When (and when not to) use a Memorandum of Understanding

People commonly confuse contracts and Memorandums of Understanding. This confusion is understandable; often they are both drafted in similar language, and at first glance both can look like legally binding documents.

Because of this, it is often difficult to decide when it is appropriate to use one or the other when thinking about entering into an arrangement with other parties. Making decisions on these arrangements without a working knowledge of the differences can lead to major headaches and potential liability down the track.

This article describes the characteristics of a Memorandum of Understanding (“MOU”), to explain the main circumstances in which an MOU is suitable to document an arrangement between parties, and when a contract might be more appropriate.

What is a Memorandum of Understanding?

An MOU can be most aptly described as falling somewhere between a handshake deal and a written contract. It is a preliminary written agreement between parties, which helps establish a framework for an arrangement. Colloquially referred to as an “agreement to agree”, an MOU usually documents a common goal or vision of the parties, seeking to ensure that all parties to the arrangement are on the same page.

An MOU is generally considered to be a high-level document, as it typically does not deal with specific details. Rather, an MOU usually sets out how the intended arrangement will operate, and can provide a point of reference as to the parties’ intentions should disagreements arise in the future.

It usually encompasses:

  • General terms of the essential aspects of the arrangement (such as price, timeframe, subject matter); and
  • An agreement to enter into a more comprehensive binding contract at a later time after further negotiations (covering specific aspects such as consequences of default).

Is it a Legally Binding Document?

An MOU should specifically address whether it is intended to be a legally binding document or not. Failing such specificity, a costly disagreement may arise as to whether it is legally binding and enforceable. Absent a clause stating that the MOU is not legally binding, if the MOU satisfies the formal requirements of a contract and it can be proven that the parties intended to be legally bound by the agreement, then it may be considered enforceable by law (regardless of whether the parties have called the agreement a “Contract” or a “Memorandum of Understanding”).

Contents of a MOU:

An MOU may set out a number of basic elements or an arrangement which might include (but is not limited to):

  • the common goal or objective of the arrangement;
  • expected benefits of the arrangement;
  • the roles and responsibilities of each party;
  • dispute resolution mechanisms;
  • agreed protocols and procedures;
  • resource use arrangements;
  • reporting and accountability;
  • confidentiality;
  • duration; and
  • signatures of the parties.

In particular, the MOU should clearly set out what each party has agreed to do.

When should an MOU be used?

Some parties choose to use an MOU as a preliminary document to “test the waters” with a potential business partner to explore whether the parties are on the same page, as well as how well the parties can communicate with each other. If they are happy with how the MOU stage goes, then they would choose to progress to the formal contract stage.

An MOU is ideal in the stages of an arrangement where the parties are developing and finalising their mutual goals and expectations.

On the contrary, it is best not to use an MOU when there is a reliance on the other party to act, or if you stand to lose money if the other party fails to act. In this situation, a contract – not an MOU (which is usually non-binding) – should be entered into.

Relevant for the charity sector – MOUs and the New External Conduct Standards

Effective from 23 July 2019, the ACNC has introduced a series of reforms which apply to the overseas operations of charities, in the form of proposed External Conduct Standards (the “ECSs”). The ECSs are applicable to any registered charity that is operating outside Australia, or working with third parties that are operating outside Australia.

A detailed Memorandum of Understanding can be a crucial tool in managing the intersect between the requirements of the ECS and working with third parties that operate overseas. See our article on the External Conduct Standards here.

For more information regarding MOUs

We note that MOUs and contracts are not the only way to document an arrangement with another party. We suggest seeking legal advice on the most appropriate way to documents your intended arrangement. Please contact our Business Development Team or call us on (07) 3252 0011 to book an appointment with one of our specialist Commercial Lawyers today.

This article was written by Courtney Linton & Nina Flewell-Smith

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