The Concept of Memorandum of Understanding Defined
A Memorandum of Understanding is a type of document that outlines an agreement between two or more parties. The MOU describes in general terms each parties’ requirements and responsibility in the "understanding" it is making. An MOU typically expresses a convergence of will between the parties on specific courses of action, present or future.
MOUs are usually informal and less legally binding than a contract. However, they may be enforceable like a contract under certain conditions, such as when it contains an offer, acceptance, and consideration (although not necessarily monetary consideration). If the agreement does not establish a close enough connection between the parties, such as a very definite meeting of the minds, a court may hold it is not enforceable.
For example, a potential business partner and creditor may enter into an MOU to signify that they are serious about working together. They may not be entering a legally binding contract; they may actually sign a non-binding MOU simply to memorialize that they have come to an agreement . An MOU can be an essential step before aligning two parties on specific roles and responsibilities, identifying financial contributions, and deciding on other matters like satisfying certain conditions before moving forward.
Or, consider a property lease transaction. To avoid a more formal deal and because both parties agree it is acceptable to do so, they may sign an MOU that identifies all the basics of their agreement, such as that the tenant will pay a specific monthly amount for occupancy in a certain unit. The MOU may be accompanied by a receipt indicating payment of a good faith deposit that could also be applied to certain damages if the tenant fails to meet the terms of the MOU.
Conversely, both parties may call the document an MOU, but the document may actually contain contract language. NOTE though that relying on the language used rather than the actual intent of the parties as evidenced by their conduct and other facts surrounding the case could lead to erroneous decisions by a court.
Gaining a Deeper Understanding of Contract
While the terms of both a memorandum of understanding and a contract may appear similar, they are both quite different from one another and can be differentiated by the binding nature and legal elements required to understand each type of agreement.
Contracts are written or verbal agreements which include one party (the first party) receiving something of value from the other party (the second party), and the second party receiving something of value in return. For a contract to be binding, it must also involve either a promise for an act or a promise not to do an act.
Typically, our clients request us to review contracts to ensure that parties they are engaging with will be bound to agreements they have entered into. Contracts may be oral or written, but the terms of a contract clearly define behavior and actions so that they are commercially binding and enforceable by law. For a contract to be binding, it must include the following elements:
- Offer
- Acceptance
- Consideration (which can take the place of something valued)
- Competence or Capacity (i.e. legal capacity to contract)
- Mutuality
- Legal Purpose (i.e. legality of purpose/code)
The UK Department of Trade describes the following types of contracts: ‘Service Contract’, ‘Fixed Price Contract’, ‘Framework Contract’, ‘Supply Contract’, ‘Works contract’, ‘Construction Contract’.
Exploring the Key Distinctions Between MOU and Contract
An MOU is often used in situations where two entities want to outline an agreement amongst themselves and go on the record, but don’t intend for it to be binding. A contract, however, is always – at least in theory – binding. The distinction, then, between this non-binding document and a binding one, is that an MOU does not create a legal obligation for either party to fulfill any particular promise identified within it.
An MOU also does not stipulate behavior to the same extent a contract does. The nature of an MOU is informal, and as such, it tends to leave a great deal of the particulars involved with an agreement for the two parties (or more) to figure out as they work toward a given end goal.
These two documents can also differ in the case of their enforceability. Since an MOU does not necessarily create legal obligations, it is inherently not binding. A legally binding contract, on the other hand, puts forth expectations for what each party is obligated to do, what it will gain in return for its performance, and what would happen if the contract were to be breached.
While a contract is legally binding, an MOU is not. But this is not to say that an MOU is always just an MOU. It may be legally binding, even if not always considered so.
One of the biggest distinctions between the two is the relatedness of intent, formality and details. An MOU simply focuses on the "spirit" of a bilateral understanding, and in so doing, it tends to involve a less detailed outline of the agreement.
A contract, in contrast, is a much more formal document. It requires more intention, by way of a signature, in order to clarify parties’ intentions and make the agreement possible.
The more specific the agreement in question is, the more essential a contract becomes. If the two parties in question have a great deal of detail to put forth because of the specific nature of the agreement, it can be in their best interests to enter into an official contract with one another.
An MOU is typically about outlining broad strokes of an agreement, creating the spirit of the agreement, while a contract involves specific, and sometimes, exhaustive details about the agreement itself.
Legal Aspects and How MOU is Regulated and Enforced
Both MOUs and contracts carry legal implications. In the case of MOUs, both parties intend to be bound by their agreement. However, oftentimes, an MOU is a non-binding agreement in which one or both of the parties are free to exit without incurring a legal liability. On the other hand, a contract is a formal legally binding agreement of two or more parties. Because of the legally binding nature of contracts, the consequences for non-performance or breach can be severe. Breaches include being liable for direct and indirect damages, back pay, loss of future income, compensatory damages, and even contract rescission. However, an MOU that is not compliant with the law, such as those that are contrary to public policy, are void and unenforceable. Agreements that are based on fraud, duress, lack of capacity, illegalities, or unreasonable restraint of trade may also be unenforceable.
