Why memorandums of understanding (MoUs) make practical sense for sealing the deal

An MoU is a document that records the willingness of two or more parties to move forward with a legal contract.

Also known as ‘heads of terms’ or ‘letters of intent’, they are used for a wide range of purposes and are often put in place to assist with the negotiation of supply and distribution agreements and service contracts.

Are MoUs legally binding?

Memorandums of understanding are not intended to be legally binding in their entirety.

The commercial terms included in an MoU are usually a general indication of the parties’ intentions and form the basis for negotiating and preparing a formal contract. The more commercial points or issues that are identified at this stage the less need for negotiation when the content of the MoU is eventually converted by lawyers into a detailed formal contract.

However, MoUs often contain specific provisions that are intended to be legally binding until the formal contract is prepared, signed and dated, particularly those relating to confidentiality, exclusivity, business protection restrictions and abortive cost clauses, particularly if the parties have not already entered into a separate exclusivity or non-disclosure agreement. Such legally binding aspects of an MoU help to protect commercial positions when parties may be exposed to bad faith activity to snoop on rivals or gain know-how without paying for it.

When drafting a memorandum of understanding, if you intend the parties to be legally bound by a provision, you should ensure that the provision is clearly identified as such within the document.

Benefits of an MoU

 There are several benefits to agreeing to a memorandum of understanding for a commercial transaction. These include:

• transparency for all parties about their responsibilities under the deal, what each is getting out of it and related timescales; and
• giving the management and directors the chance to review and approve the related transaction at an early stage and to scrutinise it before it is signed off.

What to include in an MoU

Although there’s no ‘one size fits all’ template for a memorandum of understanding, some common provisions found in one include:

• Contract Particulars: The contracted duration of the project or commercial arrangement; core activity, deliverables and dependencies from each party in respect of the project or commercial arrangement and pricing and payment terms.
• Principles of collaboration: You should agree to adopt a number of principles when carrying out the project or progressing the commercial arrangement. For example, collaborating and co-operating with one another, being open, acting in a timely manner and adhering to statutory requirements.
• Exclusivity: This provision should be included if the parties intend to work under an exclusive arrangement. For example, in a supply agreement, the buyer may agree to buy the goods exclusively from the supplier and not any third party.
• Data Protection: This provision should identify the role each party plays in data processing, what processing activity will take place and whether any personal data is to be transferred outside of the UK and European Economic Area (EEA) territories.
• Confidentiality: This provision is generally intended to be legally binding as most parties want to ensure that any negotiations they enter into regarding a deal (including the nature and scope of it) remain confidential. When drafting a confidentiality provision, you should carefully consider the time period within which the parties must comply with their obligations (this should be dependent on the sensitivity of the information).
• Intellectual property: The intention of each party around ownership of intellectual property rights that are created in the course of the collaboration should be recorded, so that it’s clear which party owns these. A licence should then be granted to the other party so that they can use the intellectual property for the purposes of the project.
• Restrictions: These are often included to prevent the parties from doing something or acting in a specific way. A typical restriction would be for non-solicitation of business. Although the parties are free to agree whatever restrictions they wish, the starting point is that they need to be reasonable to be enforced – so protecting a legitimate business interest.
• Abortive costs: Often parties agree that if one of them ends negotiations for the formal contract then one party is to pay a proportion of the legal and other costs of the other party. This can, even if not intended, operate to deter bad faith negotiation where one party has no real intention of ever entering into a formal contract and is only using the process to evaluate a rival or gain know-how without paying for it.
• Governing law: You should choose an appropriate governing law and jurisdiction clause to apply to the agreement. Generally speaking, if all parties to the MoU are based in England, and the project will also be undertaken in England, it would be sensible to choose English law as the governing law.

Key takeaway

To reiterate, memorandums of understanding are not intended to be legally binding and should not be used as a substitute for a legally binding contract.

MoUs are not designed to include much detail but should identify core commercial points/issues that are to be used in preparing the detail of the formal contract.

An MoU should serve as a tool to help with drafting a legally binding formal contract and, if you intend for the parties to be bound it, you should ensure that it’s as detailed and carefully drafted as a formal contract.