Without any editorializing by me, here’s an extract from this article by Sathnam Sanghera in the Times Online:
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.
Ronald Reagan’s famous formulation—trust, but verify—works well here.
If no major issues (e.g., misappropriation of intellectual property) are at stake, it also may be possible for the business to begin on a handshake basis, with a formal written agreement to follow.
Where there is trust, and both parties are willing to agree that the other party can walk away on short notice, a legal agreement can be put in place quickly, with minimal haggling—provided that the lawyers don’t feel the need to draft lengthy detailed contracts, either for CYA reasons or to justify their existence. So long as you have the right to walk away, you can often accept terms that you would never accept in a binding, multi-year contract.
I see a few problems.
First, trust is (and should be) a slow process in and of itself. People relying on a handshake because they’ve had a twenty year relationship to twenty years to show mutual respect, interest and investment spent twenty years building that relationship. Other things like friendship, family relationship, etc. are not short term investments. I think that the same thing applies in both examples cited in the story: there is some other consideration that was not quickly (or easily) established that mitigated the chances for long-term, expensive disputes.
Second, the contract drafting process can often be the first indication about how well the relationship will go if things do sour. Many transactions have short lived interactions between the parties, involve one-time players with repeat players, and have one party bearing more risk than another. In each case, there is something that militates against the handshake approach. If another party is not willing to help balance the relationship via a contract, then they’re unlikely to be real great partners.
Third, even if parties go without a written contract, there still is a contract, verbal or otherwise. Verbal contracts are still contracts and still have contractual rules. Whether that benefits one party or another is still a legal questions—albeit one that is more costly to sort out after the fact. And in the “otherwise” case, there is usually a written contract and its usually the other party’s form contract attached to an invoice, order form, at the bottom of a website, etc. I’d wager good money that a party that believes there is no contract and only a handshake is in fact party to a form contract.
In reality, the article (and those like it) are simply looking at the reality of the situation: very few contracts are ever disputed; and when they are disputed, many parties can simply come to an agreement how to resolve the dispute before going to court. But then there’s a chicken and egg problem: do contracts help avoid disputes? And, if they can’t avoid the dispute altogether, do they give the parties the information that they need to resolve the dispute without going to court?
Good points Mike. Seems like the title of the article ought to read “Are consciously negotiated written contracts really necessary?”
Someone once said in some materials I read that “informality in contract typically favors the party with more power.” I’ve generally found that to be true.
It’s the handshake (backed up by the phantom form) or the quick and dirty deal memo, which the parties are comfortable reviewing without counsel, that often does serious damage to the party with less power.