M&A Vocabulary – Experts explain: Memorandum of Understanding in M&A Transactions

There are various situations in business life, which may require an agreement which is somehow formal, but not binding and more formal than just a verbal discussion (which may be binding in itself). This is particularly the case in more complex transactions (such as M&A or some real estate projects): the detailed execution of the projects may involve comparatively high costs and a substantial management time investment to (i) conduct a due diligence on the target, (ii) obtain regulatory approvals (if required) and (iii) draft, negotiate and finalise all transactional documents including a Share Purchase Agreement (in a share deal) or Asset Purchase Agreement (in an asset deal).

Prior to embarking on the detailed project execution, the parties quite often require a confirmation of some basic commercial terms, which simultaneously serves as a basis to pursue the M&A project. The main term would be the envisaged purchase price or the method of calculating the purchase price, but also a definition of what is being purchased and also the structure, e.g. acquisition or merger, assets, or shares. There are various terms to describe such confirmations of basic terms with MoU, Letter of Intent or Term Sheet being the most common ones.

While the parties do require some formality to define some of the key commercial terms to have a framework for the envisaged transaction, care should be taken to avoid a situation in which the MoU pre-empts the provisions of the main transactional document, i.e. is legally binding, although the parties do not wish to be legally bound at an early stage of the transaction, as the agreed terms may evolve, e.g. the purchase price may change following the finding of the due diligence. 

Please be aware, that in respect of the question if a document is binding or not, the name of the document does not matter, i.e. a Memorandum of Understanding for example, is per se not more binding than a Letter of Intent. Binding or non-binding obligations are created if the parties intend to create such obligations. Additionally some jurisdictions (in particular civil law like Germany) recognise the legal construction of a pre-agreement or an agreement to agree, which normally creates the obligation to negotiate the main agreement (here SPA) in good faith. Other jurisdictions (on particular common law like England) do not recognize such concepts: here an agreement is either binding or not.

In the light of this, great care should be taken to define within the MoU, whether the parties intended for the MoU to be binding or not. Ultimately, whether a MoU is binding or not, may depend on the law and jurisdiction it is used in or subject to.

Finally, an MoU also creates certainty, as typically the parties will have a high volume of meetings and discussions to agree on the framework of a transaction in its early stages: an MoU documents these discussions and may prevent the creation of unintended agreements based on discussions or e-mail correspondence by confirming what was said and the fact that the discussions are not binding until the main transactional documentations will be signed.

Other Ancillary Documents

Please also note that there may be other ancillary arrangements at an early stage of a transaction, such as exclusivity or non-disclosure undertakings, which usually are legally binding and drafted to be enforceable. These should be either agreed separately from the MoU or alternatively in the MoU and it should clearly state which provision of the MoU is binding and which is not.

Conclusion

A MoU is standard tool in M&A transactions to define certain terms at an early stage of transactions without creating a legally binding effect, provided that the MoU is skilfully drafted. An unintentionally binding MoU can have disastrous consequences. Please also note that usually the MoU will not be legally binding, but create a strong indication what is commercially desired by the parties, which means that departing from its provisions usually requires a good reason (such as an unexpected due diligence finding) to be acceptable by the other party.