Search
LearnBlogCareersHelpLog InSign Up

What is a Memorandum of Understanding (MOU)?

definition

A memorandum of understanding is an agreement that two parties make to outline the terms of their relationship.

🤔 Understanding memorandums of understanding

When two parties are entering into a professional relationship, often in a business setting, the two might draft a memorandum of understanding (MOU). The MOU (also known as a letter of intent) is the document where they write down the terms of the agreement. An MOU is often of the first step two parties take before entering into a contract or negotiation together. Though an MOU is not usually legally binding, they have a considerable amount of importance placed upon them. MOUs typically indicate that a legally binding contract will follow. The MOU will generally outline the names of the parties and the scope of the relationship they are entering into.

example

Let’s say that two local business owners, Steve and Brenda, are seriously considering opening a new local business together. The two aren’t quite ready to sign the contract and close the deal, but they want to outline what their partnership would look like if they did sign the contract. Steve and Brenda draft a memorandum of understanding, where they stipulate the terms of their agreement and the responsibilities that each of them will have. Once they are both happy with the terms, they will be ready to move on to drawing up a contract.

Takeaway

A memorandum of understanding is like a couple getting engaged…

When a couple gets engaged, they’ve indicated that they intend to get married. They haven’t tied the knot yet, but they’ve planned the wedding and sent out the invitations. All that’s left is to sign the marriage license and make it legal. MOUs are similar in that they aren’t usually legally binding, but they indicate that both parties are ready to take the next step.

Tell me more...

What is the purpose of an MOU?
Is an MOU a legal document?
What is included in an MOU?
What is the difference between an MOU, an MOA, an agreement, and a contract?
What are the pros and cons of an MOU?

What is the purpose of an MOU?

A memorandum of understanding (MOU) allows two parties to formalize some of the details for their business relationship before signing a legal contract. Two parties might enter into an MOU together if they are entering into negotiations for a business deal.

Individuals, companies, and governments can all enter into MOUs. One example of when an MOU might appear in a business setting is in the impending merger or acquisition involving two companies. The two firms might have more negotiating left to do, but they want to sign a document where they both indicate their intention to go forward with the deal.

The two companies could draft an MOU to accomplish that. In the MOU, they would write the names of the two parties, the hopeful end goal of the merger or acquisition, and any terms they’ve come to so far. They’ll also note in the MOU that a formal contract is pending.

Parties could also use an MOU in a situation where they want to enter into a loose agreement but have no intention of ever entering into a legally binding contract. One example of when an MOU might be preferable to a formal contract is in the situation of international relations.

If two countries enter into a treaty together, it becomes public. But there are times where international partners don’t want to make the terms of their agreement public. In that case, they might use an MOU instead.

Another example of when an MOU might come in handy is when the two parties are a part of the same organization. Two departments of a corporation or a government might come to a particular agreement and sign an MOU instead of a contract.

Is an MOU a legal document?

Whether a memorandum of understanding (MOU) is a legally binding agreement depends largely on the contents and wording of the document. It’s less important what you call the agreement and more important what the terms of it are.

First, if you don’t want your MOU to be legally binding, both parties must be on the same page about that. MOUs that are not legally binding will often include specific language to indicate that. The writing could say, “subject to formal contract” or “non-binding.”

If you make it clear from the beginning that the document isn’t binding, then you can avoid legal troubles if one of you has to back out. But things will be a little trickier if your MOU includes all the contents of a formal contract without any language to indicate it is not legally binding.

Be wary about signing a document if both parties aren’t on the same page about what the agreement is. If you sign a document without making it clear that it’s not to be legally binding, the other party could have a case in court if you back out. The fact that you call it an MOU might not matter.

Even though MOUs are usually not legally binding, they do carry a certain level of seriousness with them. Both parties are generally indicating they’re taking the situation seriously, and other parties will expect them to keep their word.

What is included in an MOU?

A memorandum of understanding (MOU) typically contains all of the relevant information about the parties and the relationship they are entering into together. When two parties are planning to enter into an MOU together, it is common that both parties will come to the table with their own draft of an MOU. These drafts will be their starting point for the negotiations. The parties will often look over the two drafts together and meet somewhere in the middle.

