What is a memorandum of understanding?

Contracts can take different forms. One is the oral agreement, in which the parties agree verbally to create a legally binding agreement but do not memorialize it in a writing. Another is the formal written agreement in which the parties set out all of the performance terms and conditions in documentary form.

Somewhere in between the oral and the written agreement is another form of agreement: the memorandum of understanding (MOU). But what are the circumstances under which such a memorandum may be used?

An MOU is typically an "agreement to agree". The two sides to negotiations will outline the areas that they have negotiated a rough agreement on as the basis for a more formal contract later on. This situation can arise when the parties are negotiating a complex transaction and both sides want to make sure that they concur on the important details before they begin drafting a formal agreement. MOUs are often used in government contracts and in international business transactions, but can be found in almost any negotiated arrangement (including domestic agreements).

MOUs are usually uncontroversial, but whether they are enforceable as contracts can raise factual issues that the parties should be aware of. In the 1980s, for example, Texaco attempted to interfere with an MOU between Pennzoil and Getty Oil, believing that the MOU was not a valid contract. Pennzoil sued Texaco and the jury in the case agreed that the MOU was in fact a legal agreement, awarding Pennzoil what was at the time the largest jury verdict in history at more than $10 billion (the case eventually settled when Texaco paid Pennzoil $3 billion).

Whether you should use an MOU in your business transactions is not something that this post can address. If you have questions about whether and when to create an MOU, you should bring them to a law firm that has experience with business-to-business contract negotiations, drafting and litigation.

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