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1 Memorandum Of Understanding on Tue 14 Jul 2009 - 12:41



The concept of Memorandum of Understanding is very simple. It is supposed to be a freely negotiated document between the Government, acting as the owner of Central Public Sector Enterprises (CPSEs) and a specific CPSE. Second, it is supposed to clearly specify the intentions, obligations and mutual responsibilities of both parties to the Memorandum of Understanding (MOU). If either of the above two conditions is violated, the effectiveness of the MOU as an instrument of performance improvement is bound to be affected. Further, MOU makes an attempt to move the management of CPSEs from management by controls and procedures to management by results and Objectives. Another way of saying the same thing is that MOU makes an attempt to move the management of CPSEs from reliance on ex-ante controls to a system of ex-post controls.


The objectives of the MOU system are to:

 Measure the performance of CPSEs taking into account the complexity fusing social and financial objectives and translating them into measurable parameters

 Ensure simultaneous increase in autonomy as well as accountability;

 Set up new institutions and administrative & personnel systems;

 Replace 'multiple principles with multiple objectives' with clarity in goals and objectives


The MOU is not merely a document; it is a way of life or a management system.
This tool for performance improvement incorporates within its fold three sub-systems, namely, performance information system, performance evaluation system and performance incentive system. Performance evaluation in MOU
Involves five steps. First three steps are taken at the beginning of the year and the last two steps are taken at the end of the year.


STEP 1: Criteria Selection

STEP 2: Criteria Weight Selection

STEP 3: Criteria Value Selection at the end of the year

STEP 4: Performance Evaluation

STEP 5: Performance Reward

STEP 1 - Criteria Selection
In the first step, one has to choose an appropriate set of criteria to be included in the MOU. This raises the question: what constitutes an appropriate set of criteria? According to the MOU philosophy only those criteria’s should be included in the MOU which are "fair" to the manager, as well as "fair" to the country and have been negotiated freely. Performance criteria must be selected carefully and not arbitrarily. These should be based on the enterprises' corporate plan that looks at three to five years in the future. They must also be consistent with plan and budgetary goals of the Government.

STEP 2 - Criteria Weight Selection
Next step deals with criteria weight selection. For running an enterprise successfully a chief executive has to undertake a number of tasks. However, no tall the tasks are of equal importance. A smart chief executive therefore, priorities his tasks based on his perception of the relative importance of different activities in hand. At the end of 1989-90, the Government of India found it difficult to evaluate the performance of CPSEs based on their MOU commitments. Thus, after a careful examination of how this problem had been overcome in other countries, it was decided to introduce this system of relative weights.

STEP 3 - Criteria Value Selection
The third step in the performance evaluation system relates to criteria value selection. To understand one needs to distinguish between "criteria" and "criteria value." The sources of information which could assist in setting criterion values include:

 The original objectives at the project formulation stage
 Comparisons with similar firms in the public or private sector
 Standards achieved by similar undertakings in other selected developed
and developing countries
 Comparisons with the performance of the same firm in the previous years
 Professional judgment by third parties
 Professional judgment at the ministry level
 Professional judgment at the enterprise

STEP 4 - Performance Evaluation

The fourth step is taken at the end of year, when we look at the achievements of the CPSEs and compare them with the criteria values and determine the scores. The value of the composite score will also lie between "1" and "5". If the management has done excellent in all fronts included in the MOU, they will get a score of "1". But, suppose, they have done terrible job on all fronts included in the MOU, they will get a score of "5". A mixed performance will get them a score somewhere between "1" and "5".

STEP 5 - Performance Reward
While performance evaluation of CPSEs provides a measure of the degree of achievement of the objectives set out, evaluation by itself does not lead to improvement of performance. Unless performance evaluation is coupled with a
system of rewards and penalties (for good and bad performance) and utilized as a means for that purpose, it provides no motivation to the CPSEs for improving their performance. A transparent system of rewards and punishment is thus a corollary to the introduction of an objective performance evaluation system of the CPSEs. Thus a performance reward scheme constitutes an essential complement of the MOU system.


The basic drive for designing the institutional arrangement for the MOU exercise is in response to the two major criticisms leveled against the MOU system in its earlier years. First criticism by many CPSEs chief executives was that the MOU was a contract between "unequals". They claimed that how can one party to the contract be also the judge to that contract. They were referring to the fact that in the past the onus of evaluating the performance of CPSEs against the commitments made in the MOUs rested primarily with the administrative Ministries. Second major concern expressed by some observers of the MOU exercise was related to the imbalance in technical expertise available between the Government and the CPSEs. It was argued that, perhaps, Government was not technically equipped to make a proper assessment of CPSEs

MOUs are of course, by their very nature, stop gap measures which often fall short of giving the parties the level of commitment they desire. So why would a party want to use one? Some of the benefits are:

 Signing an MOU can make a party feel that they have some kind of commitment from the other party even if the MOU is not binding

 Having a signed MOU can support an internal or external business case needed to commence work on the particular matter

 MOUs can help cover the interim period before a full agreement is signed by providing some contractual coverage for the parties (confidentiality and costs are examples)

 Negotiating the terms of an MOU with reasonable detail can help the parties with their future --negotiations by forcing them to consider even the most complicated issues early (who will own intellectual property is a good example of this)

 MOUs can be a useful starting point for full agreement drafting. They can also be used as a guide to resolve potential misunderstandings down the track.

While MOUs do have an important role in documenting commercial arrangements they are not without their dangers.

Following are some of the common pitfalls and the tips to help avoidthem:

Don't think just because an MOU is written in 5 minutes on a scrap of paper that it isn't legally binding! Parties have been shocked to find that an MOU signed by one of their employees in the heat of the moment is in fact binding. This is probably one of the most common areas of dispute relating to MOUs.

TIP: To avoid this simply state in your MOU whether or not the intention is that the MOU be legally binding. If only one or two provisions are binding (eg. confidentiality) and the others are not, this should clearly be stated.

Sometimes it can take just as long to prepare and negotiate a reasonable MOU as it does a full agreement, especially when the main commercial terms have not really been agreed or fully considered.

TIP: Consider whether it would be easier (ie quicker and cheaper) to negotiate the full agreement (especially if the other party's willingness is high) now.

Often, after spending considerable time and effort to negotiate an MOU, the parties find when they come to negotiate the full agreement that they are forced to renegotiate the same terms and conditions, wasting time and money.

TIP: To minimize this likelihood, while you are negotiating the MOU, try to put as much effort as you can into documenting and settling all of the commercial terms (even if some commercial terms subsequently don't make it into the MOU). This will also save you legal dollars as you will be able to give clear and final instructions to your lawyers.

Be aware that your commercial bargaining power might be reduced once you sign a MOU. For example, if you're the customer and your 'gazillion dollar system' is 78% installed and it comes time to finalize the full agreement, you might find the other party's enthusiasm for negotiating a full agreement has dwindled! This of course almost always disadvantages the party wanting more detail and contractual coverage.

If you have any detail, put it in the MOU. This is especially true if you are the party that will suffer from the lack of detail (eg a customer). It's often very easy to attach relevant documents to the MOU as the basis for negotiation of the full agreement or the requirements for services.
Most importantly, get your legal department to review the MOU. It may 'only be a MOU', but the commercial terms that you agree to in a MOU can have far reaching implications both in the interim and when you come to negotiate a full agreement.

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