Home Contracts Letter of intent, memorandum of understanding, and contracts : an analysis

Letter of intent, memorandum of understanding, and contracts : an analysis

September 29, 2021

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This article is written by Pranjali Aggarwal of the University Institute of Legal Studies, Punjab University, Chandigarh. This article deals with the basics of letter of intent, memorandum of understanding, and contract and the difference between the three.

Introduction

The commercial transactions revolve around a letter of intent, a memorandum of understanding, and contracts. These terms are used synonymously by people on an everyday basis but these terms vary based on their usage and objective. The whole concept of these three instruments is discussed in the article.

Letter of intent

A letter of intent is a formal letter or a document, sent by one party to another, that elucidates the intention of entering into a contract in the future. The letter outlines the material terms of the prospective deal which are negotiable and can be altered accordingly while entering into the final contract. It also prescribes the tasks or procedures that are to be followed by the parties, till the time the final agreement is entered into. It is also referred to as a ‘letter of inquiry’ or a ‘concept paper’.

In the case of Rajasthan Co-op Dairy Federation Ltd versus Mahalaxmi Migrate Marketing Service Pvt. Ltd (1996), the Honorable Supreme Court held that the letter of intent only indicates the willingness and intention of the party to enter into the contract. These do not lead to any kind of legal relationship between the parties.

Contents of letter of intent

The letter of Intent is generally written in the format of a formal letter and primarily includes the following contents:

Summary statement
Statement of the issue
Tasks to be performed
The result of the procedure
Budget and financial aspects of the transaction
Closing paragraph
Signature

Advantages of letter of intent

Deciding material terms of the deal – It helps to ponder over broad strokes of the contract before delving into finer points which ensures that the parties are on the same page from the beginning. It also aids in ruling out any existing or potential misunderstandings before the parties get legally bound to the agreement. This ‘cutting to the chase’ method is effective as well as convenient.
Guide to the deal- As all the major pointers of the deal are already drafted, it acts as a guiding principle to the final agreement. One can prepare the essentials of the contract based on the letter of intent because all the deal-breaking points are already discussed and clearly laid down.
Establishment of trust and confidence- Ordinarily, the terms and conditions of the letter of intent are not binding, but deciding the particular matters and the intention of parties to enter into an agreement, builds trust and confidence between them. This mutual trust will make the transaction process more smooth.
Protection of interest- It gives certain security to the parties and hence big projects like mergers or joint ventures can be announced publicly, before entering into the contract. And generally, it is observed that the negotiating parties do not indulge in the negotiation of the same contract with other parties. This ensures the protection of the interests of all the parties involved.

Disadvantages of letter of intent

A liability for the parties- In some cases, even though the parties did not intend the letter to be binding yet because of wrongful drafting, the letter of intent becomes binding and the transaction takes place against the interests of the parties. Thus, imposing unnecessary liability on the parties.
Limits the scope of a better deal- While preparing the letter of intent, all the essential terms of the contract are already decided, and parties have to work on the pre-decided terms only that do not leaves much scope of variation in the future Thus, the chances of negotiating a better deal are lost by the parties.

Memorandum of Understanding

A Memorandum of Understanding (MoU) is a document between two or more parties that enumerates the details and instructions of the contract that they wish to enter in the future. Before signing the memorandum, both the parties should have discussed all the major aspects of the agreement and both the parties stand on the same footing regarding the contract. It can be said that this document lays the foundation for a future contract. The memorandum of understanding is a more formal document than any verbal proposal but less formal than the final contract. The MoU is not legally binding but the parties are bound by estoppel. If any party suffers loss because the other party refuses the acceptance of the MoU, the aggrieved party is entitled to recover damages.

In the case of Jai Beverages Pvt. Ltd. v. State of Jammu and Kashmir and Ors. (2006), it was held by the Honorable Supreme Court that if the conditions to the MoU are otherwise acted upon, the parties to the MoU are entitled to get the benefit out of the MoU.

