In the present-day business world, business organizations enter into different kinds of agreements while carrying out their business. These business organizations, while negotiating with their potential business partners, joint ventures, vendors and agents, generally enter into a preliminary agreement with them as the first friendly step towards a possible alliance.
This agreement is known as the ‘Memorandum of Understanding’. However, there exists an ambiguity on whether ‘Memorandum of Understanding (MoU)’ is legally binding in India or not.
What is Memorandum of Understanding (MoU)?
As a term, ‘Memorandum of Understanding (MoU)’ is generally used to define a non-binding contract that describes the intention of two people or businesses to work in consensus. So it is that, an MoU in India is also known as the ‘Letter of Intent’.
However, simply calling an agreement a ‘Memorandum of Understanding’ does not automatically imply that a contract is non-binding. In the Indian legal scenario, nomenclature of an agreement is usually irrelevant. The Supreme Court of India, in the case of State of Orissa & Others v. Titagar Paper Mills Company Ltd. & Another, has laid down that:
“It is true that the nomenclature and description given to a contract are not determinative of the real nature of the document or of the transaction thereunder. These, however, have to be determined from all the terms and MOU clause of the document and all the rights and results flowing therefrom and not by picking and choosing certain clauses.”
In essence, a ‘Memorandum of Understanding’ expresses the understanding of parties with respect to a particular transaction or a project which they wish to undertake. However, the mere existence of a document with respect to an understanding reached between the parties does not necessarily lead to the conclusion that such a document is a contract.
According to the Indian Contract Act 1872, every agreement is not a contract. And, only those agreements which are legally binding are contracts which are enforceable by the court of law. Therefore, the question which arises is that, “Is MOU legally binding in India?”
Section 10 of the Indian Contract Act, 1872 lay down the essential requirements of a legally binding agreement or contract as hereunder:
- There must be an offer made by one party and accepted by another
- The consent of the parties must be free and not affected by fraud, coercion, or undue influence
- The parties must be competent to enter into a contract. It means that they must be more than 18 years old, must be of sane mind, and not considered as insolvent/bankrupt
- There must be a lawful consideration
- There must be a lawful object
- There must be an intention to create legal relations
An MOU validity in India might fulfill the first-five requirements mentioned above. But, if it lacks the intention to create legal relations, it is not a contract and is incapable of specific performance.
The intent of the parties can be deduced from the contents and the material provision of the MOU. Thus, the legal nature of an MOU depends upon the rights, duties, obligations it creates among parties. So, it is very important to understand and appreciate the nature of the relationship created by the parties in the legally-binding MOU.
A clarity has to be established on whether the parties intended the MOU to be an informal agreement which is incomplete and merely an agreement to agree, or whether it is a complete contract for which the parties consider themselves to be bound. In case the parties merely record their understanding with a clause to negotiate and execute a formal detailed agreement in the future, such an understanding lacks the consideration and intention to create legal relations.
In the case of Jyoti Brothers v. Shree Durga Mining Co., (A.I.R. 1956, Cal. 280), the court declared that a contract to enter into a contract is not considered to be a valid contract in law at all. However, the same is not conclusive. The court will depend upon the degree of importance of such understanding to the parties based on the fact whether either of them acted in reliance on such Understanding.
In the case of BrikramKishore Parida v. Penudhar Jena, (AIR 1976 Orissa 4), the court ruled 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.
Hence, it follows that caution has to be exercised in the language, titles, and clauses used while drafting a ‘Memorandum of Understanding’. Here, it may be remembered that clauses such as jurisdiction clause, applicable law, indemnification have binding effects to the agreement.
Similarly, the use of the word “shall” will give a binding effect to the MOU and the use of the word “should” a non-binding effect. One other way in which intention may be displaced is to include a clause in the agreement itself saying that this agreement is not intended to be a contract.