Understanding the legality of Memorandum of Understanding

Posted By MyAdvo / December 30, 2015 / Corporate / 1 Comment

Written and contributed by Mr. Kanti Rustagi
In the modern business world, various business organizations enter into different kinds of contractual agreements while carrying out their business.
These business organizations, while negotiating with their potential business partners, joint venture partners, vendors and agents usually enter into a preliminary agreement with them as a first friendly step towards a possible alliance, which they often term as the “Memorandum of Understanding.” But there exists ambiguity with respect to legal enforceability of such Memorandum of understanding (“MOU”), as
The term Memorandum of understanding is commonly used for non binding agreements, but simply calling an agreement a Memorandum of Understanding does not automatically denote that it is non-binding agreement. In the Indian Legal scenario, nomenclature of an agreement is irrelevant .The Supreme Court of India in In the State of Orissa & Others v. Titagar Paper Mills Company Ltd. & Another   has laid down as under –
“It is true that the nomenclature and description given to a contract is not determinative of the real nature of the document or of the transaction there under. These, however, have to be determined from all the terms and clauses of the document and all the rights and results flowing there from and not by picking and choosing certain clauses.”
In essence, a Memorandum of Understanding embodies the understanding of Parties with respect to a particular  transaction or a project which they wish to undertake  , but a  mere existence of a document with respect to understanding reached between the parties does not necessarily lead to the conclusion that such document is a contract.
As per the Indian contract Act 1872, every agreement is not a contract. Only those agreements which are legally binding are contracts ,enforceable by the court of law.
Section 10 lays down  the essential requirements of a legally binding agreement or a contract  which are as follows: – a)  There must be offer from one party and its acceptance by another, b) Consent of the parties must be free, c)  Parties must be competent to contract, d)  There must be lawful consideration, e)  There must be lawful object , f)  There must be intention to create legal relations
An MOU might fulfill the first five requirements as mentioned above, but if it lacks the intention to create legal relations, it is not a contract and is incapable of specific performance.
The intent of the Parties can be deciphered from the contents and the material provision of the MOU . Thus the legal nature of an MOU rests on the rights, duties, obligations, it creates among parties. Hence it is very important to understand and appreciate the nature of  relationship created by the Parties in the MOU.
A distinction has to be drawn on whether the Parties intended the MOU be an informal agreement which is an incomplete and merely an   an agreement to agree or whether it is a complete contract on which the Parties consider themselves to be bound.
When Parties merely record their understanding with a clause to negotiate and execute a formal detailed agreement in future.  Such an understanding lacks consideration and intention to create legal relations.
In Jyoti Brothers v. Shree Durga Mining Co.,  A.I.R. 1956, Cal.
280). – the court laid down that the that a contract to enter into a contract is not considered to be a valid contract in law at all. However , the same is not conclusive.
The court will rely upon the degree of importance of such understanding  to the parties and to the fact that whether any of them has acted in reliance on such Understanding.
In Brikram Kishore Parida v. Penudhar Jena, [AIR  1976 Orissa 4]  held that test of an intention to create legal relations is an objective one.  It may be that promisor never anticipated that his promise would give rise to  any legal obligation but if a reasonable man would consider  that he intended so to contract, then he will be bound to make good his promise.
Therefore , caution has to be exercised in the language , titles , clauses used while drafting a memorandum of understanding. Clauses such as jurisdiction clause , applicable law , indemnification have binding effects to the agreement. Similarly  the use of the word “shall” will give a binding effect to the MOU and use of the word “should” a  non binding effect. Another way in which intention may be displaced is to include a clause in the agreement itself saying that this agreement is not intended to be a contract.


One Comment

    January 1, 2016 at 6:13 pm

    A good informative write-up. Thanks !!

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