Determining When an MOU or Contract is Necessary
An MOU is not appropriate for every situation. For instance, if you are trying to secure a contract where financing is dependent upon an agreement being in place for an extended term, then an MOU is not the best choice. In many instances where there is a large financial component, a contract is preferable. A contract specifies the terms of the agreement and the performance of each party with respect to those terms, whereas a MOU lays down the basic framework for a deal. In some contexts, such as when a builder or developer wants to buy land, an MOU is not sufficient because the purchase of the land must be documented by a deed.
Having said that, there are some scenarios, such as when parties are seeking a joint bid for a government contract or are coming together on a collaborative effort, where an MOU might be the better choice . In these cases, it would be up to the parties to decide in which way would be most beneficial to them and whether a legally binding contract would be optimal. In summary, the best way to know which document is appropriate for a deal is to assess the needs and goals of the parties involved. For example, if all that is needed is a statement of intent, then an MOU would be an appropriate and efficient approach. However, if there is significant value at stake, a contract may be justified. Still, in these circumstances, the parties may want to first enter into an MOU to serve as a basic guide for the deal. Too often parties fail to establish if a deal has been struck and will engage in expensive litigation to discover that no deal had been reached and there is no basis to sue for breach.
Practical Applications and Case Studies in the Real World
We’ll use two examples from the healthcare industry to compare MOUs and contracts, and how the different levels of legal enforceability can play a part in day-to-day operations. In both scenarios, we’re assuming that a hospital group is merging with another group, and setting up a joint venture.
Example #1
The joint venture is deemed to be a big success, everyone working well and creating a quality healthy system together. The joint venture turns out to be very good for all those associated with it, and meets all parties’ needs.
Example #2
The joint venture isn’t working out so great. It hasn’t been in operation long enough to really tell if this system will work, but already there are problems. The two hospital groups don’t share the same goals for the system and top doctors aren’t happy with it. Even though the relationship needs to be reviewed and reassessed, it’s not clear that how to do that in the MOU (or even what the MOU says), and no one is even sure where the written agreement is kept.
Important Things to Remember When Drafting an MOU or Contract
When crafting either a MOU or a contract, one of the first questions parties must determine is whether they wish the agreement to be binding or non-binding. This distinction can have a dramatic impact on the nature of the agreement. If a binding contract is preferred, it should generally contain all of the terms necessary for valid contract formation under applicable law-including consideration, mutual intent to be bound, an offer, an acceptance, and the required legal capacity of the parties to contract. Even MOUs can bind parties to perform contractual obligations (although, certainly, the parties could clearly indicate in the MOU that it is non-binding), which is why it is best to address such matters up front in the document. Moreover, treating an MOU as a binding contract could mean that a party is obligated to pay damages for a breach and fails to plead illegal contract formation (e.g., unconscionability, incapacity, etc.). Parties should also prevent any injustice that may arise; if there is any potential for misunderstanding between the parties in entering into the MOU or contract, or in performing the obligations thereunder, they should be sure to include appropriate provisions to address those issues. One way to gain clarity is by incorporating appropriate legal language into the agreement. Moreover, to ensure mutual understanding of the agreement, the parties should consider the following best practices: Any particular considerations to avoid are the following: By following these practices, parties will be better protected when entering into a MOU or contract.
The Closing Thoughts on MOU vs. Contract
In conclusion, understanding the differences between an MOU and a contract is essential for parties looking to formalize their agreements. While both documents serve to record the terms of an agreement, an MOU typically conveys a sense of formality and commitment to collaborate in a formalized process, or to work towards a specific outcome, whereas a contract creates legal obligations enforceable by law once signed by the parties.
While the MOU process may not be legally binding, it is vitally important that the parties clearly set out the roles, responsibilities, and expectations of everyone involved, as a detailed, written document will help to minimize future disputes or misunderstandings. Although MOUs do not create legally binding requirements, if not applied with caution, they may create unintended legal consequences.
It is important to note that while an MOU is generally not legally binding, any number of clauses within an MOU may express the intention of the parties to ‘bind’ themselves and create legal obligations. For example, if an MOU contains a provision committing the parties to an arbitration process in the event of any dispute, then that provision may be enforceable in a court of law. Any such provisions should be carefully considered before drafting an MOU , as the unintentional legal implications could result in a premature and needless intervention by the courts.
When deciding whether to use an MOU or a contract, always consider the level of formality you want the document to reflect, and how strictly you want the document to be enforceable. It is also important to consider the anticipated course of your relationship: if you expect a long term collaboration with both parties’ interests vested in the success of the endeavor, for example I would suggest an MOU; if you anticipate a more transactional and independent relationship then a contract is more appropriate.
While MOUs are a useful tool that assist with maintaining an informal and collaborative relationship, they can also be used for strategic reasons. They can act as a suitable means to enable two parties to examine key issues and determine whether a formalized legal relationship is in their best interests. Further, they give the impression to larger external parties that the parties are organized, willing, and ready to engage formally, which will often be important when dealing with funding sources or other stakeholders.
Putting it all together, the differences between MOUs and contracts must be considered in each context, as they can help your organization to choose the right document for the job, and ultimately minimize potential future legal consequences.