Tuesday, July 05, 2005

Picture this, you’ve found that joint venture partner that you’ve been looking for to take your business to the next level or that black economic empowerment partner with all the right credentials. You’ve had a few meetings with your new potential partner and you’ve started planning the way forward in your head. You realise that the proposed joint venture is going to involve a number of complex agreements that will take a long time to negotiate and finalise but you don’t want to lose the momentum that you’ve got going at the moment. So you decide late one night to prepare a memorandum of understanding ("MOU") to encapsulate the salient points of your understanding with your potential partner and a proposed timeline for the signing of the substantive agreements. You also believe that the signing of a MOU will be a signal of good faith and will illustrate a level of commitment to the deal and the negotiating process on the part of both parties. Additionally, you may have the view that a signed MOU will help facilitate the raising of finance and the obtaining of various regulatory approvals.

Your potential partner promptly signs the MOU that you have drafted and you in due course make an appointment with your lawyer to instruct him or her to draft the necessary agreements to give effect to the intentions of the parties as set out in the MOU. Stop. Rewind. In this article we will explain that the more prudent approach is to see your lawyer before your commit to an MOU.

It is a common misconception that MOUs (which are also referred to as letters of intent and heads of agreement) are always non-binding or that if you take a document that reads like a binding contract and add the heading "Memorandum of Understanding" it becomes non-binding. MOUs can be binding, non-binding or partly binding and partly non-binding, it all depends on the intention of the parties and the drafting. Uncertainty is rarely a good thing in the context of legal documentation and what you don’t want is your counterparty bobbing up in a couple of weeks’ time and strongly arguing that what you believed was a non-binding MOU is actually, in the view of your counterparty, binding. The resulting uncertainty could have adverse consequences for you. Even later on down the line a poorly drafted MOU containing binding provisions has the potential to haunt the signatories in court if the envisaged substantive agreements are never signed. Further a poorly drafted MOU might make it difficult for you to raise and negotiate new points which were not included in the MOU.

It will be a question of the law of contract as to whether a MOU is binding, for example, if there is an offer, acceptance, a determinable price or consideration and an objectively determined intention to be bound on the part of the signatories then there will be a strong presumption that a binding contract exists. Conversely if the essential terms are not all present a MOU will be held to be void for vagueness.

You may ask why, if it is the intention of the parties for a MOU to be totally non-binding, bother expending the time and effort on it in the first place when you could better spend time and effort drafting the substantive agreements. A MOU is never a pre-requisite and can often serve to delay the drafting and negotiation of the substantive agreements.

Practically speaking, a MOU cannot always be avoided, for example, on particularly complex deals or where a negotiating party treats a MOU as a deal breaker and insists that one be drafted. A well drafted MOU will be partly binding and partly non-binding and will expressly state at the outset which clauses are binding and which clause are non-binding. The following are examples of the binding clauses that, depending of course on the circumstances of the particular deal, we would expect to see included in a MOU:

· confidentiality / non-disclosure clause (if not incorporated in a separate agreement);
· lock in / no negotiating with third parties clause;
· costs clause;
· governing law and jurisdiction clauses.

Bear in mind that if you are contracting with an overseas counterparty you should take particular care to ensure that the MOU is not governed by the law of a country with which you are unfamiliar. Civil law systems (such as in Holland and France) often have a very different approach to MOUs and the courts in Holland in our experience will more readily find that a contract exists or compel the parties to negotiate any outstanding points.

Where parties are negotiating a mutually beneficial deal then trust may be enough to get the deal through but where this is not the case a MOU may provide some certainty for the parties in relation to the negotiating process. A well drafted MOU which clearly sets out which clauses are binding and which are non-binding can set the tone for the negotiation of the substantive agreements to be drafted at a later stage and makes it difficult (but not impossible) for your counterparty to raise fresh issues. If it looks like a MOU is unavoidable then it should be taken seriously. Almost inevitably it will be a document which creates rights and obligations and you need to be sure that the MOU properly reflects your understanding of the arrangements.