Making MOU’s, LOI’s, and Term Sheets Great Again

On Friday, President Trump made some not-so-fake news by openly clashing with United States Trade Representative Robert Lighthizer in front of both China’s Vice Premier Liu He and members of the gathered press in the Oval Office. The exchange was recorded on tape and can be viewed below:

As Lighthizer was explaining the latest MOU (or “Memorandum of Understanding”, i.e., the basic legal framework of any trade deal with China), Trump interjected, “I don’t like MOUs because they don’t mean anything. To me they don’t mean anything. I think you’re better off just going into a document. I was never … a fan of an MOU.”

Lighthizer, who perhaps has been living under a rock the past two years and one month, foolishly attempted to correct POTUS, explaining that MOUs were a standard procedure in forming trade agreements. “An MOU is a contract,” Lighthizer responded, “It’s the way trade agreements are generally used … A Memorandum of Understanding is a binding agreement between two people,” Finally adding, “It’s a legal term, it’s a contract.”

What is an MOU? LOI? Term sheet?

As a Phoenix business attorney, I see the confusion between MOUs, LOIs (“letters of intent”), and term sheets quite often. I’ve seen this both in my prior life working on complex real estate deals, as well as my current practice involved in corporate and commercial finance transactions.

I’ve written about LOIs in an earlier post. They, as well as MOUs and term sheets, can be important tools in setting forth the basic framework of the proposed transaction. The principals to the deal can determine early on if everyone is on the same page and willing to accept the same key business terms and, if not, avoid the grind (and cost) of negotiating and drafting a final, “definitive agreement”.

In this post, I examine the legalities of the MOU, LOI, and term sheet not from the standpoint of international trade agreements (apologies in advance to my macroecon geeks out there) but from the practical perspective of the real estate and commercial transactions I’ve dealt with as an Arizona business attorney.

Are MOUs, LOIs, and Term sheets enforceable?

When it comes to assessing the enforceability of an MOU, LOI, or term sheet, most courts will look to the language of term sheet, LOI or MOU itself to determine its effect.

The law generally considers a document’s language to be the best objective indicator of the parties’ intent. This is known as the “four corners rule” (named after the four corners of the pages the document is written on).

In most everyday cases, this is not a problem. However, where key terms are ambiguous or left open to differing interpretations, things can get interesting (and not usually in a good way).

Some courts have viewed a party’s partial performance and acceptance by the other party of such performance as indicative of an enforceable agreement. In general, courts will apply a flexible analysis that considers, among other things: the subject matter, the complexity and type of transaction, the nature of the remaining open terms, and industry custom and practice.

Finally, courts sometimes also consider the context of the negotiations themselves when construing the disputed meaning of one of these documents.

The point is, while a court may interpret an MOU, LOI, or term sheet to be a completely non-binding, negotiating device that places zero obligations on the parties, depending on the actual language of that MOU, LOI, or term sheet, a court might also find that even though the parties planned to craft a later, more comprehensive final agreement, the parties nonetheless reached a binding, enforceable contract in the MOU, LOI, or term sheet.

Under such an outcome, one party could sue the other for damages or specific performance for a breach of such MOU, LOI, or term sheet. Courts can also impose injunctive (i.e., other than money damages) relief or award reliance damages if one party decided to arbitrarily exit the deal after the other party took action (or did not take action) in reliance upon the exiting party’s promise.

Recommendations for MOU, LOI, and Term sheets

It is important for parties to first consider what they are trying to accomplish by using an MOU, LOI, or term sheet.

For example, a party might seek to bind the other side to legally enforceable obligations (such as a “confidentiality” or “no shop” clause) while the two sides negotiate their anticipated ultimate and final agreement. On the other hand, a prospective buyer may desire to walk away from the negotiations at any time, for any reason, and without legal repercussions. Lastly, a party seeking some “skin in the game” from the other side may want to insist that the other side escrow or agree to cover the party’s legal or accounting fees should that other side decides to suddenly bail on the deal.

Once the objective of the pre-contractual writing has been settled on, and depending on what the transaction is, one of these documents may be more appropriate than the others to achieve the objective.

As a practitioner, I’ve used and negotiated all three and have often done so interchangably (oftentimes not by choice). However, an easy guide to follow is that an MOU is generally in the form of, you guessed it, a memorandum, while an LOI comes in a basic letter format. Term sheets proposes key economic terms in a bullet point format.

I have found LOIs are pretty much everywhere in sophisticated commercial real estate transactions like purchases and sales, development agreements, or commercial leasing. In contrast, a startup seeking its latest round of funding will almost certainly see a term sheet coming its way from a prospective investor.

So…who was right? Trump or Lighthizer?

From the legal standpoint at least, when dealing with private commercial transactions and commercial real estate deals, they both were.

In general, MOUs, LOIs, and term sheets are considered to be non-binding, however a party entering into such a preliminary agreement cannot and should not take non-enforceability for granted, particularly parties that require certain “outs” or do not intend to be bound by one or more of the business points laid out in the MOU, LOI, or term sheet.

Careful consideration and forethought should be given to the goals behind any MOU, LOI, or term sheet. Proper attention must also be paid to the presence and scope of any binding language contained in such a document to be sure that it aligns with said goals. Failure to do this could turn what should be a useful negotiating tool into exactly the opposite–a minefield for future disagreements and possible litigation.

Ben Bhandhusavee is the Managing Attorney for BHANDLAW, PLLC, a Phoenix business and technology law firm working with start-up companies, creative intellectual property, Internet and digital media matters, and complex corporate M&A and technology transactions.  Ben can be reached at (602) 222-5542 or by e-mail at bbhand@bhandlaw.com