04 May 2005

Terms Sheets, MOUs, Heads of Agreement and getting things down on paper

by Bernard Wall

Commercial considerations as well as other legal factors must be considered before committing to an MOU.

Heads of Agreement, Terms Sheets, Memoranda of Understanding (MOU) and Letters of Intent are all preliminary documents commonly used during the negotiation of commercial arrangements (we will use the term MOU to refer to the types of documents generally).

While an MOU can be a good method of recording the key terms or areas of agreement between the parties, getting these terms down on paper to allow for later expansion into an agreement can be tricky. Here are some things to consider.

What is an MOU?

An MOU is a document recording the basic terms of a proposed transaction. Conceptually, the idea is that the parties sign the MOU in the pre-contractual stages of negotiations with the intention of continuing negotiation and ultimately signing a more formal contract at a later stage (often after the involvement of legal and other advisors). In general, an MOU can be used to provide:

  • A framework for the parties to negotiate a final contract.
  • A record of key terms agreed on to date.
  • Detail of fundamental arrangements or a party's commitment for the benefit of third parties such as financiers or potential investors.
  • Mechanisms dealing with pre-contractual issues such as exclusivity, confidentiality, due diligence and intellectual property.
  • Some degree of comfort that a deal is possible before the parties incur further expense.

Is an MOU binding?

It is important to note that some people immediately assume that an MOU is legally binding, while others immediately assume that it is not.

Whether an MOU is legally binding on the parties depends on the circumstances.Key issues that commonly arise when determining if an MOU is binding are:

  • Did the parties intend to be bound by the obligations set out in the MOU?
  • Is the MOU sufficiently clear and certain to be legally binding?

Did the parties intend to be bound?

To determine whether the parties intended to be bound by the obligations set out in the MOU, a court would take an objective approach to examine whether an intention of the parties to be bound can be inferred from the circumstances. As you would expect, the best way to avoid uncertainty on this issue is to ensure the MOU has a clear statement as to whether or not the parties intend the document to be binding.

Is the MOU sufficiently clear and certain?

Sounds simple enough so far? However, even if the parties are clear on whether they intend for the MOU to be binding, the MOU must be sufficiently clear and certain to actually be binding in practice.

It is common in an MOU to have (often because the MOU is signed at a preliminary stage) certain obligations expressed to be "on the usual terms", "at a fair price" or "subject to contract". The general presumption is that obligations under an MOU are not binding on the parties if the obligations are expressed to be "subject to contract" because the agreement between the parties is too vague to be enforceable. This presumption arises because from an objective viewpoint, the obligations must be sufficiently clear and certain so the parties know what the obligations actually are in order for them to be enforceable. It is not a good approach to rely on a court to figure out what the parties actually meant, as suggested in one of the leading cases in this area:

"Courts are not well equipped, drawing on their own experience, to fill out the detail of such contracts where the parties leave gaps in their own agreement. The fact that this may result in wasted time and money is a risk which parties to negotiation must always weigh up. Courts cannot enforce such agreements because they are incapable of judging where the negotiation on particular points would have taken the parties…"[1]

If there is a need to use an MOU when some elements of the transaction are uncertain, consider whether it is appropriate to have a mechanism in the MOU dealing with such elements in the event that the parties are unable to agree (for example, a reference to an objective base pricing index or determination by an independent expert). This type of approach may assist in ensuring the obligations of the parties are sufficiently clear.

Other potential liability

So you state whether the MOU is binding or not and take care to have any binding obligations clear and certain – is that all you need to worry about? Not so fast. Be aware that in the event of a dispute, the words used by the parties are not the sole consideration used by a court to determine the obligations of the parties.

The intention of the parties, evidenced by the surrounding circumstances and actions of the parties, can be used to infer obligations, depending on the circumstances. This may be the case regardless of what the MOU says on paper, particularly if the parties are acting in a manner that is inconsistent with the terms of the document. For example, even if the MOU is expressed to be not binding:

  • Aparty might be estopped from denying that the MOU is actually binding because of its conduct. For example, if A acts as if the MOU was binding, A might be prevented from later arguing that that the MOU was not binding, particularly if B acts in reliance of A's conduct.
  • Aparty might be liable due to its conduct under statutory provisions such as misleading and deceptive conduct under the Trade Practices Act 1974 (Cth).

We'll cover these separate issues in a future article in Insights. For now, it’s enough to point out that the parties should consider whether the MOU should contain some disclaimers that may limit a party's ability to claim it was relying on either the terms of the MOU or the other party's actions. If in doubt, seek some specific advice on this issue.

Tax issues

Irrespective of whether the MOU purports to be legally binding, the parties should consider the tax implications prior to entering into an MOU. In some cases, tax liability may be assessed on the basis of the transaction evidence in the MOU, even if the ultimate transaction is structured on a different basis!

The date of the MOU may also be taken as the date of the transaction for tax purposes. This may have ramifications in terms of penalties if the ultimate transaction is finalised at a much later date.

Again, if in doubt, seek some specific advice on potential taxation implications before entering into an MOU.

Things to consider

So what are the key things to consider? When negotiating a commercial transaction and someone suggests using an MOU, it pays to weigh up:

  • Do you actually need an MOU? For example, if you only need to deal with confidentiality, will a confidentiality deed, rather than an MOU, suffice?
  • Will an MOU limit your flexibility in negotiating the final commercial arrangements or affect your bargaining power?
  • Is the MOU intended to be legally binding and, if so, are the obligations on the parties set out in the MOU sufficiently clear to be enforceable?
  • If the MOU is not intended to be legally binding, whatare the potential ramifications even if the document is expressed not to be legal binding? Remember that a court, having regard to the surrounding circumstances, can still decided that parts of an MOU are legally binding even if this is not what one party intended.
  • What are the key terms that are yet to be agreed on and is it commercial to have these terms determined by an objective reference point in the event that the parties are unable to reach agreement (or alternatively, that the MOU ceases to have effect if these terms are not agreed on by a certain date)?
  • Is a "no reliance" disclaimer clause appropriate?
  • What will happen if formal commercial arrangements are not reached? For example, the parties might want to be bound by the MOU if a formal commercial contract is not completed by a certain date. If this is the case, care should be taken to ensure the MOU is legally binding and the obligations on the parties are sufficiently clear to be enforceable.
  • What are the potential tax or duty implications of signing an MOU?

Above all, if in doubt, seek some specific advice before you get something down on paper.

 

[1] Coal Cliff Collieries Pty Ltd v Sijehama Pty Ltd (1991) NSWLR 1 at 20.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.