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Not understanding a Memorandum of Understanding can lead to legal risks

One of my clients wanted to go into a business arrangement with another business owner to share knowledge and resources. He was presented with a Memorandum of Understanding (MoU) by the other business owner and because he didn’t want to get ‘locked into a legal contract’ at this stage, he signed it. The reason he did this was because he thought that a MoU was a more casual arrangement. Later on, my client thought there would be a chance to enter into a formal legal agreement. My client signed the MoU without getting legal advice. As time went on, the business arrangement went sour. Now my client was coming to me because he wanted to get out of the arrangement but it was not so easy. His business partner was arguing entitlement to a percentage of my client’s business. ‘I didn’t think an MoU was legally binding,’ he said when he finally came to me for legal advice. ‘It depends,’ I told him. As I read the pages it was clear to me that this MoU set out the elements of a contract. The language was clear and the rights and obligations were firm. The document set up detailed terms about the services the other business would provide my client in exchange for a share. The MoU was legally binding and now my client would have to negotiate a way out.

What is an MoU?

An MoU is a 'Memorandum of Understanding'. MOUs are used to document a relationship of goodwill between the parties entering into the MOU. For example, arrangements to share information, work collaboratively or promote the events of each other’s business. Used in this context, MOUs are generally not legally binding. If you want to enter into a non-legally binding MOU start the document with words that clearly make this point. For example, ‘’The Parties do not intend this MOU to be legally binding”. Furthermore, do no set out obligations for both parties using language such as "Abacus shall do xyz". You should sign an MOU when you do not intend to create legally binding arrangements.

Legally binding terms in an MoU

An MOU may be legally binding if it satisfies the elements of a contract. For instance, if the parties have finalised all the terms of the agreement and put those terms in a written document but called it an ‘MOU”, it is likely that this is a legally binding agreement because the intention of the parties was to be immediately bound. The introduction of the document may also state that the document was intended to be legally binding. Further, the language of the terms will indicate if there is a contract. For instance, if the document states ‘The parties will do this’ and there are terms for payment and shares in profits. Why? Because it is clear the parties intend for these obligations to be met, and if they are not, then they hope to legally enforce their rights.

To ensure that this doesn’t happen to you, you should get legal advice on the MOU.

If you want to enter into a true MOU to express mutual good faith relationship then use words such as ‘non-binding’ and make the spirit of the document non-legally binding.

If you want the MOU to be a precursor to a formal document to assist with working out the commercial terms, then state that it is ‘subject to contract’ but make sure that all the terms are not set out.

Tips for drafting documents that set out relationships

1. If it’s a legal agreement, get legal advice and negotiate terms

When drafting a document to set out a business relationship, it is important to be clear from the start about what the relationship is between the parties. The first thing to consider is whether or not the arrangement is legally binding. If the arrangement is intended to be legally binding, for example, ‘X will receive 30% shareholding of the business in return for developing the source code’, then the intention is that the arrangement is legally binding. Calling the document an MoU may make it sound less intimidating but the risk is that the parties do not get legal advice to understand the terms, or try to negotiate the terms before signing.

2. If it’s a document to express high level arrangements, be clear the MOU is not legally binding

An MOU can be used to establish a framework for the collaboration between businesses and express the common vision of the parties to the MOU who want to work together. In general, a MOU is more ‘big picture’ and does not deal with the specific details.

If you want to enter into an MOU to start a business relationship and work towards a legal agreement, an MOU can make the arrangement clearer to the parties so as to speed up the process of negotiation in relation to the final legal agreement. But do not feel pressured to sign an MOU at the end of a business meeting. You can always record the meeting as a ‘record of discussion’ or ‘meeting minute’.

To be clear that your document is intended to be an MOU include a Statement of Understanding along the lines of the following:

"This document is a Memorandum of Understanding and is not intended to create binding or legal obligations on either party. "

If you are entering into a business relationship, you should always get professional legal advice to help you understand the terms and negotiate.

Terri Janke and Company Pty Ltd | Lawyers and Solicitors

PO Box 780, Rosebery NSW 1445

Email: | Phone: 02 9693 2577 | Website:

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