Memorandum Of Understanding The Precursory To A Contract

memorandum of understanding the precursory to a contract


Memorandum of understanding: the precursory to a contract- It is a well-known fact that contracts are not formed overnight; rather it’s a result of numerous agreements and negotiations. Parties to a contract often hold various discussions about the nature and details of their transaction and formulate certain preliminary agreements for the same, indicating their willingness to carry out a transaction in a particular way as mutually agreed upon by them. Such preliminary agreements are often referred to as Memorandum of Understanding (or MoU). In simple terms, a Memorandum of Understanding is often considered to be ‘anon-binding agreement’ which has no legal enforceability and merely summarizes the framework for a transaction that is under discussion and the intent of parties to formalize it as a contract in the later stage. A MoU generally does not intend to create a legal bond, due to which there is no relief in case of non-performance.

Objectives of a MoU

  1. Mutual trust and commitment – It may be intended to demonstrate parties’ mutual trust and commitment to deal with each other. A MoU enlists the obligations of each party and sets out a definite plan to discharge the obligations.
  2. Tool for further negotiations – It may act as a tool for further negotiations by recording what parties have agreed on till date. Such agreements may later on be included in the final contract. It also provides confidential transmission of information.
  3. Framework for future transaction – It can also be used as a framework or template for further transactions that are anticipated to occur. In this manner, it would avoid redundancy and expense to carry out negotiations in the later stage.
  4. Indication to third-party -It may also be shown to a third party, such as a financier or a government agency, which wants or needs an indication that parties have reached an agreement.
  5. Offers Flexibility – A MoU offers flexibility to parties and can be altered numerous times until the parties reach a conclusion. This kind of flexibility makes it favorable for parties who wish to explore the possible business relations without getting into nitty-gritty of contracts.

Elements of a MoU

Although different preliminary agreements can be signed for different purposes, there are certain elements that are found in majority of the agreements. These include, but are not limited to:

  1. Name and address of the parties involved
  2. Purpose of entering the MoU
  3. Roles and Obligations of each party
  4. Terms and conditions for discharging their obligation
  5. Resources provided by each party
  6. Remuneration, if any
  7. Signature of all parties involved

At this stage, it is pertinent to mention that the nomenclature of a MoU is of paramount importance in the eyes of law. The enforceability of a MoU largely depends upon the verbatim and the structure of a MoU.

Legal Position of MoU: the Indian perspective

Here arise a degree of confusion regarding the legality and enforceability of MoU, especially in the business community. Some people equate it with lack of intention to contract, while others assume exactly the opposite.

In India, all agreements are governed by The Indian Contract Act, 1872, Section 10 of which enlists certain conditions for an agreement to become a contract. Under S.10 of the Act, all agreements are contracts if:

(1) They are formed by free consent with intent to form legal relations

(2) By the parties who are competent to contract

(3) For a lawful consideration

(4) With a lawful object

(5) And are not expressly declared void by virtue of coercion, misrepresentation, undue influence or fraud

Therefore, a MoU fulfilling all the above-mentioned conditions may be considered to be a contract. However, the intent of parties to create legal relationship and the verbatim of the agreement has the colossal importance. The parties’ intention must be objectively ascertained from the terms of the document when read in the light of the surrounding circumstances.[1]

The courts in India have also opted for a case to case approach to determine whether a preliminary agreement is binding or not. The Court ascertains the intent of parties from the verbatim of the agreement and the parties’ subsequent acts. There have been numerous judgments where a MoU was held to be legally binding. Memorandum of understanding: the precursory to a contract

In the case of Nanak Builders and Investors Pvt. Ltd. v. Vinod Kumar Alag[2], the hon’ble Delhi High Court pronounced that where the essential and substantial terms are being decided by the parties and write it down into paper, and the agreement does not mention that whether a subsequent agreement will be executed or not, then the Court shall not consider this agreement as an incomplete agreement. Further, it was also held that the heading or title in the documents will not taken into consideration and it is only the contents of the agreement.

In Bikram Kishore Parida v. Benudhar Jena[3], the Court held that the test of an intention to create legal relations is an objective one. It may be that the promisor never anticipated that his promise would give rise to any legal obligation but if a reasonable man would consider that he intended to enter into a contract, then he will be bound to make good on his promise.

However, in a lot of cases a MoU was not given the status of a contract.

Other judgments

  1. Energy Ltd. v. Union of India and Ors.[4]
  2. Jyoti Brothers v. Shree Durga Mining Co.[5]

Hence, it can be said that mentioned cases that there exists no hard and fast rule as to determine the legality and enforceability of a MoU. Different circumstances have time and again called for the wise eyes of the law to determine the status of a MoU.

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The legal position of a MoU has been a matter of debate in domestic as well as international jurisdictions. Nevertheless, a majority of courts have as a matter of principle accepted that a promise to negotiate in good faith might be enforceable. It is also advisable to draft a MoU with great caution and expressly mention that the said MoU shall not be legally enforceable. Vital importance should be given to the verbatim of the agreement. For instance, words like ‘shall be’ instead of ‘may be’ can imply intent to form a legally binding agreement. These little details in an agreement can change the color of an agreement into contract. Therefore, a greater imperative should be given to these details while drafting an agreement to avoid legal hassles in the later stage.

[1]GR Securities v. Baulkham Hills Private Hospital, (1986) 40 NSWLR 622

[2]AIR (1991) Del 315

[3] AIR (1976) Orissa 4

[4] (2012) 7 SCR 644

[5] AIR (1956) Cal. 280

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