Contract vs. Memorandum Of Understanding: What’s The Difference?

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Contracts and memorandum of understanding (MOU) are often considered synonymous and used interchangeably. While it is true that they are both agreements between two or more parties, there are substantial differences between the two.

This article covers what each is, what it constitutes and when you can use either of the two.

Defining a Contract

A contract is a written and legally binding document that two or more parties enter into. It contains the roles and obligations each party will fulfil and these are legally enforceable.

All contracts, per Australia’s contract law, must contain offer and acceptance, intention and capacity to enter into the contract and the exchange of value or ‘consideration’. Without these elements, a contract is considered void. Additionally, fulfilment of a contract is mandatory and failure to do so leads to legal consequences.

Constituents of a Contract

For any agreement to be considered a contract legally, it needs to have the following elements:

  1. Intention – Both parties must intend to enter into the contract and fulfil it.
  2. Capacity – According to law, some individuals cannot enter into contracts e.g. minors, etc. Hence, the contracting parties must have the capacity to enter into contracts.
  3. Offer – One party needs to make an offer to another party, that is, an expression of a willingness to enter into a contract on certain terms.
  4. Acceptance – The other party needs to indicate that they accept the offer.
  5. Consideration – The other party also needs to offer consideration (usually money) in exchange after the acceptance of the offer.

Defining a Memorandum of Understanding (MOU)

An MOU is also a written document but isn’t considered a legally binding contract. Several consider it to be a documented handshake when two or more organisations decide to work with each other. Signed before a contract, the MOU outlines the purpose of the partnership formed and the general agreement of why the parties are collaborating. Such an MOU may highlight the framework and structure of the relationship but details are added in the actual contract signed later.

Elements of an MOU

Since the MOU isn’t a legally enforceable document like a contract, its constituents are generally flexible. They can depend on what the MOU is being signed for and the context of the agreement. However, the following are generally included in MOUs:

  1. Identification and recognition of contracting parties
  2. Schedules and key dates
  3. Benefits and objectives either party hopes to achieve
  4. Roles and duties of each party
  5. Privacy and information clauses
  6. Liability clauses

When Should You Use an MOU?

An MOU is generally signed between parties to document and put into writing a formal working relationship. For example, an MOU may be signed between two parties who have agreed upon sharing some resources or office spaces. This agreement would not include an offer or consideration, but some clauses regarding the shared use of space and conditions agreed upon.

Commercial organisations often also sign MOUs to highlight the beginning of a mutually beneficial relationship, but do not want to form legal relations at this point. This is also sometimes the negotiation stage for parties as they debate and settle on their eventual relationship and contract terms. Hence, the MOUs serve as the precursor to the eventually negotiated contract.

Benefits of an MOU

An MOU is not a legally enforceable document but by no means does this mean  you should do away with one. Signing one can help you negotiate terms and clauses for the actual contract to be signed later. During negotiations, the parties involved are likely to go over multiple scenarios and are bound to agree on some conditions and disagree on the others. The MOU can be the perfect tool to outline and establish a mutually agreed upon and documented relationship before crafting and signing the actual contract.

The MOU can also serve as a reminder of what was initially agreed upon by the involved parties. It becomes a point of reference to understand why the parties collaborated in the first place and what they hoped to achieve.

When Should You Sign A Contract?

A contract should be signed when you require the other party to fulfil an obligation. The contract will detail what the obligation to be fulfilled is, what you will offer in return and the legal remedies in case the contract is not performed.

Businesses should also sign contracts when they require the performance of services by other parties or organisations. This way, both parties can be on the same page regarding what is expected of them and the details of the services.

It is advantageous and advisable to sign an MOU before signing a contract. This way, you are likely to have achieved a consensus on what the interests and goals of the parties are and what should be the key terms of the contract.

Benefits of a Contract

There are several benefits of signing a contract when relying on other parties to fulfil their obligations. Firstly, you have a legally binding agreement which means that all involved parties are mandated by law to perform the contract. In case of non-performance, you can seek compensation or remedy by pursuing legal action.

A contract also helps protect the business’ interests through the various clauses it contains. Not only roles and responsibilities, but the split and ownership of assets as well as their use is detailed in the contracts. They also set safeguards against liabilities and warranties, thereby, helping the business to safeguard themselves in cases of conflict or any unfortunate circumstances.

Contracts also set out dispute resolution methods. In case of any issues arising, parties can invoke any of the dispute resolution methods detailed in the contract to renegotiate or discuss the terms of the contract. Alternative methods of dispute resolution help save time and costs for firms compared to them pursuing litigation as a means of conflict resolution.

Key Takeaways

  • An MOU is a formal written document serving as a precursor to a contract, describing the key terms of a working relationship between two or more parties.
  • It is not legally binding, unlike a contract, as exemplified by the case Masters v Cameron.
  • An MOU does not contain elements like offer and acceptance, which are the essential features of a contract. No intention or capacity to contract is required for an MOU.
  • Signing an MOU helps achieve a consensus on what the parties expect out of the relationship and what roles they will play to achieve the goals they wish to achieve through working together.

Crafting an MOU

Although they are not legally enforceable agreements, MOUs are important documents that form the basis of your future contracts. Hence, it is imperative that you pay attention to the process and carry it out diligently. Seeking legal counsel can help you draft an excellent MOU that best serves your business’ interests.

At Lazarus Legal, we are committed to ensuring your businesses thrive by protecting your interests as you negotiate deals and contracts with collaborators. Our expert commercial lawyers are not only experienced contract law experts but also have helped countless businesses draft and negotiate MOUs, agreements and contracts. If you require expert help, connect with our business lawyers today to discuss your business needs.

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Mark Lazarus

Mark Lazarus

Mark Lazarus, the visionary behind the business and the fresh blood of the Lazarus Legal team, Mark (or Laz as he is often known) owes much of his success to his past experiences. And he’s made it his personal goal to bring that wisdom and formula to the firm.

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Contract vs. Memorandum Of Understanding: What’s The Difference?