In the modern 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 usually enter into a preliminary agreement with them as the first friendly step towards a possible alliance.
This agreement is termed as the ‘Memorandum of Understanding’. However, there exists ambiguity whether Memorandum of Understanding (MoU) is legally binding in India or not.
What is Memorandum of Understanding (MoU)?
The term ‘Memorandum of Understanding (MoU)’ is commonly used for a non-binding contract, that describes the intention of 2 people or businesses to work in consensus. An MoU in India is, therefore, also known as the Letter of Intent.
However, simply calling an agreement a Memorandum of Understanding does not automatically denote that a contract is non-binding. In the Indian legal scenario, nomenclature of an agreement is irrelevant. The Supreme Court of India, in 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 embodies 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 document is a contract.
As per the Indian Contract Act 1872, every agreement is not a contract. Only those agreements which are legally binding are contracts which are enforceable by the court of law. Hence, 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:
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There must be an offer made by one party and accepted by another
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The consent of the parties must be free and not affected by fraud, coercion, or undue influence
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The parties must be competent to enter into a contract. This means that they must be more than 18 years old, must be of sane mind, and not considered as insolvent/bankrupt
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There must be a lawful consideration
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There must be a lawful object
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There must be an intention to create legal relations
An MOU validity in India might fulfill the first-five requirements mentioned above. However, 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 deciphered from the contents and the material provision of the MOU. Thus the legal nature of an MOU rests on the rights, duties, obligations, it creates among parties. Hence, it is very important to understand and appreciate the nature of the relationship created by the parties in the legally binding MOU.
A distinction has to be drawn 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. When the parties merely record their understanding with a clause to negotiate and execute a formal detailed agreement in the future, such an understanding lacks consideration and intention to create legal relations.
In Jyoti Brothers v. Shree Durga Mining Co., (A.I.R. 1956, Cal. 280), the court laid down 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 rely 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 BrikramKishore Parida v. Penudhar Jena, (AIR 1976 Orissa 4) held 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, caution has to be exercised in the language, titles, and clauses used while drafting a Memorandum of Understanding. 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. Another 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.
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External Links:
1. Indian Contract Act, 1872 - The Indian Contract Act, 1872 prescribes the law relating to contracts in India and is the key act regulating Indian contract law.
