MEMORANDUM OF UNDERSTANDING: LEGAL NATURE AND DRAFTING

(First published in All India Reporter) In present day business parlance, Memorandum of Understanding (MOU) as this term is being used, it has become the most misunderstood term. It is used for relationship varying and oscillating in between non binding to binding nature. However, from legal point of view the term Memorandum of Understanding"(MOU) should only be used to depict and embody the understanding of the parties in principle without creating any right or obligation of binding nature. In essence, MOU is a simple and pure gentlemen's agreement which does not create any right or duty of binding nature to be enforceable by a Court of law. It is generally observed that after meeting of Heads of States, announcement of their agreement in principle to cooperate in different fields is made and this understanding is reduced in writing in the form of MOU providing that respective Government departments will further discuss, deliberate and enter into detailed contracts later on. Similarly, when parties are carrying on negotiations and they feel that for further evolution and concretization of ideas detailed deliberations are required so as to reach acceptable bargain maturing into contract and enough time is available, they execute a document outlining the underlying agreement in principle to cooperate and to further negotiate and finalize the contract. Such a document may be in the form of MOU. Therefore, 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. A distinction is drawn between, on the one hand, documents which are only informal memoranda, and, on the other, those which are intended as complete contract document, i.e. exhaustive records of the terms finally agreed to which parties consider themselves bound. (Vide Treitel G.H., An Outline of the Law of Contract, Vth Ed. Butterworths P.75). In Milner V. Percy Bilton [(1966) 2 All E.R. 894], the term "understanding" was held to mean "some thing quite different from a binding legal contract; at utmost the word connotes a gentleman's agreement". Very similar to the concept of MOU is letter of comfort. Its issuance and use is a modern development which is meant for assurance and encouragement of a party generally by a Government but it falls short of guarantee. It is well settled principle that the true effect of a document depends on words used in it. In Kleinwort Benson Ltd. V. Malaysian Mining Corpn. [(1989) All E.R.785], Hirst J. held that letters described as comfort letters having come into existence as part and parcel of a commercial banking transaction ,were to be
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presumed to be intended to create legal relations ( vide Smith &Thomas, A Case Book on Contract, IXth Edn.Sweet & Maxwell.p.188). On the other hand in J.H.Milner & Sons v. Percy Bilton Ltd. it was held that vagueness of language used in letters of comfort may also lead to the conclusion that when issued in the course of commercial negotiation they do not have contractual force. Legal Nature The term MOU, in practice, is used to denote relationship which may be binding or non binding in nature. Therefore, it is necessary to probe deeper and dwell in detail so as to understand and appreciate nature of relationship created amongst the parties by MOU. The legal nature of M.O.U essentially rests on the nature of rights, obligation/ duties or legal relationship it creates among the parties. No doubt, it embodies understanding of the parties in principle, however all understandings do not mature in contracts or in other words may not result in conferring of rights and imposition of duties and as such can not be enforced by the legal process. As per Section 10 of the Contract Act 1872, the essential requirements of a legally binding agreement are as follows: a) b) c) d) e) f) There must be offer from one party and its acceptance by another, Consent of the parties must be free, Parties must be competent to contract, There must be lawful consideration, There must be lawful object. There must be intention to create legal relations

