What is the Difference Between a Contract & a Memorandum of Understanding?

Written by Michael Krznaric
Edited by Rajah Lehal

Although a memorandum of understanding can offer an alternative way to create relationships, it is important to consider how this agreement differs from formal contracts.  As this post explains, poor drafting of a memorandum of understanding can cause significant legal issues.

1. Enforceability

The key difference between a contract and a memorandum of understanding is enforceability. Contracts are created when two or more parties intend to create a legally enforceable agreement.  Parties enter into contracts after an offer has been accepted, with consideration.  Parties to contracts are legally obligated to comply with the terms and conditions of the agreement.  If a term or condition of a contract is breached, parties will face legal consequences.

 Courts can also rule that parties intended to make only some parts of a memorandum of understanding enforceable.  This is illustrated in a recent case decided by the Ontario Superior Court of Justice.  In Georgian Windpower Corporation et al v.

Stelco Inc, the parties entered into a two-year memorandum of understanding.  The agreement, however, was terminated by the defendant, before the end of the two-year period.  The Court awarded damages to the plaintiff for the wrongful termination of some but not all of the terms of the agreement.

2. Outline of expectations rather than list of obligations

A memorandum of understanding is a document used to articulate an agreement between two or more parties.  The document is likely to detail the scope of the agreement, the length of the agreement, and state how the agreement can be terminated.   A memorandum of understanding is often used before parties are ready to make a formal agreement.   Parties can use a memorandum of understanding to outline expectations and responsibilities before a full agreement has been reached.  Unlike contracts, however, a memorandum of understanding is not intended to be a legally binding agreement.  As a result, parties can typical avoid the agreement with no legal consequences.

3.  Intention (or lack thereof) to create a legally binding agreement

Although there are clear theoretical differences between a contract and a memorandum of understanding, the practical differences between these two agreements can be limited by party intent.  An agreement becomes enforceable when there is evidence that the parties intended to create a legally binding agreement.  Thus, the enforceability of a memorandum of understanding depends on the intent of the parties.  If the parties do not wish to make their agreement legally binding, Courts will not enforce the document.   If the parties, however, show intent to make the agreement legally binding, Courts can rule that the parties effectively entered into a contract.  

Takeaways:

• In theory, contracts and memorandums of understanding are intended to differ significantly in their enforceability
• As the case above illustrates, simply calling a document a memorandum of understanding does not guarantee that Courts cannot enforce the agreement
• If parties do not wish to create a legally enforceable agreement, the memorandum of understanding should be carefully drafted to express this desire. Failure to do so could result in significant unwanted consequences.

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos.

Orginally posted at Clausehound.com.