As we all know, business organizations today enter into various kinds of agreements while carrying out their business. As things stand, while negotiating with their potential business partners, joint ventures, vendors and agents, these business organizations generally enter into a preliminary agreement with them as the first friendly step towards a possible alliance.
In common parlance, this agreement is known as the ‘Memorandum of Understanding’. But, the question is whether ‘Memorandum of Understanding (MoU)’ is legally binding in India or not.
Defining ‘Memorandum of Understanding (MoU)’
By definition, ‘Memorandum of Understanding (MoU)’ is usually said to mean a non-binding contract that describes the intention of two people or businesses to work in consensus. In India, moreover, an MoU is also known as the ‘Letter of Intent’.
Be that as it may, simply calling an agreement a ‘Memorandum of Understanding’ does not automatically imply that a contract is non-binding. It has also been observed that 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.”
Fundamentally, a ‘Memorandum of Understanding’ expresses the understanding of parties with respect to a particular transaction or a project which they wish to undertake. Yet, the mere existence of a document with respect to an understanding reached between the parties do not necessarily lead to the conclusion that such a document is a contract.
If we go by the Indian Contract Act 1872, it says that every agreement is not a contract. According to it, only those agreements which are legally binding are contracts that are enforceable by the court of law. So the question that arises is, “What is the legality of MOU in India?”
Indian Contract Act, 1872 & ‘Memorandum of Understanding (MoU)’
Section 10 of the Indian Contract Act, 1872 lays down the key 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
In the current state of affairs, an MOU validity in India might fulfill the first-five requirements mentioned above. On the other hand, if the MoU lacks the intention to create legal relations, it will not be considered a contract and will be incapable of specific performance.
As a matter of fact, the intent of the parties can be ascertained from the contents and the material provision of the MOU. It follows that the legal nature of an MOU depends upon the rights, duties, obligations it creates among parties. Hence, it is of utmost importance to understand and appreciate the nature of the relationship created by the parties in the legally-binding MOU.
Again, it is crucial to clearly establish 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. And, in the event that the parties wish to simply record their understanding with a clause to negotiate and execute a formal detailed agreement in the future, such an understanding will lack the consideration and intention to create legal relations.
To quote that 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. But, 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.
If we refer to the case of BrikramKishore Parida v. Penudhar Jena, (AIR 1976 Orissa 4), here 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.
Therefore, it is clear that due caution has to be exercised in the language, titles, and clauses used while drafting a ‘Memorandum of Understanding’. It may also be noted here that clauses such as jurisdiction clause, applicable law, indemnification have binding effects to the agreement.
Likewise, the use of the word “shall” will give a binding effect to the MOU and the use of the word “should” will give it a non-binding effect. One more 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.