In a pure and simple MOU, there may be offer and acceptance among competent parties with their free consent and object may also be lawful but still no binding relationship is created or come in to existence because when it is tested on the touchstone of above ingredients it emerges that MOU lacks consideration and intention to create legal relationship. Lack of Intention to Create Legal Relationship and Consideration The intention to create legal relations may be negatived or excluded expressly in a document or may be implied from the terms contained in it. In Rose and Frank Company V. J.R.Cromption and Bros. Ltd [(1925) A.C 445]; Kings Bench Division [ (1923) 2 K.B.261 ], an agency agreement provided "This arrangement is not entered into, nor is this memorandum written, as a formal or legal agreement and shall not be subject to legal jurisdiction in law courts either in United States or England but it is only definite expression and record of the purpose and intention of the....... parties concerned, to which they each honorably pledge themselves with the fullest confidence ,based on past business
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with each other ,that it will be carried through by each of the three parties with mutual loyalty and friendly cooperation". It was held that this "honour clause" negatived contractual intention and the agreement concluded does not give rise to legally binding relations as parties did not intend so. In social and family relations such an intention is implied whereas in business matters it may be expressly excluded. In business matters parties may intend to rely on each other's good faith and honour, excluding in clear and unambiguous terms all idea of settling of disputes by any outside intervention, Scrutton L.J. observed in Rose and frank C. V. J.R. Crompton. His Lordship Scrutton L.J. also considered the opinion of standard text writers and quoted the following in his judgment:In Sir Frederick Pullock,s language (9th Edn. 1921 p.3)" an agreement to become enforceable at law must be concerned with duties and rights which can be dealt with by a court of justice. And it must be the intention of the parties that the matter in hand shall if necessary, be so dealt with, or at least they must not have contrary intention . Sir William Anson requires in contract "a common intention to affect the legal relations of the parties" [(vide Smith 44& Thomas, A Case Book on Contract, sixth Edn. Sweet & Maxwell 186-188; also see Jones V. Vernons Pools Ltd. 44(1938) 2 All E.R; Appleson V. Littlewood Ltd. (1939) 1 All E.R. 464; Guest V. Empire Pools (1964) 108 S.J. 98.[Para 124, page 70-71, Chitty on Contracts, 25th Edn.] On the other hand in Home Insurance Co. v. Administration Asignrarilor de slat [(1983) 2 Lloyed's Rep. 674], a reinsurance contract provided that "it was to be interpreted.... as an honorable engagement rather than as a legal obligation". Held that these words affect the interpretation and not the binding character of the contract. The statements contained in an MOU may have some affect in law, but its exact nature depends on whether these are mere representations and understandings or in the nature of binding terms and conditions. The difference between MOU and a contract is a difference of should and shall i.e. in contract obligations are created by using the word "shall" whereas in MOU parties agree that they " should" do a particular thing reflecting their solemn desire to do so. A contract deals with agreement in reality which is to be acted upon whereas MOU is an agreement in principle falling short of taking any action and leaving it to the sweet will of the parties. In the State of Orissa & Others v. Titagar Paper Mills Company Ltd. & Another [AIR 1985 S.C.1293] the Supreme Court 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 thereunder. These, however, have to be determined from all the terms and clauses of the document and all the rights and results flowing therefrom and not by picking and choosing certain clauses."
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An agreement even though it may be supported by consideration, may not be binding as a contract if it was made without any intention of creating legal relations between the parties. The onus of proving that there was no legal intention is on the party who asserts that no legal affect is intended, and the onus is a heavy one. [(Bahamas Oil Refining Co. V. Kristiansands Tankrederei A/S (The Ployduke) (1978) 1 Lloyd's Rep 211]. The reliance is also placed with respect to 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 promiser 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. On the issue of intention to contract, Lord Wright in Scammel v. Ouston (19141 A.C.251 at 268) expounded the legal position as follows:"The object of the court is to do justice between the parties, and the court will do its best, if satisfied that there was an ascertainable and determinate intention to contract, to give effect to that intention, looking at substance and not mere form. The test of intention is to be found in the words used. If these words, considered however broadly and untechnically and with due regard to all just implications, fail to evince any definite meaning on which the court can safely act, the court has no choice but to say that there is no contract. When parties enter into MOU incorporating 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. The effect of such stipulation also depends on its purpose. One possibility is that the agreement is regarded by the parties as incomplete ,or as not intended to be legally binding until the terms of the formal document are agreed and the document is duly executed in accordance with the terms of the preliminary agreement which may be termed as Memorandum of Understanding.On the other hand, parties may embody all the essential terms and only details are left to formal agreement to be executed in future. In this situation since the agreement contains all the essential elements and if acted upon by the parties is capable of independent existence and therefore to be given effect. Therefore, terms of the first document are the determining factor to decide the question whether signing of a formal contract is a condition precedent or not? The fact of continuation of negotiation and preparation of subsequent agreement may be evidence that the previous negotiations did not amount to an agreement but this test is not conclusive.( See Ridway V. Walton 6 hlc 289;Harichand Manacharam V. Govind Luxman Gokhle,ILR 47 Bomb. 335.)

