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What is a Memorandum of Understanding and is it Legally Binding?

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Last revision: 29th May 2020
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Category: Sales and Commerce

A Memorandum of Understanding (also known as an "MOU" or a "Heads of Agreement") is a very useful document in many business transactions. It is an informal document, outlining the basic terms of a deal, but not going as far as a formal contract does. It is intended to be quick and easy to prepare, so that the parties can set out their basic agreement, and can confirm they are on the same page.

Usually, an MOU is not legally binding. However, as with any legal matter, this can vary depending on the circumstances. In some cases, MOUs have been found to be legally binding. We will cover this in more detail later in this guide, but if you have any concerns about your own situation, seek legal advice.

What is an MOU?

An MOU is a basic document which can be used between two or more parties that are interested in working together on a particular project. It is intended as a starting point for the parties, as it enables them to set out the preliminary agreement which has been reached and can help them to work towards a more formal agreement.

For example an MOU could be used as a first step before parties commit to working together under a Partnership Agreement, Service Agreement, Business Sale Agreement, Contract for Sale of Goods, or a Joint Venture Agreement. Although the parties may intend to eventually enter one of these agreements together, in many cases, for a variety of reasons, the parties may not be ready to actually formalise the arrangement.

For example, the parties might have reached an agreement in principle, and they want to document this. But before finalising the terms and making it legally binding, they want to go away and discuss the matter with their business partners, professional advisers, or lenders. In order to facilitate these sorts of discussions, it can be very helpful for the parties to have the general terms of the agreement written down in an MOU.

Most MOUs are not intended to be legally binding, meaning that the parties may not actually be legally obliged to comply with it. This is because in many cases, parties may not actually be certain about the specific terms which they can agree to, but they still find it beneficial to put something in writing, outlining some broader goals (such as the general nature of the project), and confirming that they will act in good faith in pursuit of those goals. Often, parties may sign a Memorandum of Understanding outlining some general agreement, and then will go away and make some further investigations before working out the finer details.

Although a party may not be legally bound by this Memorandum, many parties feel compelled to comply with it anyway - firstly, because the Memorandum does actually describe what they intend to do, and secondly because they are wary that a failure to comply can harm their professional reputation and their ongoing relationships.

When should I use an MOU?

Think of an MOU like a "handshake agreement". It is very useful if you are not quite ready to enter a binding legal agreement, but you do want to indicate your commitment to some kind of project or endeavour.

For example, you might use an MOU if you are proposing to sell a business, and you have reached an informal agreement with the purchaser about the price and the basic terms of sale. It can be helpful to prepare an MOU so that you can both go and speak to your lawyers, accountants, lenders, business partners, spouses or other relevant parties, in order to get the ball rolling on the transaction.

Alternatively, MOUs are often used between two or more parties who are considering some kind of joint venture or business partnership. Again, the parties use it to set out the basic terms in an informal manner, before going away and spending time clarifying the finer details.

What are the advantages of an MOU?

An MOU can be prepared in a few minutes, rather than the few weeks that it might take to finalise a formal contract.

Although an MOU is usually non-binding (meaning that the parties can pull out of the deal without legal consequences), it does show that an "in principle" agreement has been reached. For most people, this does count for something, and they will act in good faith in accordance with the MOU.

It also allows parties to be somewhat more vague, if there are certain details that they are not clear about. This can be both an advantage and a disadvantage. For example, a purchaser might need to check with their financial institution before committing to a particular payment schedule. In an MOU, they may be able to enter an approximate payment schedule, without fear of legal repercussions if they fail to meet it.

How do I know if my MOU is legally binding?

As we've already discussed, most MOUs are not legally binding. However, this obviously varies from one MOU to the next. We cannot confirm whether or not your MOU is legally binding. If you need to be sure about this, then you should seek legal advice.

There are various factors which will help to clarify whether or not an MOU is legally binding.