In the case of M/s. Nanak Builders and Investors Pvt. Ltd. v Vinod Kumar Alag (1991), it was held by the Delhi High Court that the legality of the MoU would depend on the contents and nature of the agreement. For ascertaining the enforceability of the MoU, the intention of parties is to be seen through the clauses of the MoU. If it could be deduced from the MoU that the parties intend to enter into a binding agreement, then MoU could be legally enforceable.

Contents of MoU

The following aspects are mainly encompassed under the memorandum of understanding:-

Details of the parties entering into the MoU;
Purpose of entering into the MoU;
The obligations and duties of each party;
The resources employed by each party;
The proposed benefits for each party;
Duration and termination of MoU;
Signature of the parties involved.

Advantages of MoU

Setting up clear objectives- All the objects and prospective terms are already decided before signing the MoU. Thus, it provides a clear objective as well as a broad picture of the contract to the parties.
Reduces uncertainty- The MoU’s are based on pellucid and explicit intentions of the parties to enter into the contract. The parties only sign an MoU if they both agree to terms and conditions which prevents disagreements in the future. Thus, reducing the chances of uncertainty in the future.
Ease of exit- Before entering into an MoU, all the major aspects of the prospective contract are made clear and if the expectations of the parties are not met, they can exit from the contract at the initial stage only without wasting time over the same.
Foundation for a future contract- The crucial terms of the potential contract are already decided in the MoU. This sets an outline for the future contracts which makes it easier for the parties to decide the future terms.

Disadvantages of MoU

The document is not legally binding- The signatories of the MoU are not bound to enter into the future contract. Any party can easily refuse the terms of the contract. Thus, it will not lead to any liability regarding the performance of the same contract, but the other party can claim losses if occurred due to non-performance of MoU.
Leads to confusion- The terms of the MoU’s can be confusing because in certain conditions the terms are made enforceable by the judge even though the disclaimer shows the contrary intention. Thus, the interpretation of the MoU’s might lead to confusion.
Increased negotiation time- The drafting of the MoU itself takes time and in case of the time crunch, it may pose difficulties to the parties because of increased negotiation time.

Contract

In common parlance, a contract can be said to be a document backed by law. In the Indian Contract Act,1872, the term ‘contract’ is defined under Section 2(h). A contract is an agreement between two or more parties that create certain mutual obligations which are enforceable by law. If any party breaches or fails to perform the contract, the other party can knock on the doors of the court to redress the issue. The contract can be for any purpose either to perform an act or to abstain from doing any act.

Essential elements for the valid contract

Agreement

Section 2(e) of the Indian Contract Act, 1872 defines the term ‘agreement’ as a promise or set of promises between two or more parties for consideration. When one party offers or proposes to do something for another party and the other party accepts the same, it forms the agreement. The parties entering into an agreement should be on the same wavelength regarding the terms and conditions of the agreement.

Competency

Section 11 of the Indian Contract Act, 1872 enumerates the competent people who can enter into the contract. The conditions laid down for competency are;

The person should have attained the age of maturity (18 years as per Indian law)
The person should be of sound mind while entering into the contract
The person should not fall under the category of people that are disqualified to enter into the contract as per law like Alien enemy etc.

Free Consent

Section 14 of the Indian Contract Act,1872 defines the term free consent. The consent of the parties entering into a contract is said to be free if it is not obtained through coercion, fraud or misappropriation, etc. The parties should be willing to enter into the contract without the usage of any malpractice.

Consideration

Section 2(d) of the Indian Contract Act,1872 defines the term consideration. It means ‘something in return’. The consideration for the promisee (a person to whom the promise is made) is the price paid by the promisor (a person who makes the promise) for the promise (either for the commission of the act or for the non-commission of the act) being performed by him according to his desire. On the other hand, the consideration for the promisor is the act or omission done or to be done by the promisee as per his intention. For example- A and B enter into an agreement according to which A will teach music to B for Rs. 10,000. Here, the consideration for A is Rs. 10000 and for B is learning music. For the contact to be valid the consideration should be lawful and adequate.

