Contracts Are For Honest People, So Why Bother?

Contracts are for honest people. They are like locks on your house. An honest person will test the door and accept they cannot enter if they find it locked. A dishonest or desperate person will find a way in anyway. And a dishonest or desperate person will agree to anything and does not care about what they agreed to already.

So why do we bother with contracts at all? In my experience, there are several good reasons for using contracts in business which include the following:

Process – The first is process. The process of making a contract forces us to talk through and document our assumptions and make sure we are all rowing the same boat in the same direction. This process is a test of our commitment, goals, aspirations, and understanding, including our commitment to a mutually beneficial exchange that meets the needs of all parties. It is best to have all these put on the table and openly discussed before the contract is signed. When the process works, a meaningful and resilient commercial relationship is formed and the contract that results is often put in a drawer and never looked at again.

Risk – The second is risk appreciation and allocation. The contract process and the contract that results should address both the most obvious and less obvious risks to the parties, including the risks of unspoken assumptions, mistakes, misrepresentations, undue influence, third party interference or failures, frustration, insurance, and fraud. Price, timing, terms, and risk are all related. If the process and contract result in a mutually understood and agreeable allocation and acceptance of risk, then the resulting risk matrix can be reflected in the price and terms and suitable risk management tools can be put in place including representations, warranties, covenants, conditions, deposits, due diligence, disclosure, inspection, and insurance.

Insurance – The third is dispute resolution. A properly prepared contract is like an insurance policy. You put it in place at the outset and hope you never need to use it. But if things do not proceed as expected it can be pulled out of the drawer to provide the parties with pre-agreed guidelines for disengagement or dispute resolution which should be certain, timely, and cost-effective.

Contract disputes are inevitable in business. If you do enough contracts some of them are bound to end up in messy situations. However, if all your contracts are approached and managed in the right way then those situations should be rare and should sort themselves out without too much trouble.

If contract disputes become protracted, expensive or existential, the root causes will often be a failure of honesty or integrity, desperation or heighten emotions on one side or the other, or a failure in the contract management process from the outset.

Overall, the worst disputes I have seen have arisen where there is no contract at all. Trust and respect are necessary supports for any commercial relationship but are not to be assumed or taken for granted and are best earned and confirmed during a good contract negotiation process.

With all that in mind, here are two final closing thoughts:

The absence of a contract is not proof of a great business relationship but can be evidence of a yet untested one.

And like insurance or tax planning, the value of a contract is only known if it is tested after the fact, which will be after it is too late to negotiate a better one or implement a better process to put a good one in place.

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