1. Do the parties intend to be legally bound?

Many MOUs that are not intended to be legally binding, will include some words to this effect. For example, they might include a clause which says "This Memorandum is not intended to be legally binding". Obviously, this sort of wording is a clear indication that the parties do not intend it to be legally binding.

However, aside from this, a court would look at the entire circumstances of the matter, to determine whether the parties actually intended to be held legally accountable for what was said in the MOU.

For example, if a party is going to face significant losses in the event that the MOU is not complied with, then a court might find that the parties actually intended for there to be legal recourse in the event that one party backed out.

Additionally, in some cases, the parties might use an MOU to bind them immediately, notwithstanding that they are going to follow up with a formal contract that goes into a bit more detail. Again, in these sorts of cases, an MOU might be found to be legally binding.

Our template Memorandum of Understanding is not intended to be legally binding, however we cannot guarantee that this is what a court will decide in your circumstances. Therefore, if in doubt, seek legal advice.

2. Is the MOU a complete agreement?

An MOU is more likely to be binding if it contains a complete outline of the essential terms of the agreement between the parties. If it only includes some of the terms of the agreement, with further details to be clarified at a later date, then it is less likely to be legally binding.

In many cases, parties do not have all of the essential terms available when they prepare an MOU, and this is part of the reason that they are preparing an MOU rather than a final contract. However, in some other cases, the parties do actually have the essential terms available, and enter them into the MOU.

When we talk about the essential terms of the agreement, we are talking about the essential terms that set out how the arrangement between the parties will take shape. The finer details may not be necessary. For example, if the parties have agreed to buy/sell some goods between themselves, then the essential terms of the agreement might include details such as:

  • description of what is being bought/sold
  • purchase price
  • deposit
  • date of transaction
  • date of payment
  • date of delivery
  • consequences for breach of the agreement

However, details such as the form of payment (ie whether it is by cash, cheque or bank transfer), or the name of the freighting company that will deliver the goods, might not be essential to the agreement. If the MOU contains all of the essential terms, it might be legally binding, even if the MOU does not confirm the name of the relevant freighting company.

3. Is the MOU a final agreement?

If the MOU indicates that the parties have not yet come to a final agreement, then a court may find that it is not legally binding.

For example, if the parties have actually said within the MOU that it is subject to final agreement, subject to further details being provided, or subject to further negotiation, then this clearly suggests that the MOU is not the final agreement, and the parties do not intend to be legally bound.

In fact, this is a common reason why many parties choose to prepare an MOU in the first place. They want to start some kind of commercial relationship with the other party, but they are not ready to confirm their final agreement.

4. Did both parties promise something?

Under Australian law, for a legally binding agreement to be created, both parties need to promise something to the other party, in exchange for something else.

For example, in the case of a contract for a landscaping project, one party promises to perform some landscaping work, in exchange for a sum of money. The other party promises to provide the sum of money, in exchange for the landscaping work.

If this sort of exchange of promises has occurred, then this can indicate that the agreement is intended to be legally binding. However, many MOUs do not actually contain this sort of exchange of promises. Instead they set out what the parties "might" do or what they aspire to do.

Applicable law

Although an MOU may not be legally binding, ordinary principles of contract law, as provided by the common law, may still be applied in interpreting and understanding the agreement between the parties to an MOU. These principles of contract law may also be applied in order to determine whether or not the MOU is legally binding.

In the event that a party acts in bad faith, causing another party to suffer loss, then general principles of equity, estoppel, or laws dealing with misleading and deceptive conduct may become relevant.

In conclusion

A Memorandum of Understanding or MOU is an extremely useful document in many business negotiations. It provides a quick and easy way for parties to outline the basic terms that they have discussed, and can enable them to get the ball rolling on the proposal.

In most cases, an MOU is not legally binding, but in some cases it is. Of course, whether or not your MOU is legally binding is going to come down to your own personal circumstances. If in doubt, seek legal advice.

Templates and examples to download in Word and PDF formats

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