A handshake may start a business relationship, but most organizations know better than to rely on a verbal agreement alone. Putting expectations in writing can prevent confusion and help everyone stay on the same page. The problem is that not every written agreement carries the same legal weight. Knowing the difference between a memorandum of understanding and a contract can help business owners make informed decisions.
Key Takeaways
- An MOU helps parties organize expectations while they negotiate a future agreement.
- Contracts are designed to protect legal rights and define enforceable responsibilities.
- Calling a document an MOU does not automatically prevent it from becoming legally binding.
- The language used in an agreement can determine whether an MOU is treated as a contract.
What Is a Memorandum of Understanding?
Sometimes two professionals or companies want to formalize their agreement by putting it into writing. However, they aren’t ready or willing to sign a legally binding agreement. That is when a memorandum of understanding (MOU) could be used. It’s more serious than a handshake but not as serious as a contract.
A memorandum of understanding can be used as a stepping stone towards contract signing. The parties will write down their shared intentions. They can sometimes be called a letter of intent (LOI) or letter of agreement (LOA). The idea is to formalize each party's commitment to work together in good faith.
What Makes a Contract Legally Enforceable?
Not all contracts are legally binding. To be so, they must satisfy the requirements outlined by law. There are six elements that the contract must have:
- Offer
- Acceptance
- Awareness
- Consideration
- Capacity
- Legality
The first elements of an enforceable contract are the offer and acceptance. This is when one party makes the offer to form the contract, and the other party agrees. There needs to be a meeting of the minds, where the parties agree to the same deal. They also need to have the intent (or awareness) to make a contract with each other. Each party in the contract must give something and gain something for the agreement to be legally enforceable. This is called consideration. The benefit each party receives needs to have value to them. It could be an item, money, or a service. However, there doesn’t need to be a financial component. The benefit just needs to have value to the party receiving it.
Both parties need to have legal capacity to enter into a contract. That means they need to be a legal adult, of sober and sound mind, and able to understand the contractual language. There are ways around these, such as a minor having a court-appointed representative contract on their behalf or a translator interpreting a contract in a foreign language. The final element is legality. The contract that violates the law isn’t legally enforceable. For example, you can’t enforce a contract for the sale of illegal substances or for the sale of stolen property.
What Are the Key Differences?
The primary difference between an MOU and a contract is legal enforceability. The MOU establishes an intent to enter into a formal agreement in the future. A contract is that formal agreement. Generally, an MOU is going to include broad objectives and generalized timelines. A contract is going to include specific terms. Most parties will use an MOU to express their intention to enter negotiations or begin a relationship. It’s the contract that formalizes those negotiations.
When Should I Use a Contract?
A contract is the better option when the agreement involves a significant investment, such as a large monetary payment or long-term performance. If you are buying or selling a business, hiring employees, signing a commercial lease, or entering into a vendor or service agreement, you need a contract. A misunderstanding can quickly become an expensive dispute.
When Should I Use an MOU?
Sometimes the parties simply need a roadmap before making legal commitments. A memorandum of understanding provides that flexibility by documenting the intentions of everyone involved without necessarily creating enforceable obligations.
Businesses and organizations commonly use MOUs during:
- Early partnership discussions
- Joint venture planning
- Strategic business alliances
- Community development projects
- Nonprofit collaborations
- Cooperative efforts between government entities
An MOU helps everyone understand the direction of the project while leaving room to negotiate important terms before signing a formal contract.
Can a Memorandum of Understanding Become Legally Binding?
Despite MOUs generally being non-binding, this isn’t a “get out of jail free” card for parties. Simply calling an agreement an MOU doesn’t automatically make it one. The court looks at several factors to determine if the agreement truly is an MOU or actually a contract. Language and terms that are commonly found in contracts, party intent, and consideration can all turn an MOU into a contract. If the court determines that the agreement is actually a contract, then it becomes legally enforceable.
Work With an Oklahoma Business Attorney
A memorandum of understanding can be a valuable tool for establishing expectations and outlining a future partnership, but it is not always a replacement for a legally binding contract. Before signing any agreement, it is important to understand what commitments you are making and whether the document provides the protections you need.
Titus Hillis works with clients throughout Oklahoma to draft, review, and negotiate agreements designed to support their business goals. Before you sign an agreement that could impact your organization’s future, schedule a consultation.
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