Lawful object

The contract should be made regarding the lawful object to be fulfilled by following lawful means. According to Section 23 of the Indian Contract Act,1872 following objects are unlawful:-

Object that is forbidden by law; or
If object is of such a nature that if allowed would be against provisions of any law; or
The object is fraudulent; or
If the contract entered into would cause injury to the person or property of another; or
the object is immoral or against public policy; or
Any contract for illegal activities or using illicit means will render the contract void.

The contract entered should not be expressly void

Certain contracts as enumerated under Section 25 (agreement without consideration), Section 26 (agreement putting restraint on marriage), Section 27 (agreement restraining trade), Section 28 (extinguishes rights of any party), Section 29 (uncertain agreements), and Section 30 (wagering contracts) of the Indian Contract Act,1872 are expressly void. The contracts between parties should not be regarding these aspects which are expressly considered void by the law.

Advantages of contract

Legally binding- The contract is a legally enforceable document and thus any party not complying with the contract can be sued and thus the issue can be redressed in court. This also creates a sense of security for the parties.
The clarity in obligations and duties- The contracts provide a lucid picture of all the obligations and duties to be performed by the parties. Thus, no chaos and confusion arise regarding the relationship and agreement between the parties.
Acts as evidence- The contract is in writing and thus acts as a piece of evidence regarding the terms and conditions agreed upon. Thus, it can be shown in the court of law by the aggrieved party to get the relief.
Pre-decided measures for dispute resolution- In several contracts, the procedure to be followed in case of dispute is already decided by the parties which ensure easy redressal of the dispute.

Disadvantages of the contract

Tedious and cumbersome process- The drafting of the contract is a cumbersome process and requires a good deal of energy and working hours so that all the aspects are covered.
Expensive- The contracts generally are drafted or reviewed by the lawyer which makes it a costly affair.
Language acts as the barrier- The language of the quiz sometimes leads to unclear contracts which creates a hindrance while performing the contract.

Differences between the letter of intent, memorandum of understanding, and contract

Sr no.	Basis	Letter of intent	MoU	Contract
1	Parties involved	It is prepared and signed by one party and is accepted by the other.	Two or more parties are involved.	Two or more parties are involved.
2	Contents of the instrument	It contains several important points agreed upon before finalizing the deal.	It encompasses the roles and responsibilities of the parties to which they have to adhere to before entering into the contract.	It encompasses every detail regarding the agreement to be performed.
3	Intention for formation	It is framed to indicate one’s intention to enter into the prospective contract.	It is almost like a prior agreement agreed upon by both parties which provides, a framework for future contracts.	It is a final agreement that is legally binding on both parties.
4	Order of formation	It is the document prepared at first showcasing the intention of one party to enter into a contract with another party.	It is next in line in which an outline is prepared regarding the material terms.	In the end, the contract is formed which was the ultimate objective of the parties.
5	Binding	It is not binding unless the parties intend so.	It is also not binding unless the parties intend.	All the valid contracts are binding on the parties and they have to stick to the contract.
6	Legal enforceability	It is ordinarily not legally enforceable.	The terms of MoU are not enforceable by law per se but if the intention of the parties is such that then it can be enforced.	All the valid contracts are legally enforceable and if any party deviates from the contract then such party can be held liable for the same.

Conclusion

The letter of intent, memorandum of understanding, and contract are the terms that are mostly used interchangeably. Even under Indian law they have not been expressly differentiated and thus primarily depend on the intention of the parties and how terms of the contract are interpreted. As held by the Honorable Court in the case of Jyoti Brothers versus Shree Durga Mining Company (1956), a contract to enter into a contract is not binding on the parties. However, this criteria is not conclusive. To decide the enforceability of the instrument, the court will rely on the intention of the parties while framing the instrument.

References

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