A Memorandum of Understanding expresses the intention of the parties to come together for an arrangement. Here’s an article on the basics of MOU. Now, considering that MOUs are not categorized as contracts, there is often ambiguity regarding the enforceability and binding nature of MOUs. In this write-up, the author has attempted to clear the said ambiguity and discussed the possible types of MOU from the legal point of view.
Is MOU legally binding?
Going by the purpose and primary nature of an MOU, it’s non-binding. However, in exceptional circumstances it may fall under the category of a legally binding agreement. In this article, the author has analyzed the following criteria which are often used to determine the binding nature of an MOU:
1. Nomenclature: The term ‘Memorandum of Understanding’ is usually used to establish a non-binding agreement. But it does not always imply a non-binding agreement. The Hon’ble Supreme Court in the matter of State Of Orissa & Other vs The Tltaghur Paper Mills Company held that “…the nomenclature and description given to a contract is not determinative of the real nature of the document or of the transaction thereunder. These, however, have to be determined from all the terms and clauses of the document and all the rights and results flowing therefrom and not by picking and choosing certain clauses and the ultimate effect or result….” Therefore, it is clear that the nomenclature is irrelevant when it comes to identifying the binding nature of an arrangement in MOU.
2. Essential elements of a contract: The fact that both the parties promised each other to undertake a transaction, would not turn it into a binding contract in the absence of the essential elements of a contract. Section 10 of the Indian Contract Act lays down following the essential requirements for an agreement to be treated as a contract:
- The agreement should be made with the free consent of the parties.
- The parties shall be competent to contract.
- There should be a lawful consideration and lawful object.
- The agreement must not be expressly declared to be void.
If the above elements can be proved and the MOU does not violate any of the provisions of the Indian Contract Act, it shall be considered as a legally binding agreement irrespective of the nomenclature or non-binding disclaimer.
3. Legal Intention: Intention of the parties play a huge role in identifying an MOU as legally binding or non-binding. But how do courts examine the intention of the parties which may or may not render an MOU as legally binding. Following are few scenarios through which the intention of the parties is examined:
- Insertion of legally binding clauses: Clauses such as ‘exclusivity’, ‘indemnification’, ‘dispute resolution through arbitration or courts’, and ‘applicable laws’ expresses the intention of the parties for a legal commitment.
- Stamping or registration: Apart from statutory requirements, stamping or registration also safeguard the interest of the parties and makes it easier to enforce the MOU or allow it to be used as evidence in case of disputes. These requirements also solidifies the intention of the parties for having a legally binding agreement.
- Acts of the parties: In case the parties are rigorously complying with their responsibilities, they may try to enforce the MOU in case of any breach or default.
- Language: Usage of words such as “shall” instead of “may” or writing expressly about the legally binding nature of the MOU reflects the intention of the parties.
Three types of MOU
Now that we have examined whether an MOU is legally binding or not, it is prudent to understand the possibility of all kinds of MOU. Surprisingly, even after considering all the MOUs that people enter into, there exists only three kinds of MOU. Every MOU can be categorised in any one of the following kinds of MOU:
1. Legally binding: At times, parties do not intend to enter into any definitive agreement at all. They only put together an MOU and consider it final and fully binding agreement amongst them. These MOUs are generally entered by government corporations, international organizations, charitable/ research institutions, etc. These kinds of MOUs are generally not subject to any formal agreement and consist of all the essential elements of a contract and thereby serve as a legally binding contract.
However, sometimes, parties enter into legally binding MOU at a nascent stage when all the terms and conditions are not finalised and negotiations are yet to take place. But the deal is finalized and parties intend to legally bind themselves to the commitment and later on enter into formal agreement after negotiations and finalizing all the crucial terms.
Through this MOU, parties express their commitment to complete the transaction.
2. Non-binding: These agreements are entered at the preliminary stage of a transaction and are made subject to execution of a formal agreement at a later stage. Parties may enter into a non-binding MOU for various reasons such as the terms and conditions are not completely determined, kick-off the negotiations or just to officially announce that the parties are proposing a deal.
3. Hybrid – vague combination of above two: The binding nature of these MOUs is subject to the discretion of the courts who may or may not enforce it by analyzing the language of the MOU. All the dubious cases hanging by the thread in which it is difficult to figure out the binding nature of MOU falls under this category. Usually, these MOUs fail to clearly express the intention of the parties due to poor drafting. It is hard to identify the true nature of the MOU because of following reasons:
- Certain clauses determines a non-binding MOU as a binding one; or
- One party intended the MOU to be legally binding, but not other; or
- The MOU was subject to become binding on occurrence of certain event
Just because of drafting the MOU with words “binding” or “non-binding”, its binding nature does not get determined. The language of the MOU and intention of the parties determines whether the MOU is enforceable or not. Whatsoever, a non-defaulting party may still try to recover damages from the defaulting party in courts by proving the intention or commitment of parties. The parties must be discreet while drafting the MOU because if it is drafted in language similar to that of a contract, the parties may indirectly bind themselves in a legally binding commitment regardless of the terminology used for that MOU.