Ultimately, an MOU should include the following information:

  1. First, an MOU should identify the two or more parties entering into the agreement.

  2. The MOU should also loosely define the goal of the relationship. If the companies are discussing a potential merger or acquisition, they would mention that. If two countries are coming to an informal agreement in place of a treaty, they would indicate that.

  3. In the MOU, parties should also indicate any specific terms they have come to. In an MOU that will lead to a formal contract, the two parties may not have worked out many of the particular terms yet. In other cases, such as an international agreement, the two parties likely will have agreed on specific conditions.

  4. In addition to outlining the terms, the MOU should also outline each party’s responsibilities. Let’s go back to the example of an acquisition. One company has offered to purchase another — The other company is still mulling it over. One of the components the two parties put into the MOU is that the company interested in acquiring the other will make a final offer by a specified date, while the other party will either accept or deny the offer within a particular time frame.

  5. An MOU should also contain language to make it clear that the document is not a legally binding one. An MOU that too closely resembles a contract could result in a fight in court. Eliminate all the confusion by inserting language into your MOU to ensure all parties are aware of what the MOU really is. Clarity is key.

  6. The final step is for the two parties to sign the MOU.

What is the difference between an MOU, an MOA, an agreement, and a contract?

There are several terms that people often use interchangeably with or in the same context as a memorandum of understanding (MOU). While some of those terms usually mean the same thing as an MOU, others have a different meaning.

A memorandum of agreement (MOA) is similar to an MOU in that it is not quite a formal contract. Think of an MOA as one step above an MOU. It typically outlines the partnership details specifically and acts as a conditional agreement where one party agrees to take a specific action if the other performs a particular action first. Another term for MOA is simply a formal agreement.

Another similar term is a contract. Unlike the other types of documents covered in this section, a contract is one that both parties usually intend to be legally binding. By signing a contract, both parties are agreeing to meet a particular obligation. Once they sign the contract, they’re officially in business together.

In many cases, two parties might start with an MOU and then move onto a contract. For example, let’s say one company has offered to buy another. In the early stages, the company entertaining the offer isn’t sure it wants to accept. There are many terms they would have to work out before they would feel comfortable agreeing.

The two companies might sign an MOU, indicating they are working toward the common goal of acquisition. They haven’t worked out any of the terms, but they sign an MOU and enter into negotiations.

During the negotiation process, the two companies work out the more specific details of the potential acquisition. Once they’ve worked out those terms and the company has accepted the other company’s offer, the two would sign the legal contract.

What are the pros and cons of an MOU?

Pros

One key benefit of a memorandum of understanding (MOU) is that for parties planning to enter into business together, it allows them to indicate their intentions without signing a binding contract. In a situation where one party is hesitant about wasting their time in negotiations that won’t go anywhere, the MOU can send a signal to both parties that they are working toward the same outcome.

MOUs also provide a level of flexibility. There are situations where two entities want to work together, but without the legal strings that come with a formal contract.

MOUs have benefits in the international community as well. While signing a treaty can be a lengthy and public process, signing an MOU lets countries agree on specific terms without the hoops to jump through with a treaty.

Cons

Despite the benefits, some downsides come with entering into an MOU as well. The most obvious argument against MOUs is the fact that they are not legally binding. So while the two parties in an MOU might intend to enter into a formal contract, the MOU is only the first step. There’s still room to back out or go back on the terms of the MOU.

20200311-1116792-3359293

Related Articles

What is an Acquisition?

Updated January 10, 2020

What is a Corporation?

Updated April 15, 2020

What are Accounts Receivable?

Updated May 11, 2020

What is a Smart Contract?

Updated January 10, 2020

What is a Limited Liability Company (LLC)?

Updated January 27, 2020

What is Profit?

Updated May 13, 2020

You May Also Like

What is Communism?

February 21, 2020

Communism is a political ideology focused on creating a classless society, eliminating private ownership of property, and promoting communal ownership of the means of production.

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.
Robinhood Financial LLC provides brokerage services. Robinhood Securities, LLC, provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading. Robinhood U.K. Ltd (RHUK) provides brokerage services in the United Kingdom. All are subsidiaries of Robinhood Markets, Inc. ('Robinhood').
© 2020 Robinhood Markets, Inc. Robinhood® is a trademark of Robinhood Markets, Inc.