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How a Memorandum of Understanding (MoU) can help your business
What is it?
MoU stands for Memorandum of Understanding but they are also known as heads of terms, letters of intent, or term sheets It’s a milestone towards the realisation of a project with the input of different parties and is used at the Intention Stage of a project.
For the sake of clarity, let’s consider the project is a joint venture company launching a new product or service. The next milestone is the incorporation of a new company jointly held by the parties to the MoU and the signature of a shareholders agreement commonly named a joint-venture agreement or JV agreement; this occurs during the Contract Stage.
Why do I need one?
A comprehensive MoU should set a clear roadmap to its parties on how they will perhaps move from the Intention Stage to the Contract Stage. The parties may never be able to move on from Intention Stage without an MoU.
Key elements of an MoU
A comprehensive MoU should address the following questions:
Who?
1. presentation of each party;
What?
2. definition of the project;
3. contribution to the project in kind or in cash that each party is expected by the other parties (and agrees) to take responsibility for in the project ( ex. funding, marketing, sourcing, manufacturing etc.);
4. what needs to be done: detailed conditions to meet before proceeding to Contract Stage (ex. preparation and validation of a business plan by all parties, with a list of questions that need to be addressed);
How?
5. kick-off event (conditions in 4 completed) or withdrawal event (conditions in 4 not completed); long stop date (i.e. the latest date agreed by parties to decide to go ahead or not);
6. what is the next stage (see 2nd paragraph of this article);
7. who will be in charge of having the documents prepared for the Contract Stage;
8. how the preparation of the Contract Stage will be funded (both parties should contribute and be refunded by the company);
9. structure of JV agreement (details and drafting to be agreed later on good faith, based on market practice to ensure protection of each parties ‘interests, including the company):
- repartition of share capital between parties (need to be stated in the MoU);
- number of board members and how many shall be appointed by each party (minimum one, maximum 3-5)(need to be stated in the MoU);
When?
10. set schedule for (i) signing the MoU), (ii) completing the conditions and deciding to go ahead with the project or not, (iii) preparing and signing the JV agreement, and (iv) getting actually started with the project;
Common Mistakes
The most common blunders that can occur with an MoU are:
Too General
Making the MoU too general so it doesn’t contain provisions where each party formulates in express terms what they need to know from the other parties in relation to the project; or
Too Detailed
It’s far too detailed and contains very detailed provisions for the shareholders agreement. Too much detail can cause parties to spend time arguing on the finesses of those clauses before the business plan has even been validated.
In the latter, where the MoU contains very detailed provisions for the shareholders agreement, it’s likely those provisions will need to be amended later to be workable and achieve a balance between the parties interests as well as the company’s (which should be a party to the shareholders agreement). The mere fact that the MoU contains very detailed provisions for the shareholders agreement often has the effect to freeze the discussion and make any changes difficult to agree upon. For this reason, unless parties take professional advice for drafting or negotiating the MoU, it is advised to focus on parties’ contributions to the project and the structure of the future shareholders agreement.
Other important clauses
11. reasonable confidentiality provisions;
12. exclusivity clause;
13. termination clause (what happens if at least one party decides to withdraw from the project);
14. costs;
15. standard clause for dispute resolution including mediation or other alternative dispute resolution method agreed in advance by the parties.
By addressing the 15 points above in your MoU, you will express in clear terms the who’s and what’s which will eventually determine your decision to commit to the project, or not. If you don’t address these points in clear terms in the MoU, you will find yourself in muddy waters if you want to withdraw from the project or go ahead but on different terms. These confusions, ambiguities, omissions, or even mistakes at the MoU stage lead to misunderstandings with your future partners working on the wrong assumptions, and vice-versa.
For this reason, the all-important MoU clearly states what other parties are expected to bring to the table (by you); what they expect you to bring to the table; and what needs to be worked out at this stage (business plan, regulations etc.). When negotiating an MoU, it’s crucial to bear in mind it is the last non-binding document before you commit to the project.
Don’t be fooled by the fact that most clauses in an MoU are expressly qualified as non-binding. It’s true they are not legally binding and you cannot be ordered by the court to execute them. But they are a declaration of intention to the other parties and wrong assumptions can be impossible to overcome as they dent the trust between parties and can lead to the end of the project or a project built on a foundation of sand.
Maeva Slotine is Founding Partner of SLOTINE, the Hong Kong Solicitor’s firm specialising in cross-border business law. Her main areas of practise are M&A, International Investments, Corporate Finance, Private Equity and Corporate Governance.
This article does not constitute legal advice.
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