of the agreement to refer to in cases of any dispute between parties or for any breach of the terms of the agreement.
x. Signatures – All MoUs should have signatures of all parties to reflect an agreement between all parties.
From the above contents, it should be imperative to note that certain clauses could be intended either to be legally binding or non-binding.
How to use a Memorandum of Understanding?
Once the MoU has been drafted and signed, it must be vetted properly. However, to increase their efficiency it would be useful to consider the support of a legal professional that could help to remove errors & omissions. After the terms have been settled between the parties, it would be essential to register the document. Though drafting an MoU is not tough, preparing the documents needs efforts to ensure that the terms & conditions discussed between the parties are achieved. In case the parties decide the MoU is legally binding and get it registered, the terms & conditions cannot be altered by parties. There could be various forms of MoU that are standardized and prepared as per the business requirement of the clients, which include the following-
i. Joint Venture MoU
In cases where the parties wish to enter a joint venture agreement, they may use an MoU for negotiation purposes in the early stages of discussions amongst two or more parties, which also goes by the name co-venture agreement.
A joint venture agreement is a temporary business agreement where parties mutually agree and decide to work together to fulfill a common goal and identify their respective roles & responsibilities. Further, there are two types of joint venture agreements namely, the contractual and general joint ventures.
ii. Service Agreement MoU
A service contract is a form of legally binding MoU entered between a service provider & his client and outline the terms and conditions of the services to be abided by the parties in pursuance of the business relationship. A service agreement MoU would create a mutual understanding and specify the services that would be provided by the service provider to his client in a non-binding document typically during preliminary negotiations.
iii. Outsourcing MoU
An outsourcing agreement is a contract entered between two or more parties which normally includes a company and a service provider. In pursuance of the agreement, the service provider agrees to provide specified services that are outsourced by the company. It includes elements such as expectations from the Services, legal consequences for breach of provisions, expected time of delivery of deliverables, or any potential exit strategies, etc.
iv. Asset Purchase MoU
An asset purchase agreement is an agreement signed between a seller and buyer to transfer ownership of an asset for a pre-determined price. Under the agreement, the seller decides and agrees to sell specific assets or to exclude any specific asset, if he wishes to exclude any. Some of the key elements include the aims & objectives of the agreement, details of the asset, pre-determined prices, Representation and Warranties, any conditions to be fulfilled before closing, etc.
v. Share Purchase MoU
A share purchase agreement is entered between the parties when one of the parties wishes to purchase shares of the other business entity and acquired ownership in the business. Such form of MoU includes terms & conditions such as rights & obligations of the respective parties, representations & warranties, identification of the parties, any restrictive covenants, agreed price of shares, consideration, etc.
Conclusion
Therefore, MoU is an important document useful in the early stages of a business negotiation before the preparation of the final draft contract and signing it for effect. Regardless of whether the agreement is legally binding or not, it is beneficial to put certain points which should be set out in the MoU. Also, if you wish to keep the information so shared during the process of discussions & negotiations, you should not forget to include the clause of confidentiality & non-disclosure which shall state that the statements/information exchanged between parties shall be kept confidential at all times and should not be disclosed to any third party or public. Once the memorandum of understanding is documented, the parties could also decide to make a certain clause legally binding while some other clause could be non-binding. Therefore, parties could ensure the enforceability of the important clauses in the MoU from the beginning by taking some small steps and keeping themselves aware of the legal implications of entering into the MoU, so that no party deviates from its agreements or promises in the future.
