M&A Vocabulary – Understanding the Experts: “Memorandum of Understanding in M&A”

Nature of the Memorandum of Understanding (“MoU”)

In business, there are various situations where it may make sense to enter into an agreement that, despite its formal character, is not binding, yet more formal than just a conversation (which can be binding as such). This applies in particular to more complex transactions (such as M&A or certain real estate projects): detailed project implementation can involve comparatively high costs and the investment of considerable time in project management to (i) conduct due diligence on the target company, (ii) obtain (potentially necessary) regulatory approvals, and (iii) draft, negotiate, and finalize all transaction documents, including the share purchase agreement (in a share deal) or asset purchase agreement (in an asset deal).
Before the parties deal with the implementation of the project in detail, they very often require confirmation of some of the basic terms and conditions, which simultaneously serves as a basis for pursuing the M&A project further. The most important provision concerns the target purchase price or the method of Purchase Price Calculation, but the definition of the object of purchase and the structure—i.e., acquisition or merger, assets or shares—are also regulated. There are various terms used to describe such a confirmation of basic business terms, the most common of which are MoU, letter of intent (LOI, Letter of Intent (LOI)), or term sheet (fixing the key points).

Legally binding or not?

Even if the parties require a formal document as a framework for the planned transaction that fixes the most important terms of the deal, care should be taken that the MoU does not anticipate the provisions of the core transaction document—i.e., is legally binding—even though the parties do not wish to bind themselves legally at an early stage of the transaction, as the agreed terms may evolve; for example, the purchase price may change as a result of the findings of a due diligence.
It is important to note that when assessing whether a document is legally binding or not, the title of the document is irrelevant; i.e., a Memorandum of Understanding is not per se more binding than a letter of intent. Obligations are considered bindingly or non-bindingly agreed if it is the intention of the parties to agree on such obligations. Furthermore, in some jurisdictions (particularly civil law jurisdictions such as Germany), the legal construct of a preliminary contract or an “agreement to agree,” which normally establishes the duty to negotiate the main contract (here: SPA) in good faith, is recognized. In other jurisdictions (particularly the common law system such as in England), such concepts do not exist: there, an agreement is either legally binding or it is not.
In view of this, an MoU must define with extreme care whether the parties intend to give the MoU legal binding force or not. Ultimately, whether an MoU is legally binding or not may depend on the laws governing the MoU and the legal system in which it is applied.
In the end, an MoU also creates security, as the parties will meet very frequently and hold many discussions to agree on the framework for the transaction in advance: an MoU documents these meetings and can help avoid unintentional agreements being made through conversations or email correspondence by confirming what was said, as well as the fact that the discussions are not binding until the core transaction documents have been signed.

Other accompanying documents

It should be noted that at an early stage of a transaction, there may also be other accompanying agreements, such as exclusivity or non-disclosure agreements, which are regularly legally binding and intended to be enforceable. These should either be concluded separately from an MoU or—if they are included in the MoU—it must be clearly defined which provisions of the MoU are legally binding and which are not.

Conclusion

The MoU is a standard tool in corporate transactions to non-bindingly establish certain terms at an early stage, provided the MoU is skillfully drafted. An MoU that unintentionally develops a binding effect can have devastating consequences. The MoU is regularly legally non-binding, but contains strong indications of the parties’ business intentions; this means that a valid reason is usually required (such as the unexpected result of a due diligence review) if its provisions are to be deviated from so that the other party agrees to it.

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