Problems with Memorandum of Understanding and Heads of Agreement

 

These days, business agents, investment banks, accountants and many clients have come to believe that Memoranda of Understandings and Heads of Agreement are an essential part of the transaction documents.  They are not.

 

Problems with MoUs and Heads of Agreement

 

There are enough problems with using a Memorandum of Agreement (“MoU”) or a Heads of Agreement (“HoA”) to seriously wonder if they should be used at all – at least from your lawyer’s point of view.  The fact is, however, that everybody seems to want to use them, so it is best to be clear about the problems you can come across.

 

When commercial people (i.e.: non-lawyers) prepare MoUs and HoAs, they often think that they have an agreement of sorts.  To some degree, depending on the language, they often have.  They try to agree on price and how price is to be adjusted, confidentiality, disclosure of financial information, exclusive dealing, intention to conclude an agreement by a certain date and some of the types of clauses you find in partnership agreements such as dealing in good faith.  There is also usually a list of things yet to be agreed.  In most of cases, the MoU or the HoA is subject to a final contract.

 

Problems


The biggest problem with preliminary agreements like these is whether or not a contract has been entered into or not.  How do you tell?

 

Well, as with large areas of contract law, it depends on the facts.  There are three, perhaps four, types of preliminary agreement in Australia.  In the case of Masters v. Cameron (1954) 91CLR 353, the High Court of Australia said that there were three types of preliminary agreement:

  • Where the parties agree to be bound immediately, but want a further agreement that is fuller or more precise,
  • Where the parties agree to be bound immediately, but agree that they are not going to act on one or more points until there is a formal agreement signed, and
  • Where the parties do not agree to be bound until there is a formal contract signed.

There is probably a fourth scenario – one that arose in Baulkham Hills Private Hospital Pty Limited v. GR Securities Pty Limited (1986) 40 NSWLR 622:

  • Where the parties agree to be bound immediately, but expect to make a further contract in the future that will replace the first one.

Is My MoU or HoA Binding?


So how do you tell whether the MoU or the HoA you are about to sign is going to be binding?

  • The first thing to do is look at the language in the document.  With luck it you will see the words, “non-binding” or “binding” in front of various clauses.  Alternatively, you might see words that expressly say whether you are bound or not.
  • Another clue is whether you or the other party has already started acting in accordance with the MoU or HoA.  It is pretty hard for someone to argue the document was not binding if they have already started acting on it,
  • If you or the other party conduct yourselves in accordance with the document after it is signed, then arguably you or the other side consider it binding.  Why else would you or they have acted that way?
  • If the document covers most of the points and leaves little to be agreed in the future, the inference might be that it is binding.  Conversely, if it covers very few points in detail and leaves a lot of matters to be agreed, the inference might be that it is not binding.
  • If it is a relatively informal agreement or it is about simple subject matter, it might be more likely to be binding that if it was a complex or large transaction where you would expect a lot more writing.
  • If you and the other party have been conducting business for some time on an informal basis or on similar short documents, it might be more likely that you considered yourselves to be bound that if you always enter into full contracts and are always surrounded by lawyers.
  • If the preliminary agreement is workable despite some gaps where matters still need to be agreed, then it might be more likely to be binding.

Conclusion


If you use these preliminary agreements, you need to understand that there may come a time when you either want them to be (a) enforceable, or (b) unenforceable – all according to your commercial imperative.  The factors above would probably help a court decide, so forewarned is forearmed.

 

Disclaimer: I shouldn’t really have to write a disclaimer here about using this as legal advice as I am sure you are smart enough to work out that it is general commentary only and it may not suit your own personal circumstances.

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