In the initial stages of a deal, you may be asked to sign a ‘non-binding’ document that sets out the key parameters for the negotiation. That document is called by many different names: a term sheet or a memorandum of understanding (MOU) or a letter of intent (LOI) or numerous other names.

Some experts claim that the documents described by each of these terms are different. However, to me, a rose by any other name is still a rose. While by convention or practice, the description used for the same type of ‘non-binding’ document is different for different types of transactions, the terms are very often used interchangeably such that the name is not important. A term sheet is often the description used for the non-binding document in M&A or financing deals while MOU or LOI is used to describe the non-binding document in other commercial transactions. But do not be surprised if you find MOUs being used in M&A deals or term sheets being used in distributorship negotiations.

What is important is to make sure you understand what are the parameters set out in the document, whether it is binding or non-binding, and if binding, which parts are binding. For this article, the term “MOU” will be used to describe such documents generally.

Purpose of the MOU

Often, while negotiating deals, it is important to set out the broad areas of agreement or the boundaries of negotiation. However, parties may not want binding agreements, either because some of the terms may require the approval of upper management or have to be cleared by their lawyers. So they draft and sign a non-binding MOU. Its language is often non-legalistic and anticipates that binding definitive agreements will be signed later.

In general, the MOU will provide:

(a) A framework for the parties to negotiate a final contract.

(b) A record of key terms agreed on.

(c) Details of the fundamental commercial arrangement or commitment reached.

(d) A mechanism for dealing with pre-contractual issues such as exclusivity, confidentiality, due diligence and/or intellectual property.

(e) A degree of comfort to the parties that a deal is possible, ie no deal beaker issues, before they incur further expenses.

The signed MOU can also be used as a basis to seek funding for the deal from third parties subject of course to any binding confidentiality obligations. It will also form the basis for parties’ professionals like their accountants and lawyers to prepare the required accounting and legal documentation.

Is an MOU binding?

Many people assume that an MOU is not legally binding. After all, it is only an ‘understanding’ and not a contract. Unfortunately, that is not always the case. In certain circumstances, an MOU or parts of it can be binding. The two key questions to determine if the MOU (or some parts) is or is not binding are:

(a) Did the parties intend to be bound by all or certain obligations set out in the MOU? A court would first examine the content of the MOU to make this determination. Therefore, to avoid uncertainty, the MOU should have clear statements as to whether the parties intend for the MOU to be or not to be binding, and if binding, which parts are binding.

(b) Is the MOU sufficiently clear and certain to be legally binding? A court will not ‘fill in the blanks’ in an MOU for the parties. A court also will not interpret obligations that are not clear. As an example, “obligations on the usual terms” or “sold at a fair price” are generally unenforceable unless there is a custom of trade where the phrases “usual terms’ or “fair price” is determinable.

What to Look Out for in an MOU?

When negotiating a commercial deal and one party suggests using an MOU, it is important to consider the following:

(a) Do you really need an MOU? If you only need to deal with confidentiality or to require parties to not negotiate with other parties while negotiating this deal, would a non-disclosure agreement or an exclusive negotiation (or lock-out) agreement suffice? After all, you may not want to commit to positions that you are not ready for in the MOU, which is the next point.

(b) Will the MOU limit your flexibility to negotiate? Even no-binding MOUs can affect your bargaining power. The counter-party can refer to positions set out in the MOU as ‘moral’ power against you. A hint. If the counter-party for reasons specific to its case needs something to be stated but you are still undecided, it is possible to state in the MOU that “ABC wants DEF to take on the responsibilities of doing XYZ. However DEF will need to consider this request further taking into consideration its own commercial needs.” That way, you can satisfy ABC’s special needs while maintaining your flexibility.

(c) Is the MOU intended to be legally binding? If so, make sure that the obligations and terms are sufficiently clear to be enforceable. You might want to seek legal help on this.

(d) If the MOU is not intended to be legally binding, is this clearly stated? To minimise the impact of one party suddenly claiming that the MOU is legally binding, have clear language to say so. Certain terms of art like “Subject to Contract” have been interpreted by courts in many countries, including Singapore, to mean that a final binding contract is anticipated to be prepared.

(e) Do you want the MOU to be binding? This is different from the earlier points. If the MOU is intended not to be legally binding and is subject to contract, then if no final binding contract is signed, there is no deal on any terms and parties are free to do their own thing. The resources spent for the negotiation is wasted. If that is not what you want, think about a binding MOU or at least making certain parts of the MOU binding. You might also want to think about having some sort of commitment by the parties for the final binding contract to be based on the broad framework set out in the MOU. Otherwise, you may be forced to re-negotiate the deal from scratch (some time termed “de novo”) again.

(f) For key terms that are yet to be agreed, do you want a mechanism to have these key terms determined? Like the decision whether you want a binding or non-binding MOU, this is another decision that is a two-edged sword. Depending on your commercial circumstances, you may or may not want such a mechanism. Having such a mechanism limits your flexibility to negotiate. Not having such a mechanism can result in no final deal and wasted resources.

(g) Do you want a ‘no reliance clause’ in the MOU? A ‘no reliance’ clause is a boilerplate (or standard) clause that seeks to prevent claims for statements or conducts made before, during or after negotiations that are not set out in the agreement (or in the present situation, in the MOU). Properly drafted, it can also prevent claims that a non-binding MOU is binding because of such ‘by-the-way’ statements or conduct.

(h) Do you want certain parts of the MOU to be binding? If you want some of the above points (the determinitive mechanism and/or the ‘no relaince’ clause) in your MOU, you will have to consider making certain parts of your MOU binding. Confidentiality provisions, protection of intellectual property provisions and exclusivity (or lock-out) provisions might be some of the other provisions you might want binding.

(i) Are there any tax or other regulatory implications of signing an MOU? Contract law aside, there could be other issues to be considered before signing even a non-binding MOU. As an example, in Singapore’s Code on Take-overs and Mergers, disclosures of agreements, arrangements or understandings between parties must be disclosed to the public.

Concluding Words

While a non-binding MOU is designed as a document for parties themselves to prepare and set out their key commercial arrangements in simple and business-friendly language, there are still some areas that parties should keep in mind to maximise the effectiveness of the MOU (as oppose to doing an MOU because everyone else is signing one) and to avoid some of the pitfalls of an MOU.

As always, if in doubt, please consult us.