Memorandums of understanding in the restructuring context

27 January 2016

Restructuring and insolvency engagements, by their very nature, present unique challenges and pressures.   The timeframes within which material and consequential decisions must be made are, as a general rule, greatly abbreviated. Rapid commercial assessments are often required in relation to a range of matters including:

  • Short term cash flows;
  • The identification of mandatory and non-mandatory payment obligations;
  • The implementation of corrective actions to protect cash;
  • Analyzing potential sources of cash generation from asset sales, equity contributions, rentals and other sources;
  • Identifying opportunities for new money funding or the continuation of financial accommodation by an incumbent financier; and
  • Devising a plan to preserve or generate sufficient cash to withstand the crisis and accommodate the restructuring process.

In the early stages of an engagement, a restructuring practitioner will rarely have the luxury of time and the ability to engage in protracted negotiation and drafting exercises when dealing with counterparties (or prospective counterparties) in relation to matters of the sort referred to above. It is for that reason that memoranda of understanding, heads of agreement and terms sheets (which are referred to collectively in this note as MOUs) are frequently encountered in the early stages of restructuring engagements. In that context, it is not uncommon to see such documents being employed to document preliminary (or, on occasion, final) agreements with respect to:

  • Interim funding arrangements;
  • Potential equity investments;
  • Restructuring plans or proposals;
  • Licensing arrangements;
  • Proposed asset/business sales ; and
  • Debt assignment proposals.

On occasion, an MOU will be employed without a great deal of thought being devoted as to the appropriateness of that approach, or the risks that it presents in a given set of circumstances. This article addresses those issues by briefly considering:

  • The contractual nature of an MOU;
  • When an MOU will be legally binding;
  • The features of binding MOUs;
  • The features of non-binding MOUs; and
  • Some practical suggestions in relation to the use of MOUs.
What is an MOU?

An MOU is a form of agreement that documents the basic terms of a proposed transaction. They are typically entered into at a relatively early stage of negotiations and with a view to ensuring that there is a degree of alignment in relation to the intentions of the parties before those parties proceed with costly and time consuming due diligence processes, negotiations and document drafting. However, the short form nature of such documentation on occasion sees the MOU being adopted for reasons of expedience as a means by which to record what is actually intended to be a final binding and enforceable agreement. For the reasons outlined below, that approach is one that can present a degree of risk depending on the outcome that is hoped to be secured by an MOU in any given set of circumstances.

Binding or not?

An MOU can be binding, non-binding or, as is often the case, a combination of the two. Each approach has its merits. A non binding agreement enables parties to commence preliminary negotiations with respect to a transaction that both parties may later formalise, on a confidential basis on terms agreed to by both parties.  A non-binding MOU with specific provisions that are binding, such as confidentiality clauses, can afford protection to the interests of both parties and remove a potential disincentive for the parties to enter into such an agreement. Finally, a binding agreement enables the parties to commit to key aspects of a transaction prior to the final documentation being negotiated and agreed.

To determine whether (and, if so, the extent to which) an MOU will be binding, it is necessary to determine whether the parties intended the agreement to be immediately binding. That question must be determined objectively having regard to the language used within the MOU.

Features of binding MOUs

An intention to be bound may be more readily established where the MOU:

  • Expressly states an intention by the parties to be bound by the MOU or specific provisions within it;
  • The promises contained in the MOU are specific and complete in nature; and
  • Addresses all of the essential elements of a contract (certainty and completeness of terms, consideration and an intention to create legal relations).

Where the intention to be bound is inferred, and provided that the usual formalities for contract formation are otherwise satisfied (see further below), the MOU will be binding and enforceable on its terms. In those circumstances, parties will be held to their promises and obligations pursuant to the MOU.

A ‘binding’ outcome may be desirable where, for example, a distressed entity or a restructuring practitioner places immediate and unconditional reliance on the commitments made by their MOU counterparty being honoured. An interim funding arrangement documented by way of MOU constitutes a common example in this regard.  Clearly, if a distressed entity or a practitioner makes a decision to continue trading (or a decision to make related commitments to landlords, financiers, suppliers, customers and employees) that is premised on the availability of interim funding from an incumbent financier, a new financier or a shareholder pursuant to an MOU, they will require comfort that the funding has been committed and will be available, and that the financier’s commitment to fund is contractually enforceable.

To achieve that outcome, and ensure that the funds are committed, the MOU would need to disclose a clear objective intention by the parties to be bound by the relevant terms of the MOU.
Even if an MOU indicates an intention by the parties to be bound by its terms, it will be unenforceable if it does not satisfy the requirements of contractual certainty and completeness. A contract can be rendered unenforceable if its terms are not sufficiently clear and certain. That outcome can follow even if the parties to the contract intend to be bound. Although the Court has the ability to afford meaning to uncertain or ambiguous contracts or terms, the Court does not have the power to complete contracts where the parties ‘leave gaps in their own agreement’. For that reason:

  • An MOU that is intended to be binding should be carefully drafted and outline the key or material terms of the proposed transaction; and
  • The drafting exercise should be attended to with the same degree of rigour and detail as would be the case for a ‘formal’ or long-form contract.
Features of non-binding MOUs

The intention to be bound will be less readily inferred where, amongst other things:

  • The promises contained in the MOU are vague and incomplete in nature;
  • The MOU expressly contemplates the formulation of more comprehensive and detailed agreements that are yet to be negotiated; and
  • The MOU contemplates that:
    i.    fresh or additional terms will be agreed upon, suggesting terms outside and new and different from those contained in the MOU; and
    ii.    that the provisions of those terms are entirely open to negotiation.

Where the intention to be bound cannot be objectively inferred, an MOU will be regarded as nothing more than an ‘agreement to agree’, that being an agreement of the sort that cannot be enforced. If a non binding MOU is breached by a counterparty, contractual relief will not be available (although it may be the case that those parts of the MOU that are expressed to be binding (for example, confidentiality provisions) may give rise to contractual relief if they are breached by the counterparty). As noted above, even if the intention to be bound is clearly manifested by the terms of an MOU, a lack of contractual certainty or completeness could render the agreement unenforceable in any event.

There are any number of circumstances in which a restructuring practitioner may seek to avail themselves of a non-binding MOU. As noted above, the utility of that approach will often be enhanced where the non-binding MOU identifies specific obligations that are expressed by the parties to be binding. Where the MOU has been employed to facilitate preliminary negotiations in relation to a proposed transaction (e.g. an asset sale or a proposed equity investment) that may then develop into something more formal, those ‘binding’ components may include some or all of the following:

  • Confidentiality obligations;
  • The obligation to negotiate in good faith or to use reasonable endeavours to reach a final agreement; and
  • Exclusivity obligations.

Care should be taken in relation to the drafting of such provisions to ensure that they will be held to be enforceable by the Courts in the event of a breach of the relevant obligation.

Practical suggestions

The utility of MOUs in the restructuring context can be enhanced by considering, at the outset, the objectives that are hoped to be achieved by the MOU ‘documentation’ exercise. A proper consideration of that issue will ultimately inform the ‘shape’ and content of the MOU document. It will also:

  • Assist the restructuring practitioner to determine whether they require a non binding agreement (on the basis that the parties simply wish to commit to non-binding discussions in relation to a transaction that may or may not be agreed or come to pass), a binding agreement (on the basis that the parties are committed to the transaction in question despite the final documentation having not yet been negotiated and agreed) or a document that has binding and non-binding aspects; and
  • Provide comfort that the documentation that has been employed is ‘fit for purpose’.

This article was written by Richard Johnson, Partner.

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