Memorandum of Understanding Before a Transaction: How Binding Is It Under Saudi Law?
There is a common assumption among entrepreneurs that a memorandum of understanding is either fully binding as a contract or entirely non-binding. That assumption can create significant risk if the legal effect of the document is misunderstood.
As a general rule, a memorandum of understanding is not binding as to the conclusion of the final contract. However, it may become partially or fully binding where its provisions clearly show that the parties intended to create specific obligations, such as confidentiality, exclusivity, or the allocation of certain expenses.
How Binding Is a Memorandum of Understanding Under Saudi Law?
As a general rule, a memorandum of understanding does not oblige the parties to conclude the final agreement. It typically records key points and preliminary terms to be taken into account when the final contract is prepared, and may serve as a reference during the drafting process.
Article 41 of the Saudi Civil Transactions Law provides that negotiations for a contract do not, in themselves, create an obligation on the negotiating parties to conclude that contract. However, the second paragraph of the same Article provides that a party who negotiates or terminates negotiations in bad faith may be liable to compensate the other party for the resulting damage. Bad faith may include negotiating without genuine intent or deliberately concealing material information relevant to the contract.
This principle does not mean, however, that the title given to a document determines its legal effect. Under Article 720 of the Civil Transactions Law, the substance, purpose, and intended meaning of an agreement take precedence over its wording or title.
Accordingly, a memorandum of understanding may become partially or fully binding where its provisions demonstrate that the parties intended to create specific obligations, such as confidentiality, the payment of certain expenses, or restrictions on the use of information.
Practical point: When preparing a memorandum of understanding, it is preferable to include an express provision identifying which terms are intended to be binding and which are not. This reduces uncertainty and helps protect the parties’ respective positions.
The Difference Between a Memorandum of Understanding and a Contract
The key difference between a memorandum of understanding and a contract lies in their legal nature and effects, even though both may be structured in the form of written clauses.
Legal Nature
A memorandum of understanding is generally a preliminary arrangement reflecting an intention to enter into a future transaction. It may contain the principal commercial points while leaving the detailed obligations to the final agreement.
A contract, by contrast, is a concluded agreement that creates defined rights and obligations between the parties. Under Article 94 of the Civil Transactions Law, rights arising from a contract take effect once the contract is concluded, and the parties must perform the obligations created by it.
Legal Effect
A memorandum of understanding will not generally bind the parties to all of its commercial terms, and those terms may be amended when the final agreement is negotiated.
A contract, however, is binding on its parties once concluded, unless they agree that its effectiveness will begin at a later date. Its terms cannot generally be amended without agreement between the parties, in accordance with Article 94 of the Civil Transactions Law.
Provisions That May Remain Binding Even Where the MoU Is Otherwise Non-Binding
- Intellectual property and trade secrets: The parties may agree not to misuse technical, commercial, or proprietary information exchanged during negotiations. Where such information is not generally known and has commercial value because of its confidentiality, it may also fall within the protection of the Saudi Regulations for the Protection of Confidential Commercial Information. Those Regulations treat the acquisition, use, or disclosure of protected information in a manner contrary to honest commercial practices as an infringement that may give rise to liability.
- Confidentiality: A party may be required not to disclose information obtained during or as a result of the negotiations. Article 113 of the Civil Transactions Law provides that a confidentiality obligation does not cease merely because the contract is terminated, unless otherwise agreed. This supports the continuing nature of confidentiality obligations after the end of the underlying relationship.
- Exclusivity: The parties may agree that one or both of them will not negotiate with third parties concerning the same transaction for a specified period. If the clause is clearly drafted, it may operate independently from the non-binding nature of the remaining provisions.
- Costs and expenses: One or both parties may agree to bear particular expenses, such as feasibility study costs, engineering fees, or other transaction-related expenditure, even if the final contract is never concluded.
How a Memorandum of Understanding May End
A memorandum of understanding may come to an end in several ways:
- Expiry of its term: If the MoU provides for a defined period, it will end when that period expires unless the parties agree to extend or renew it.
- Unilateral termination: The MoU may allow either party to terminate it unilaterally if the document expressly provides for that right.
