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

It is common for people to confuse contracts and Memorandums of Understanding. This is understandable as both are drafted in similar languages and at first glance, they both look like legally binding documents.

To avoid major headache and liability down the road, you need to have a working knowledge of the differences between the two. This is especially if you are trying to decide which one is appropriate to use when entering into an arrangement with other parties.

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. When two parties make an “agreement to agree”, they use a MOU to document their common goals and vision. The written agreement between the two establishes the framework for the arrangement and ensures that both parties 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?

It is important to be specific about whether a MOU should be a legally binding document or not. Otherwise, a costly disagreement could arise as to whether it is legally binding and enforceable.

If you do not include a clause stating that the MOU is not legally binding, you could run into trouble. That is 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?

Before parties decide if a formal contract is for them, some choose to “test the waters” by using an MOU as a preliminary document. Both parties can use this to explore whether they are on the same page as well as see how they communicate with each other. If both parties are happy with the MOU stage, they can always progress to the 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

The External Conduct Standards (the “ECSs”) were put into effect from 23 July 2019. These were reforms introduced by the ACNC which applies to the overseas operation of charities. The ECS’s apply to registered charities that operate outside Australia or are working with third parties that operate outside Australia.

Working with third parties that operate overseas?

A detailed Memorandum of Understanding can be a useful tool as you manage the requirements of the ECS and charities 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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