It is settled position that a contract to enter into a contract is not considered to be a valid contract in law at all (Jyoti Brothers v. Shree Durga Mining Co., A.I.R. 1956, Cal. 280). In Hutton Watling (1948) Ch 398) , a document set out detailed provisions as to the terms on which a business had been sold, and it was held not to be a mere memorandum, so that extrinsic evidence of other terms was rejected. Drafting Memorandum of Understanding An MOU simplicitor differs from an MOU which deals with relationship of the parties during initial transition phase in multi stage contracting. While drafting MOU simplicitor, care is to be taken that binding obligations are not created because language used in the document will determine the intention of parties whereas in some cases some clauses may be of binding nature and rest not.. Introduction of Parties This part of the document contains the date of execution and introduction of the parties. It is to be ensured that legal status of the parties and address of their registered or corporate office is incorporated in full detail. Further, while describing and defining a party, its successors, administrators and permitted assignees may also be included in the definition so that in case of succession or assignment, there may not be any need of making amendment in the introduction. The expression "administrator" is included because incorporated bodies being creation of legal fiction, act through their administrators. Following is an example of Introduction of parties:"This MEMORANDUM OF UNDERSTANDING (hereinafter referred to as the "MOU") made and entered into this.........day of ______________ 199 . (Hereinafter referred to as "Effective Date") at________ by and among: A-----------, established and existing under the laws of........ and having its registered/corporate Head office (or one of its offices) at ............... (herein after referred to as "A" which expression, unless repugnant to the context or meaning hereof, shall include its successor(s), administrator(s) or permitted assignee) of the FIRST PART. and B----------, established and existing under the laws of ------- and having its registered/corporate office Head Office (or one of its offices) at ---------------(hereinafter referred to as "B" which expression, unless repugnant to the context or meaning here of, shall include its successor(s), administrator(s) or permitted assignee(s) of the SECOND PART. (A,B,.. shall hereinafter be individually referred to as Party" and collectively as "Parties" or "Consortium").
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Preamble/Recitals Preamble of a document like MOU contains background facts which have preceded the execution of MOU and sometimes reason and objective for its execution. The legal importance of preamble is that it contains admitted facts which parties can not deny later on. An illustration is given below:"WHEREAS the t Parties have experience and capabilities in the field of co-operation and therefore the Parties desire to join their skill, experience and resources to work together for mutual interest and benefit. WHEREAS the Parties have enjoyed long lasting and mutually beneficial relationship. The future holds much promise for expanded relations and cooperation. As such, the Parties intend to explore the possibilities and opportunities that exist to further develop their relationship. WHEREAS the Parties desire to initiate negotiations. It is anticipated that these negotiations will result in a long lasting business relationship and will serve as a platform to broaden and further develop mutual cooperation. Accordingly, the Parties desire to create a frame work on which to proceed with and to diligently pursue the activities they mutually agree and to implement it in a manner consistent with the terms set forth in this MOU. Now, therefore, in recognition of agreement in understanding as follows :-" Alternative Provision "NOW, THEREFORE, for and in consideration of the premises and mutual covenants set forth herein, and for other good and valuable consideration , the Parties hereby agree as follows:-" The above provision is used when MOU is more in the nature of binding agreement or certain provisions which are intended to be binding on the parties whereas rest embodies the agreement in principle and is of non binding nature. Definitions The words which parties want to use in a meaning and sense different from the generally understood or dictionary meanings, may be defined for the purpose of MOU. The definition clause may be given at the beginning or at the end of the MOU. After a word is defined it should be used with first alphabet in upper case in the MOU so that a distinction is maintained between defined term and same term when used in a general sense in the document.
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principle, the Parties record their

