31 Jul 2015 17:39 IST

How an MoU can work for you

An MoU is the way to go if you'd rather test the waters of doing business with another entity before signing an agreement

New businesses, in particular tech companies, frequently tie-up with other entities. Let's say you're running a company that connects buyers with departmental stores across the city. You would want to tie-up with all the stores in the city. Now, this can be pretty complex. Both parties would need to agree on a long list of things, starting from whether the departmental store would give your company access to its godown, whether you would pay full price or get a discount on buying a certain number of items. While you may know what terms you want to have included after signing up and working with several stores, you will find that the first few you approach are very sceptical about getting into a legally enforceable agreement with you.

This is one instance when a Memorandum of Understanding (MoU) is required.

When to use it

When two parties only want to put on paper their intention regarding a certain transaction or a set of transactions until they can formally agree on a definitive set of conditions, an MoU is called for. You may wonder why this is even necessary. If it isn't legally binding, why should two parties even go through the trouble of putting it on paper? It's because having an MoU, rather than just an e-mail exchange, greatly increases the chance that both parties will seriously reflect on what is written. It is, therefore, likely they will honour the agreement.

Most commonly, here are the situations in which it is used:

1. To state conditions for sale or purchase

2. To schedule payment for a transaction

3. To document preliminary aspects of a business relationship before a definitive agreement can be reached

Now what is contained in this agreement is not legally binding on either party. This means that if one of the parties does not honour what was stated in it, the court will simply ignore the MoU and will only take it to mean that there were a set of conditions between the two. There is, however, one instance in which this is not true: if an MoU is for the exchange of money between two parties, it is binding in court.

Precautions

Just because it isn't enforceable in court, however, doesn't mean you shouldn't thoroughly examine what is and isn't included. Simple points that are often forgotten are penalties and a termination clause. None of it is enforceable in court, so you're probably wondering why it matters that these points are forgotten. The reality is that in business, a lot of arm-twisting can happen whether or not the courts are involved. So even without the courts, there is always the possibility that one business will try to gain from what is written or, more likely, what isn't included.

So before you sign one, be sure that it covers the necessary ground.

*VakilSearch simplifies legal for start-ups by facilitating company registration , trademark filing , documentation and compliance.

To read more from the LegalEase section, click here .