My comments follow on from Sathnam Sanghera’s article in todays business section of Times Online (Found below).
It is a sad fact of life that whether you are dealing with a member of your family or a friend or with any other person (particularly in the course of a business) that it is often in everyone’s interests to record the transaction in the form of a clear and precise and reasonably comprehensive written contract setting out respective rights and obligations and which meets legal requirements.
If you don’t then a contract may not exist or if it does may be uncertain and/or difficult to enforce or the law may apply terms to the contract or in place of it you may not like and which could have been excluded or varied. Even with a well drawn written contract you need to be reasonably satisfied with the other party and its ability to comply (including financial position) and know your remedies.
For example if a friend agrees to write a software program for your business your friend will own the subject matter created unless otherwise agreed in writing with you and may â€œhold you to ransomâ€ over payment and/or use of that subject matter.
The days of the gentleman’s agreement or when a deal can be agreed with a nod and a wink or a handshake are almost gone.
Phil Hitchen is an Associate in the Company and Commercial Department at Ralli and specialises in business transactions, funding and IP/IT.
Sathnam Sanghera’s article: “Life, after the age of 30, is basically administration ” and the enervating contents of my in-tray are an illustration of this. Here’s a letter chasing an unpaid invoice, caused by the incompetence of an insurance company. Here’s a receipt for two chairs from Habitat, which months after being ordered, still haven’t arrived. And here’s my employment contract. I was, I think, meant to have signed and returned it several months ago, but, unless this is a copy, I seem to have completely forgotten to do so.
Damn. At least, â€œdamnâ€ was my initial response. There followed the realisation that life has continued perfectly fine without it (money has been paid, work has been done), and the question: does the business world actually need contracts to function? Which might, on the face of it, sound like an insane proposition. After all, contracts are to business what salt is to cooking. Even Asian countries, where deals have traditionally been done on the basis of handshakes, are increasingly resorting to western-style contracts. The experts suggest that even if you borrow money from friends or family for business reasons, it is best to put the terms in writing. And history is littered with examples of business relationships that have foundered due to inadequate contracts.
The messiness of relationships between boxers and their managers, for instance, is often exacerbated by the lack of formal contracts, and then there’s Tony Wilson’s Factory Records. There were a number of things that contributed to the indie label’s demise, such as its decision to open The Haenda nightclub and charge low prices for entrance and at the bar. But the main thing that did for it was that almost all of Factory’s bands, such as Joy Division, did not have contracts with the label.
However, there is an argument to be made in favour of conducting business in a looser fashion an argument that Deepak Malhotra, an associate professor at Harvard Business School, made in an article published in the Harvard Business Review last year. In it he made the following three points. (1) Contracts are designed to reinforce trust and reduce risk, but when they’re too detailed or rigid, or when they send mixed signals, they can exacerbate the very problems they’re supposed to prevent. (2) Contracts that are too rigid can be problematic if they lock parties into arrangements that seem like a good idea at the time but don’t allow for important adjustments as circumstances change. (3) Many contracts include incentives such as performance pay, earn-outs and vesting schedules. However, in some contexts, such incentives can signal mistrust.
Sounds a bit theoretical and academic? Well, it’s not hard to think of people from the real world who are less than impressed by contracts. Warren Buffett, for instance, paid $1.5 billion for McLane Co, Wal-Mart’s grocery delivery unit, after a two-hour meeting with Wal-Mart’s chief financial officer and a handshake. We did no due diligence,the billionaire investor said afterwards. We knew everything would be exactly as Wal-Mart said it would be. Meanwhile, the Boeing 747 was in effect built on a verbal promise that Pan Am would buy the plane.
In Wide-Body: The Making of The Boeing 747, writer Clive Irving says that William Allen, president of Boeing, and Juan Trippe, founder of Pan Am, had a history of talking each other into hair-raising deals without leaving any trace for example, during a golf game or a fishing expedition. However, this was apparently Trippe’s preferred style, not Allen’s, and to introduce an element of record to the transactions, Allen got into the habit of taping follow-up calls to Trippe. And when the moment came in relation to the 747 order, Allen was not at ease.
Allen had got Trippe hooked, writes Irving. Trippe went on immediately to talk of Pan Am ordering a large fleet of 25 747s. This was too much even for Allen, who tried to slow Trippe down … he suggested that Boeing and Pan Am could sit down and work out a general expression of intent. Trippe had no patience for vague expressions of intent: The problem for us, how long? Weve just got to step up.
In this short story we have an illustration of the many upsides and downsides of contracts. On the one hand, written agreements protect parties if things go wrong and provide a useful framework for engagement. But, on the other, drafting contracts slows business down something Stephen Covey emphasises in The Speed of Trust: The One Thing that Changes Everything, with the words: When trust goes down, speed goes down and cost goes up. It also creates work for lawyers in itself something worth avoiding promotes bureaucracy and undermines trust by discouraging spontaneous displays of goodwill.
This last point is something that a decade-long study of outsourcing contracts by Warwick Business School demonstrated when it found that deals conducted on the basis of trust, instead of precisely worded agreements, could lead to benefits for both parties to the tune of as much as an additional 40 per cent of the total value of a contract.
Similar paradoxes afflict contracts of employment. They contain the implication that we work because we are obliged to do so, when most of us work because we want to work. The solution, I guess, lies in compromise: have contracts but keep them as short as possible, and, once they’re signed, forget about them. There’s an analogy to be drawn here with pre-nuptial agreements: in an ideal world, it would be nice not to have them, but, if you do, you should forget the document exists the moment you’ve signed it, and conduct your relationship on the basis of something more profound. Just remember to sign it, that’s all.”