Significance of MOU and its most suitable use

Dear Readers,

In the last post we discussed what MOU is and how it is different from a contract. Please click on the link below to read it again

http://www.rkstrainings.com/2022/01/31/difference-between-mou-and-contract/

In this post, I wish to explain the significance of MOU and its most appropriate usage. Accordingly, we will realize its relevance for commercial and non-commercial agreements entered between stakeholders. Here, we shall cover the followings topics;

A) What is most suitable use of MOU
B) What is significance of MOU
C) MOU a first step towards contract formation

A) What is most suitable usage of MOU

Both, MOU and Contracts, set out the promises made by parties to meet certain objectives. Also, by signing such documents, parties make commitment to keep such promises. The only differentiator is whether the parties intends to be legally bound or not. In the event, parties are willing to create legal relationship, the document is called a Contract, otherwise, it is a just a MOU even if we name it otherwise. 

In view of the above, MOU is perfect document to form related parties’ agreements. Whereas, contract is a right document for non-related parties’ transactions. Accordingly, MOU seems a perfect fit for the following types of agreements and relationships

  1. Inter-departmental agreements of big corporates
  2. Agreements between regional offices of large organizations or between different entities of a diversified Business Group
  3. Agreements between state governments or state-central governments
  4. Cooperation agreements between different countries through their governments or government entities as part of diplomatic relationships
  5. Agreements between different ministries or between a ministry & associated PSU (e.g. between MoP and Power Generation Entity)
  6. Community development agreements to meet common objectives for mutual benefits where there is no intention of profit
  7. Collaboration agreements to undertake social, moral or public cause as a volunteer

In the above cited example, parties do not want to drag each other to court for breach of promises, rather they wish to exist freely without any legal complication. Article dated 02-03-2018 published in The Time of India – “State signs MOU with Tata Trusts for Comprehensive cancer care network” is good example to realize right usage and significance of MOU. https://www.tatatrusts.org/article/inside/government-of-telangana-tata-trusts-sign-mou-to-provide-state-wide-cancer-care

B) What is significance of MOU

Importance of MOU is evident from the following points;

  • Though MOU does not bind the parties legally, but, it clearly outlines the understanding between them by putting in record the broad terms agreed. So, by signing MOU, parties bind each other with respect to agreed terms so that they discharge their respective duties smoothly
  • MOU being a formal document imparts full clarity about the requirements & responsibilities of the parties. It lay down the action to be taken by each one to achieve the common goal. Hence, it binds the parties morally and professionally. Also it makes the parties accountable to each other with respect to agreed terms
  • In view of the above and because of signed MOU in place, a party simply cannot back out from its commitments without losing its face value, respect and reputation. This demonstrate the significance of MOU

C) MOU first step towards contract formation

MOU is generally a first steps towards contract formation. It also paves the way to enter into a legally binding contract at later stage. Please see below few situations where commercial entities prefer to initiate the relationship through MOU before signing a formal contract;

  1. Emerging business scenarios where rules of the game are not settled
  2. New experiments/first time experiences where parties want to test the strength of their relationship through a non-binding MOU before entering into a formal contract. This is additional step to limit the risk exposure
  3. Business relationships where parties wish to enter into relationship initially through MOU to see how it work before getting into a legally binding
  4. Situations where parties first sign MOU to record broad level understanding. This could be followed by detailed formal agreement at later stage. Signed MOU will them become a base for drafting contract. And MOU become a reference document and facilitates the review, negotiations and finalization of the contract

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