It often happens that parties to a business venture have discussions which they then decide to set out in writing, encapsulating the salient points of their understanding and setting out a proposed timeline for the finalisation of the various substantive agreements to be concluded in future.
These expressions of understanding and/or intent can adequately be referred to as a Memorandum of Understanding (“MOU”), but do these MOUs create a legally binding agreement and, if not, how can the parties thereto protect themselves and ensure that such agreement will be legally binding?
There is a common misconception that MOUs are always non-binding. MOUs can in fact be binding, non-binding or partly binding and partly non-binding, it all depends on the intention of the parties and the exact wording of the MOU. But uncertainty is rarely a good thing in the context of legal documentation and a poorly drafted MOU containing binding provisions, has the potential to haunt the signatories in Court if the envisaged substantive agreements are never signed. It might also make it difficult for you to raise and negotiate new points which were not included in the MOU.
It will be a question of the law of contract as to whether an MOU is binding or not. Conversely, if the essential terms are not all present, an MOU will be held to be void for vagueness.
The legal binding nature of an MOU was considered in the matter of Southernport Developments (Pty) Ltd v Transnet Limited [2004] JOL 13030 (SCA), where the court of first instance found that there was no agreement between the parties, and the mere fact that there was an obligation to negotiate in good faith did not take the matter any further, replying upon the decision in Premier, Free State and Others v Firechem Free State (Pty) Ltd which held that:
“An agreement that parties would negotiate to conclude another agreement is not enforceable, because the absolute discretion vested in the parties to agree or disagree.”
Such reasoning can prima facie not be faulted by virtue of the fact that the parties should be allowed to negotiate the terms and provisions of an agreement, and in particular the essential terms of the agreement. Should the parties during the course of their negotiations not be in a position to reach finality on the essential terms of an agreement, then an agreement should not be held to have been concluded. However, where parties have already put their “flag to the mast” and expressed their intention to conclude an agreement in regard to a certain matter, can it be expected that one party can hold the remaining party to such an expressed intention?
The Supreme Court held that the present case had to be distinguished from the Firechem case by virtue of the fact that the parties had created a specific mechanism to ensure that an agreement was concluded. This mechanism was the dispute resolution mechanism of arbitration, and provided that in the event of the parties not being in a position to agree on any of the terms and conditions, such dispute would be referred to an arbitrator.
The latter case sets out the appropriate protective measures to be used by any third party that is a party to an “agreement to agree”. It is imperative that such a letter of intent/memorandum of understanding contains a provision, which provides that in the event of the parties not being in a position to reach agreement on any of the terms of the proposed agreement, that such a dispute be referred to arbitration.
It is important to note that an MOU is never a prerequisite and can often serve to delay the drafting and negotiation of the substantive agreements. Practically speaking, an MOU cannot always be avoided, for example, on particularly complex deals or where a negotiating party treats an MOU as a deal breaker and insists that one be drafted. A well-drafted MOU will be partly binding and partly non-binding and will expressly state at the outset which clauses are binding and which clauses are non-binding.
A well-drafted MOU which clearly sets out which clauses are binding, and which are non-binding can set the tone for the negotiation of the substantive agreements to be drafted at a later stage and makes it difficult (but not impossible) for your counterparty to raise fresh issues. Where an MOU is unavoidable then it should be taken seriously. Almost inevitably it will be a document which creates rights and obligations and you need to be sure that the MOU properly reflects your understanding of the arrangements.
The prudent approach is to consult your attorney before committing to an MOU.
Reference list:
- The Law of Contract in South Africa (2006) Fifth Edition: RH Christie [LexisNexis Butterwoths]
- Southernport Developments (Pty) Ltd v Transnet Limited [2004] JOL 13030 (SCA)
For more information regarding commercial matters, please contact:
Henning Pieterse | Partner
Areas of Expertise: Corporate & Commercial Law
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)