05 Jul 2023
A Memorandum of Understanding(MoU) is an agreement entered into between two or more parties relating to their initial understanding, the rights and obligations of each party, mutual expectations and commitments prior to entering into a formal agreement or contract. It is often used in commercial transactions related to investment, sale and purchase of shares and joint ventures. MoUs, Letters of Intent and term sheets are classified as heads of terms documents, which are written documents that are used in the preliminary stages of a corporate or commercial transaction.
It is ideal for parties to sign a MoU prior to the execution of a written contract, to give a sense of direction to their negotiations especially on the key terms of their agreement or for future collaborations between the parties.
A MoU is differentiable from a contract on the following basis:
- Nature and Formality: A contract is a legally binding agreement that outlines the rights and obligations of the parties involved. It creates enforceable legal obligations and is typically used for commercial or business transactions. Contracts require a higher level of formality, often including specific provisions such as offer, acceptance, consideration, and terms and conditions. However, a Memorandum of Understanding is a non-binding agreement that expresses the intent of the parties to collaborate or work together. Unlike contracts, MoUs are generally less formal and do not create legally enforceable obligations. They are often used in situations where parties wish to establish a framework for future negotiations or cooperation.
- Distinction in terms: Contracts are generally more detailed and specific, outlining specific rights, duties, and obligations of each party. They often address potential contingencies, dispute resolution mechanisms, termination clauses, and other important aspects. MoUs are usually less specific and more general in nature. They typically focus on the broad goals, objectives, and areas of cooperation between the parties. MoUs may lay the foundation for future negotiations to develop a more detailed agreement.
- Enforceability: A contract is legally enforceable, which means if one party fails to fulfil its obligations, the other party can seek legal recourse in the form of damages or specific performance, through a court of law. One of the often debated characteristics and the key differentiating factor between a contract and an MoU is its enforceability. Strictly speaking, a MoU does not typically create a legally enforceable obligation. If one party fails to comply with the terms of an MoU, the other party cannot usually seek legal remedies with the help of well-qualified lawyers. A potential consequence would be an end to future collaborations between the parties.
- The intention of the Parties to be legally bound: In contract law, in order to have a valid contract the following elements should be present namely, offer and acceptance, intention to be legally bound, capacity to contract and lawful consideration. Since an MoU is drafted as a document which reflects the initial understanding of the parties, oftentimes it acknowledges that negotiations and future agreements are yet to take place and hence, the terms of an MoU do not legally bind the parties unless otherwise stipulated.
Enforceability of MoU in UAE:
Civil transactions within the territory of UAE are governed by the Federal Law No. 5 of 1985 the Civil Transaction Law (the UAE Civil Code). In order to understand whether an MoU forms a binding contract between parties, we can rely on the provisions of Article 125 of the UAE Civil Code: which states that a ‘contract’ is entered when an ‘offer’ is made by one party with the ‘acceptance’ from the other party along with the flow of ‘consideration’ by both parties. This must be read in line with Article 130 of the UAE Civil Code which specifies that a contract is formed by the meeting of an offer with acceptance. This indicates that if the MoU satisfies the basic elements of a contract, it is legally binding on the parties and can thus be enforced by one party against the other.
Another important provision to consider is Article 141(2) of the UAE Civil Code which signifies that in cases where the MoU is clear on the essential terms of an agreement and leaves other terms to be negotiated later between the parties and provided there is no explicit provision in the MOU which states that a contract will not be formed if the parties are unable to agree on the undefined terms, the MoU will be deemed to be a contract between the parties and subsequently, in case of a dispute with respect to the undefined terms, the Courts will have the power to decide on the undefined terms, in accordance with the nature of the transaction and the provisions of law.
In some cases, the Court may hold an existing MoU to be a legally valid contract or ‘an agreement to enter into a contract’ as per Article 146 of the UAE Civil Code, provided all the essential matters of the contract intended to be made and the period within which it is to be made are specified within the MoU.
Depending on the nature of the transaction, it may be in the best interests of a party to have the MoU be legally binding in its entirety or certain clauses to be binding on the parties while the others remain non-binding. Certain terms which parties may commonly wish to be binding can include confidentiality, governing law, jurisdiction, exclusivity provisions, duration and limitation of liability. During the course of negotiations entered into between the parties, there may be confidential information disclosed on either side and hence there should be a binding confidentiality and non-disclosure provision in the MoU. In the event of a potential dispute that may arise between the parties, it is advised to keep binding provisions relating to the governing law and dispute resolution scheme. By opting for a binding exclusivity provision, parties to the MoU can set an ‘exclusivity period’ during which they are both bound to only negotiate with each other for the purpose of concluding a final contract or agreement. If parties anticipate the possibility of seeking an interim order on an urgent basis in the event of a breach of confidentiality or exclusivity provisions, they should opt for the jurisdiction of DIFC Courts in their MoU and not local UAE Courts, as they do not provide such reliefs save in certain cases. However, parties must also be aware that costs under the DIFC Court process are significantly higher as compared to local UAE Courts.
Common terms that the parties may want to classify as non-binding are terms relating to the intended transaction/ appointment/ collaboration, commercial terms, the time schedule of the transaction and certain conditions precedent which may need revision during the course of the envisioned transaction.
As indicated in the mentioned provisions of the UAE Civil Code, it is clear that the default position is MoUs are legally binding on the parties unless expressly stated otherwise (i.e. parties are legally bound by all the terms of the MoU, unless they expressly state which terms are not legally binding between them.)