As a small business owner, from time to time, you may have discussions with another business over a new deal, project or venture and have reached a high-level understanding of what you wish to achieve but aren’t yet at the stage of agreeing all the finer details into a precise contract. Alternatively, you may seek an informal document outlining some guiding principles for a new business relationship without contractual force. 

In both of the above circumstances, a Memorandum of Understanding (MOU) can sometimes prove a useful tool.  

You may have heard the term Memorandum of Understanding before, but you may not know exactly what they are, how they are used and what to look out for. In this article, we’ll discuss this topic in greater depth to give you an overview of these documents, how they can prove helpful and the potential pitfalls.

What is a Memorandum of Understanding?

A Memorandum of Understanding is a relatively informal business document, often used where two parties wish to outline some broad-brush principles relating to a proposed new deal, arrangement, project or venture but aren’t yet at the stage of committing to a detailed and exhaustive contract or have no plans to do so. 

How are Memorandums of Understanding helpful?

These documents can be very helpful in setting out the parameters for a new arrangement without knowing all the details, which can be filled in later. They can also be helpful when the new arrangement depends on external factors such as investors or lender financing; if the external factors don’t materialise, both parties can generally abort the arrangement easily without having to terminate a contract.

Also, another great advantage of an MOU is that in agreeing on the document, key issues can be flushed out at a very early stage between the parties before additional time and expense are incurred on areas such as due diligence, financing and preparing formal contracts.

Are Memorandums of Understanding legally binding?

Generally, no. Usually, great care is spent on the document's wording to prevent it from becoming legally binding. However, from a practical perspective, it can be difficult to depart from the terms of the MOU when it comes to the contracts that follow due to the ‘moral commitment’ that arises in honouring the ‘agreed’ MOU terms. 

It’s wise to instruct solicitors to draft your Memorandum of Understanding, as they can use appropriate legal language so that your document achieves its intended purpose without binding the parties.

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What are some potential pitfalls of using a Memorandum of Understanding?

Firstly, the document should be carefully prepared to ensure that it accurately reflects the extent of the understanding that has, in fact, been reached. If you fail to do this, then issues can arise further down the line when you attempt to formalise the MOU into a legally binding contract.

The next potential pitfall is that they’d only be used when appropriate to do so. In other words, if you’ve reached a complete understanding with the other party, and there are no external factors at play or finer details to complete, then it may make much more sense just to proceed straight to the contract stage. 

After all, the time and expense that it takes to prepare and approve the Memorandum of Understanding may be better spent on the final contract.

Finally, you should always be careful from a taxation perspective in using a Memorandum of Understanding, particularly if the document is to precede a corporate transaction, joint venture, etc. 

HMRC may potentially see the MOU as evidence of an ‘arrangement’ which may later prevent the parties from availing themselves of certain tax reliefs. As such, you should always take tax advice from your accountant before agreeing on a Memorandum of Understanding.

Wrapping up

If you need advice regarding a Memorandum of Understanding, whether drafting or reviewing a new document or, analysing your rights and obligations under an existing one or require some general legal advice in this area, LawBite is here to help. 

Appointing an expert lawyer to assist you gives you the peace of mind that your documents will be professionally drafted and suited for your business needs. LawBite’s expert lawyers can advise on the detailed wording of the document to ensure it protects you and your business. 

‍About the author                                                                                                                                                                                                 Ashley Gurr is an expert contract lawyer at LawBite. Ashley has over 15 years of experience in private practice, helping SMEs and in-house for an international consultancy group advising on commercial agreements and a multi-national utility giant in a contract strategy role.

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