- Mutual agreement: The parties may agree to terminate the MoU before the end of its stated term.
- Failure of a condition: The MoU may be conditional on a particular event, such as one party being awarded a specific tender. If the condition does not occur, the MoU may cease to have effect in accordance with the applicable rules governing conditional obligations.
Can a Party Negotiate with Someone Else While an MoU Is in Force?
Yes, unless the memorandum of understanding contains an express exclusivity clause.
If no exclusivity provision exists, either party may generally continue negotiations with third parties concerning the same transaction while the MoU remains in force.
Where the MoU contains a clear exclusivity clause, however, that clause may be binding in its own right even if the document expressly states that the parties are not obliged to conclude the final contract.
In that situation, the non-binding wording relates to the future obligation to enter into the transaction, not necessarily to the separately agreed exclusivity obligation.
A party that breaches a binding exclusivity clause may be liable to compensate the other party for loss resulting from the breach, subject to the wording of the clause and the applicable legal requirements. This is also consistent with Article 41 of the Civil Transactions Law concerning bad-faith negotiations.
A memorandum of understanding is therefore neither a meaningless preliminary document nor automatically a fully binding contract. Its legal effect depends on its wording, purpose, and the obligations the parties intended to create.
While the parties may remain free not to conclude the final contract, provisions relating to confidentiality, exclusivity, trade secrets, and expenses may continue to impose binding obligations where they are clearly drafted and intended to have legal effect.
Frequently Asked Questions About Memoranda of Understanding
What Is the Difference Between a Memorandum of Understanding and a Letter of Intent?
A letter of intent, or LOI, generally expresses one party’s intention toward another and does not necessarily require execution by both parties in order to be issued.
A memorandum of understanding, by contrast, is generally structured as a mutual document reflecting an agreed framework between the parties.
In practice, however, the two terms are sometimes used interchangeably in commercial transactions. A memorandum of understanding is often more detailed in setting out the framework for the parties’ future cooperation.
Does a Memorandum of Understanding Need to Be Notarized in Saudi Arabia?
As a general rule, a memorandum of understanding does not need to be notarized before a notary public merely in order to have legal effect.
The absence of notarization does not, by itself, mean that an agreement is invalid or without effect. However, depending on the circumstances, formal documentation may strengthen the evidentiary position of the parties in the event of a dispute.
This can be particularly relevant where the MoU contains important provisions concerning confidentiality, exclusivity, or the allocation of expenses.
Can Compensation Be Claimed if a Party Withdraws from a Non-Binding MoU?
Yes, in certain circumstances.
Withdrawing from a non-binding memorandum of understanding does not, by itself, create liability. However, Article 41 of the Civil Transactions Law provides that a party who negotiates or terminates negotiations in bad faith may be required to compensate the other party for the resulting damage.
Such compensation does not include the expected profit that would have arisen from the contract that was never concluded.
Examples of bad faith include negotiating without genuine intent or deliberately concealing material information that could affect the contract.
How Long Does a Memorandum of Understanding Usually Remain in Force?
Saudi law does not prescribe a specific duration for a memorandum of understanding. The parties may determine its term depending on the nature and complexity of the proposed transaction.
More important than the duration itself is ensuring that the MoU clearly addresses how it may be renewed, extended, or terminated.
Can a Memorandum of Understanding Be Used as Evidence Before a Court?
Yes.
Even where a memorandum of understanding does not oblige the parties to enter into the final contract, it may still be relied upon as evidence of particular facts.
For example, it may help establish when negotiations began, the principal points discussed or agreed between the parties, or whether a party was aware of particular material information.
Its evidentiary value will generally be stronger where its wording is clear, precise, and free from ambiguity.
How Should a Memorandum of Understanding Be Drafted to Protect the Parties?
Careful drafting is essential to reduce the risk of disputes over whether a memorandum of understanding is binding.
The document should clearly identify the parties’ intention, use precise legal language, and expressly distinguish between provisions that are intended to be binding — such as confidentiality, exclusivity, and expenses — and those that remain non-binding.
For assistance in preparing a memorandum of understanding that reflects your company’s commercial interests and legal position, contact our legal team.
