Upcoming Mallesons seminarsIntroduction
At the outset of a project, parties often record the basic terms under which they agree to work together for the particular project. This preliminary agreement is commonly referred to as a memorandum of understanding ("MOU").1
This update examines the typical contents of an MOU and the practical and legal implications which arise as a result of entering into an MOU.
Purpose of an MOU
An MOU can be useful in giving commercial (and perhaps legal) certainty or a framework to negotiations and enabling a process to commence (eg raising financing and obtaining approvals).
However, entering into an MOU prematurely may limit flexibility in future negotiations. It may also distract focus from negotiation of a concluded arrangement.
"Usual" contents of an MOU
There are no "usual" terms of an MOU. However, the terms that are commonly found in an MOU include:
- agreement to negotiate in good faith;
- standstill / "lock-out" agreement;
- agreement to use best or reasonable endeavours to undertake contractual obligations;
- due diligence arrangements;
- announcements;
- key conditions of the project;
- confidentiality (if not already provided for in a confidentiality agreement); and
- governing law and jurisdiction.
Binding or non-binding?
At the time of drawing up the MOU, it is important for the parties to decide whether they wish to be bound by the terms of the MOU. This is a decision which will change from project to project. However, it is common practice for an MOU to be part binding and part non-binding.
Whether an MOU is binding is a question of general contract law. A contract will be binding if there is offer, acceptance, intention to be legally bound and consideration. For an MOU, what is particularly important is the intention of the parties at the time of signing the MOU.
For commercial contracts, there will be a strong presumption that the parties intend to create a legally binding contract if the terms of the MOU are clearly defined and supported by consideration.2
For this reason, if the parties do not wish to be bound by the MOU until the execution of formal documents, then the parties must state clearly and unambiguously their intention not to be bound. For example, this may be achieved by using the words "subject to contract". However, the use of the words "subject to contract" may not be absolutely conclusive. Accordingly, it is advisable to include a clause in the MOU stating which provisions of the MOU are binding and which are not. A suggested clause would be:
"Except for the provisions of clauses [… ], this MOU does not constitute or create, and shall not be deemed to constitute, any legally binding or enforceable obligations on the part of any party."
The requirement of certainty
The courts do not expect commercial documents to be drafted with strict precision. However, for an MOU to have legal effect, the essential terms must be sufficiently clear and certain. For example, terms such as "usual terms" or "fair and equitable price" may be too vague and, depending on the circumstances, the court may refuse to give meaning to them.
It is important to understand that an MOU may still have legal effect even though it contains uncertain terms or the words "subject to contract". However, if the result is a pervasive uncertainty in the document, the MOU will not give rise to contractual obligations.3
Agreements in relation to negotiations
As mentioned above, an MOU can be expressed to be non-binding as to some of the terms (typically the commercial terms) and binding as to others (terms such as confidentiality and governing law). For this reason, it is possible to include in an otherwise non-binding MOU, legally effective terms which create some sort of obligation on the parties to continue the negotiation process. These may include:
- agreement to negotiate in good faith; and
- standstill / "lock-out" agreement.
Like all binding contracts, agreements in relation to negotiations must contain all of the elements of an enforceable contract (ie offer, acceptance, consideration and intention to be bound). The terms of the agreement must also be sufficiently certain.
Agreements to negotiate in good faith
An MOU often contains a statement to the effect that the parties undertake to negotiate in good faith with a view to finalising the terms of a formal agreement to be entered into between them. For example, a standard clause would be:
"The parties agree that during the negotiation period described in [ ], they will negotiate with each other in good faith in order to endeavour to reach the concluded arrangements described in [ ]."
Traditionally, the common law does not recognise an express agreement in an MOU to negotiate in good faith as a binding contract.4 Whilst the English courts continue to apply the traditional common law approach, the enforceability of such an agreement is less clear in other countries for example Australia.5
Standstill agreements: "lock-out" clauses
Similar to an "agreement to negotiate in good faith" clause, the purpose of a "lock-out" clause in an MOU is to provide an incentive to the parties to continue the negotiation process.
A "lock-out" clause is essentially a negative agreement where the party bound by the clause agrees not to negotiate with third parties. In other words, a "lock-out" clause locks the party out of negotiation with third parties. It does not, however, in a legal sense oblige the party to complete the transaction.
A narrow form of a "lock-out" clause is called a "no-shop" clause. The essential effect of a "no-shop" clause is to restrict one party from soliciting third party offers. The party however can entertain an offer by a third party if the approach is unsolicited. A wide form of a standstill agreement is called a "no-talk" clause.
A "no-talk" clause is basically an agreement not to negotiate with a third party even where the approach is unsolicited.
There are two essential elements to a "lock-out" clause:
- good consideration; and
- length of "lock-out" is restricted to a definite period of time.
A "lock-out" clause may not be binding if the length of the "lock-out" clause reaches a point where the agreement falls foul of the restraint of trade doctrine or laws governing unconscionability. In addition, a "lock-out" clause may give rise to issues concerning directors' duties eg, if restricting the company’s freedom to deal with other potential parties is not in the interests of the company.
Best or reasonable endeavours
An MOU often requires parties to undertake particular contractual obligations with "best endeavours" or "reasonable endeavours". For example, the parties may agree to use their best (or reasonable) endeavours to obtain board approval. The issue of whether the parties should undertake best or reasonable endeavours is often a difficult issue raised during the negotiation of the terms of an MOU. A future update will consider the meaning of "best endeavours" as opposed to "reasonable endeavours".
Conclusion
When entering into an MOU, it is important to be aware of the legal and practical implications of the terms of the MOU. MOUs may unduly limit future negotiations and impose onerous obligations on the parties.
From a legal perspective, the enforceability of an MOU largely depends on the circumstances of the negotiations and the terms agreed by the parties. From a practical perspective, although an MOU may help to secure some form of commitment of the parties to the negotiation process, it is unlikely to provide commercial certainty to the outcome of the negotiations.
1 Sometimes these preliminary agreements are referred to as a "Heads of Agreement" or a "Term Sheet". However, the legal implications are the same, regardless of the name used.
2 Edwards v Skyways [1964] 1 WLR 349
3 LMI v Baulderstone [2001] NSWSC 886
4 Courtney & Faribairn Ltd v Tolaini Brothers (Hotel) Ltd [1975] 1 WLR 297
5 Kirby P in Coal Cliff Collieries v Sijehama (1991) 24 NSWLR 1 acknowledged that in some circumstances, a promise to negotiate good faith will be enforceable.
If you need legal advice on the issues raised above, please contact:
Damian McNair
T +852 2848 4646
F +852 2868 0124
damian.mcnair@mallesons.com
Robert Milliner
T +852 2848 4650
F +852 2868 0124
robert.milliner@mallesons.com
Richard Mazzochi
T +852 2848 4617
F +852 2868 0124
richard.mazzochi@mallesons.com