Legal enforceability of Letter of Intent or Memorandum of Understanding

Introduction

It is not uncommon for the parties to a contract to, upon agreeing into principal/broad terms of their agreement, reduce the same into writing and call the same as Letter of Intent (LoI), Term Sheet or Memorandum of Understanding (MoU). Such document may or may not contemplate execution of further formal document / agreement incorporating the broad terms already agreed between the Parties.  Often a question arises if such LoI, Terms Sheets or MoUs are legally enforceable. This blog examines the status and enforceability aspect of such LoIs, Term Sheets or MoUs.

Essentials for a valid contract

The foremost requirement for an understanding between parties to be enforceable in law is that there must exist a concluded contract. Under the Indian Contract Act[1], the following are the pre-requisites to bring about a concluded contract.

i) There must be parties competent to or having capacity to enter into contract. For instance the parties must not be minors or of unsound mind.
ii) There should be an offer by one party.
iii) The offer should be accepted by the other party(ies).
iv) There should be consideration.
v) Contract must be with a lawful object.
vi) The contract must be based on free consent of the parties and not be result of coercion, undue influence, fraud, misrepresentation or mistake.
vii) The contract must not be in restraint of marriage, trade or legal proceedings.
viii) The meaning of agreement must be certain, or capable of being made certain.

Once the above ingredients are fulfilled, valid and binding contract will come into existence. Such contract can be concluded orally or in writing; and the writing can well be in the form of LoI, Term Sheet or MoU.

When contract is required to be in writing

There are however, certain transactions that can be effected only by writing.  For instance, the sale[2] or gift[3] of an immoveable property. In such cases, contract must be reduced in writing. In these cases in absence of writing, there may be no valid transaction, even though all other requisites of a valid contract are met.

Contracts that require compulsory registration

Again there are certain documents that need to be compulsorily registered[4].  In absence of registration, the documents which are required to be compulsorily registered, the same are not admissible in evidence and the same may also not affect the property involved[5]. Therefore, certain transactions which in law requires to be compulsorily registered, must be effected through a registered document.

Payment of Stamp duty

There is additional requirement of payment of Stamp Duty on specified instruments/documents under the Stamp Act.  Non-payment of Stamp Duty will also make the contract inadmissible in evidence unless the requisite duty with penalty is paid.

The terms of LoI, Term sheet or MoU, if required by law to be in writing or registered and affixed with stamp duty, in order to be enforceable must comply with such requirements.

Reference to a future formal contract

Often enforceability of an agreement contained in LoI, Term Sheet, MoU is contested on the count that the same contemplated execution of a future formal contract. An argument put forth is that LoI , Term Sheet or MoU is in the nature of only an agreement to enter into an agreement and not a concluded contract itself.

If the LoI, Term Sheet or MoU relied on as constituting a contract contemplate the execution of a further contract between the parties, it is a question of construction whether:

i) the execution of the further contract is a condition or term of the bargain;  or

ii) whether it is a mere expression of the desire of the parties as to the manner in which the transaction already agreed to will in fact go through.

In the first case there is no enforceable contract because either the condition is not fulfilled or the law does not recognize a contract to enter into a contract. Thus, in a case where the signing of a further formal agreement is made a condition or term of the bargain, and if the formal agreement is not approved and signed there is no concluded contract. In the second case, there is a binding contract and the reference to the formal document may be ignored [6].

It is now thus well settled law that reference to a future formal contract will not ipso facto prevent a binding bargain between the Parties.  Merely because the Parties refer to the preparation of a document by which the terms agreed upon are to be put in a more formal shape, does not prevent the coming into existence of binding / concluded contract.[7] Once a contract is concluded orally or in writing, the mere fact that formal contract has to be prepared and initialed by the parties, would not affect either the acceptance of the contract so entered into or implementation thereof, even if the formal contract is never initialed.[8]

A LoI/MoU may be construed as an acceptance of offer, resulting in formation of contract, if such intention is evident from its terms. For instance, in works contract involving detailed procedure it is not uncommon, in order to save time, to issue a LoI communicating the acceptance of the offer and asking the contractor to commence the work with a stipulation that the detailed contract would be drawn up later. If such LoI issued to the contractor, irrespective of its nomenclature, it may amount to acceptance of the offer resulting in a concluded contract between the parties[9].

Effect of absence understanding as to non essential terms

There many cases where while parties have agreed to essential terms, certain ancillary terms such as schedule of payment, time or place of performance etc., are not agreed specifically. In such case the provisions of the Contract Act fill up the gap.  For instance, where a party undertakes to perform an obligation without an application by the other party and no time for performance is specified, the obligation is required to be performed within reasonable time.[10] Where no place is fixed for performance of obligation by the promisee, the promissor should appoint reasonable place for performance[11]. Absence of express agreement as to these terms will not nullify a valid bargain.  In fact, in contract of sale of goods it is possible to fix price by the Contract or leave the same to be determined in a manner agreed.  Failing such determination of price, buyer is required to pay a reasonable price to the Seller[12].

The take away

The above discussion shows that it is not the nomenclature of a document, but its content that determines existence of a binding / concluded contract or otherwise.  Though an agreement may be called a LOI, Term Sheet or MOU and though it may contemplate execution of a formal Agreement at a later date, if it has all the prerequisites of a binding contract, it would constitute a concluded contract.

[1] Chapters I and II of Indian Contract Act 1872
[2] Section 54 of Transfer of Property Act 1882
[3] Section 122 of Transfer of Property Act 1882
[4] Section 17 of the Registration Act, 1908
[5] Section 49 of the Registration Act, 1908
[6] Von Hatzfeldt-Wildenburg v. Alexander [1921] 1 Ch. 284
[7] Kollipara Sriramulu Vs. T. Aswathanarayana and Ors. AIR1968SC1028
[8] Trimex International FZE Ltd. Vs. Vedanta Aluminium Ltd. MANU/SC/0057/2010
[9] Dresser Rand S.A. vs.Bindal Agro Chem Ltd. and K.G. Khosla Compressors Ltd. AIR 2006 SC 871
[10] Section 47 of the Contract Act 1872
[11] Section 49 of the Contract Act 1872
[12] Section-9 of the Sale of Goods Act