When to Use a Memorandum of Understanding vs a Contract

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While forming new, potentially lucrative professional partnerships is exciting, it’s important for businesses to solidify working relationships in ways that are safe, legal, and sensible for what they’re trying to accomplish. Contracts and memorandums of understanding provide a way to do this effectively, but how do you know which is right for your partnership?

Read on to find out.

What is a memorandum of understanding (MOU)?

In business, a memorandum of understanding is basically a document that outlines the terms of an agreement between multiple parties, but isn't legally binding. This means that if one party doesn't hold up their end of the deal, the other party can't take them to court.

For this reason, memorandums of understanding are typically less formal than contracts and are used to lay out the general terms of a working relationship for parties that want a written agreement but not a legally binding one.

It can also be helpful if you're working with someone in a different country, where the laws around contracts may be different than what you're used to.

What is the difference between a memorandum of understanding (MOU) vs a contract?

The key difference between an MOU and a contract is that an MOU is not legally binding, whereas a contract is.

An MOU can be used for a variety of purposes, such as to establish business relationships, outline the terms of a transaction, or set the parameters of a joint venture. Alternatively, contracts are typically used in situations where there is a commercial exchange of goods or services and, as a result, are enforceable in court. In order for a contract to be valid, it must contain certain elements, such as an offer, acceptance, consideration, and mutual agreement.

When is it best to use a memorandum of understanding (MOU)?

You might be thinking, "Why would I ever bother with a memorandum of understanding if it's not legally binding?" And that's a valid question. The answer is that a memorandum of understanding can be a good way to test out a business relationship before you commit to anything more serious.

For example, two collaborating nonprofits may agree to contribute supplies for a mutually-beneficial cause or event, starting on a certain date. The memorandum allows both parties to outline the scope of the relationship and as the working relationship is solidified, they can decide to turn the MOU into a contract if need be.

Here are some more general circumstances for when it’s best to use an MOU:

• If you're not ready to make a legally binding commitment
• If the terms of the agreement are still being negotiated
• If the agreement is not meant to be long-term
• If the parties want to show proof of the understanding for future reference
• If the agreement is for a non-commercial transaction
  

When is it best to use a contract?

If you need to clearly define terms and conditions along with the consequences of violating them in a way that is legally-binding, a contract is best. For example, a service agreement between a company and a freelance graphic designer helps ensure the company knows how much and what they’re investing. On the other hand, the contract also helps the freelancer understand the scope of the working relationship and what they’re owed.

Here are a few other situations for when a contract is useful:

• If large sums of money are involved
• If you're entering into a long-term agreement
• If you need to enforce deadlines or milestones
• If you need to establish legally binding obligations
• If you're dealing with complex terms and conditions
  

In general, if you need to establish more formal or specific obligations, a contract is the way to go.

If you're still not sure whether a contract or memorandum of understanding is right for your situation, start by asking yourself this question: “do I want something that's legally binding, or am I just looking to outline the terms of an agreement?” However, if you need more guidance, be sure to consult with an attorney.

What should be included in a Memorandum of Understanding?

Though an MOU is less formal than a contract, all parties should be clear about expectations of the agreement to ensure a smooth, collaborative experience.

Here are some features that an MOU should have:

• The involved parties
• The context of the agreement
• The purpose of the agreement
• The date the agreement becomes effective
• The potential achievements of the agreement

What should be included in a contract?

When it comes to a contract, you want to cover all your bases to ensure you get what you need out of the working relationship and avoid any legal hiccups down the line.

Below are some elements that a contract should generally include:

• The involved parties
• The deliverable details
• The key terms and responsibilities
• The dates the contract begins and ends
• The payment amounts, methods, and timeframes
• The description of the products and services being provided
  

Does an MOU need to be signed?

All written contracts have to be signed to be valid, but what about an MOU?

Since MOUs typically aren’t legally binding, signing one won’t make it enforceable in court. But a memorandum of understanding still needs to be signed by all relevant parties and each signer should be officially authorized to sign for the party they’re representing. This helps confirm that all parties comprehend and agree to the terms of the MOU.

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