Scope and Purpose of MOU There may be separate clause defining and setting the scope and purpose of MOU. For example following provision may be included This MOU shall be the framework for future negotiation and agreements between the Parties which shall govern the rights and obligations of the Parties. Role of the Parties Since relationship has not concretized, therefore, MOU may contain role of each party. An example is given below The division of duties between the Parties shall be as set below:Party A will help in obtaining approvals and permits related to or required for the work. Party B will help and advise on fiscal and technical aspects. The Parties shall also undertake the work entrusted to them by co-ordination committee. Coordination Committee Provision for the constitution of a committee in MOU provides a permanent platform and a sort of single window so as to further achieve the objectives of MOU and helps in laying and opening up clear cut lines of communication between the parties. The various tasks which are to be accomplished may be decided by mutual agreement or through unanimity in such a committee. Establishment of the co-ordination Committee The Parties shall, as soon as practicable after the Effective Date, establish a Coordination Committee (Committee) to supervise and coordinate all of the activities of the Parties including the coordination and overseeing of any subcommittees or task forces which it may decide to set up. Each Party shall nominate in writing one (1) representative and one alternate to be members of the Committee. The representatives of the Committee or their designates shall attend the meetings and shall have the authority to represent and bind appointing Party in all matters that come before it. The Committee shall establish the rules and procedure and frequency of meeting. The nominee of 'A' shall be the chairman and shall preside over all meetings of the Committee. The decisions of the Committee shall be taken by unanimity of all the members of the Committee. The functions of the Committee shall include, amongst others:i) approval of Study(s) if any carried out; ii) approval of Work Schedule and any revisions there to;
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iii) appointment of consultants and advisors and constitution of negotiation teams; iv) approval of the detailed activities and tasks to be assigned to each Party. Managing the Finances Generally parties to an MOU bear their own costs and that is why there is no element of consideration. However, in some cases if so agreed and stipulated, third party costs may be equally shared by the parties. Examples of these clauses are given below. Parties to Bear their own Costs. All costs and expenses incurred by a Party in relation to the MOU, which include, but are not limited to, all internal balances, overheads, travel expenses, other out-of-pocket expenses and any other internal expenses shall be borne and paid by the Party incurring the same without charge to or reimbursement from the other Party. Third Party Costs If agreed by the Parties, a provision dealing with third party costs may be included. These costs may include costs and expenses for a legal advisor, financial advisor, other advisors and consultants, and other costs and expenses incurred or to be incurred in connection with the work being undertaken under the MOU on the direction of the Committee and may be shared and borne equally by the parties or in such other proportion as parties desire. Procedure for Payment In case the third Party costs are agreed to be borne then task of collecting payments may be entrusted to the Committee. The Committee may consolidate the costs on a monthly basis and ask parties to remit the requisite amounts so that expenses are shared. Billing Committee may bill each Party on or before the last day of each month for its share of the costs and expenses for the preceding month. The invoice may include a statement of all charges and credits summarized by appropriate classifications indicative of the nature No Competition among Consortium Parties Exclusivity/ Non-exclusivity An MOU may be entered on exclusive basis that is to say parties are restrained from entering into similar MOU with other parties whereas it may also be on non-exclusive basis wherein parties are free to enter into MOU with other parties dealing with the same subject matter. The drafter after analyzing the interest of the party it is representing must decide as to which provision is to be included.
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Except in accordance with the provisions of this MOU, each of the parties agrees that it and its Affiliates or associated company shall not, directly or indirectly in any manner whatsoever, associate individually or in combination with others, with respect to subject matter of this MOU. The provisions of this Article shall survive the expiry or earlier termination of MOU. Alternative Provision This MOU is being entered on non-exclusive basis and does not preclude the Parties from entering into similar MOUs with other Parties. A decision is required to be taken whether MOU is intended on exclusive or non-exclusive basis and accordingly alternative provision is to be chosen and incorporated. Term and Termination of MOU This MOU shall remain in effect until the first to occur of the following events: a) b) c) Twenty four (24) months following the Effective Date; or The execution by the parties of a subsequent agreement or Agreement of all the Parties to terminate or otherwise withdraw from this MOU.

