What Does Non-binding Mean and Why Should I Care?
This post discusses the meaning of non-binding with respect to a letter of intent (LOI) or a memorandum of understanding (MOU). (Non-binding has a similar meaning in other legal contexts, such as legislation or arbitration, but I will not discuss those contexts here.)
Although I will refer to solely an LOI in the remainder of this post, the following pertains to an MOU, as well.
Please note that whereas “memorandum of understanding” and “letter of intent” are the terms typically used in the U.S., the corresponding term in the U.K. is “heads of terms“.
The purpose of an LOI is to summarize the basic terms of a relationship into which the parties wish to enter. It also specifies that the parties will enter into negotiations to prepare a definitive agreement establishing that relationship.
Stating Whether an LOI is Non-binding
The LOI should state expressly whether it is binding or non-binding.
- Binding means that the parties are obligated to carry out the provisions of the LOI. They ultimately must sign a definitive agreement.
- Non-binding means that either party can break off negotiations at any time. The parties can walk away without having signed a definitive agreement.
In my experience, an LOI typically should be non-binding. At the time the LOI is signed, the parties may not know much about one another. As discussions proceed, it may become clear to one party, or to both, the the relationship cannot work as originally expected. There is no reason to force an unworkable agreement on the parties.
Making an LOI Non-binding
The two most important provisions that make an LOI non-binding are the following.
- The LOI should state expressly that it is non-binding. “Non-binding” should appear in both the subject line and the first paragraph.
- The LOI should state that neither party will be obligated to sign a definitive agreement unless the party is satisfied that the agreement is in its best interests.
A non-binding LOI may, however, have binding provisions. Most importantly, confidentiality provisions should be binding.
Sometimes Binding is Appropriate
Sometimes it is appropriate for an LOI to be binding. For example, one of my clients was selected to provide high-priced, sophisticated software and associated services to one of its customers. Negotiating a definitive agreement would take several weeks, but work needed to begin right away because of a tight deadline.
The parties quickly entered into a binding LOI for the first phase of the project. Services and pricing for that phase were specified. The LOI included a binding obligation to execute a definitive agreement before the deadline for completing the first phase.
In summary, the important point is not that an LOI should be non-binding. The important point is that one should think about whether an LOI should be binding or non-binding, and should prepare the LOI accordingly.
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Dana H. Shultz, Attorney at Law +1 510 547-0545 dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.