Notices Any and all correspondence made or notices to be sent or required to be made under this MOU shall be in writing, signed by the Party giving such notice (claim or demand) and shall be delivered personally ,or by facsimile transmission or by registered mail, to the other Parties as its addresses set forth herein below or at such other addresses as such other Parties may subsequently notify. All notices shall be deemed given when delivered, which includes facsimile transmissions. Party A Telephone No. Facsimile No: Address: Attention: Party B Telephone No: Facsimile No: Address: Attention:

Assignment This provision is generally not included in MOU because the relationship of the parties is in nascent stage and except confidentiality or one or more other provisions, rest of the provisions are not intended to be of binding nature. Furthermore, MOU does not create any assignable interest which may be transferred. Therefore, in an MOU simplicitor, this clause may not be included. However, an illustration is given below. "Assignment by a Party of its rights and obligations under this MOU to any other party shall be subject to the consent of the other Parties to the MOU." Applicable Law This clause is not required and provided for in MOU simpliciter but if some clauses are intended to be of binding nature and foreign parties are involved ,it is better to incorporate this clause so as to avoid any controversy in future. This MOU shall be governed by and construed in accordance with the laws of --------------- and courts at ............only shall have exclusive jurisdiction. Dispute Settlement "In the event of any difference (s) or dispute (s) arising out of the interpretation or application of the provisions of this MOU, the Parties shall immediately consult each other with the view to expeditiously resolve such differences or disputes in a spirit of mutual understanding and cooperation." Confidentiality This clause is included when confidential information or data is being exchanged so as to assess the chances of cooperation. "No Party shall disclose any information to any third party concerning the matters under this MOU. Any proprietary information (properly identified as such by the disclosing Party) to be contained in reports or disclosed by one Party to the other Party, shall be kept strictly confidential by the receiving Party, and shall not be disclosed to any third party without the prior written consent of the original disclosing Party. This clause shall not apply where; a) disclosure is made to the employees , or b) disclosure to any court, the Government or other statutory authorities or other bodies to the extent required by law, guidelines, rules or regulations applicable to any Party, c) required to consultants, advisers engaged by a Party, d) information is already in public domain but not as a result of breach of this MOU,
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e) already available with the Party from other lawful source. This clause shall survive the termination or expiry of the MOU." Public Announcement In case of PSUs and even private companies, public announcement sometimes may lead to embarrassment or complications, so it is better that parties are taken in confidence before any public announcement is made. A provision is given below for this purpose:"The release and contents of all public announcements (other than when such disclosure is required under any applicable law) related to the MOU shall be subject to the prior written approval of each Party." Survival It is better to make it clear that what are binding clauses and which clauses will survive termination. "The obligations of the Parties under Articles ----- are of binding nature and shall survive the termination or expiration of the MOU" No Right to Bind Other Party and no Entity Created "No Party shall have the right or power to bind any other party to any MOU/ agreement without the prior written consent of the other Party. The Parties do not intend merely by this MOU to create a partnership, corporation or an entity taxable as a corporation or otherwise." IN WITNESS WHEREOF, the parties have caused this MOU to be executed as of the day and year first above written. Alternative IN WITNESS WHEREOF, the Parties by their duly authorized respective representatives have caused this MOU to be executed as of the day and year first above written. For and on behalf of Party A In the presence of

______________________________ _________________________ Name: Name : Address: Address: For and on behalf of Party B

In the presence of
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_________________________________ __________________ Name: Name: Address Address: Therefore, MOU as understood in strict legal sense, lacks consideration as well as intention to create legal relationship. The MOU is simply an embodiment of the solemn desire of the parties which have developed and reached to some understanding but only in principle without creating any obligation. Such understanding is reduced in writing for the purpose of reference and further processing. However in ultimate analysis, a document is classified by its contents and not by title therefore, whether a document is an MOU or a contract shall depend on its contents and not on title. For example, a document might have been termed and titled as MOU, but contains binding terms & conditions, it is a contract and not MOU.

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