Contracts - insurance for business

Business owners often dismiss the need for formal contracts with their customers or suppliers, seeing them as a barrier to getting on with their day-to-day activities. But maybe if they viewed them as a form of insurance their opinion would be slightly different.

Business people often say to me that they don’t have or even need contracts. What they usually mean is that they don’t have formal written contracts. Instead they proceed on the basis of verbal negotiations or perhaps exchanges of email. That doesn’t mean however that there isn’t a contract in place. Just because it isn’t formal doesn’t always mean a contract hasn’t been made.

For a contract to exist only a few basic factors need to have been agreed. These include what each party expects to do as regards supplying or receiving specified products or services, the price, the intention to be bound by the agreement and the agreement being carried out. So if you’ve agreed these points on the phone or by email – you might well have a contract!

What you don’t have however is full protection. Such an agreement for example is very unlikely to have covered in any detail things like what will happen if things go wrong, who is liable for the consequences of any delays, and so on.

Of course, there may be occasions when you make a commercial decision to take the risk and work without a formal contract. This approach is usually taken when working with a customer or supplier you are familiar with, on the basis that few or only minor problems may have been experienced previously. You proceed in the hope that this will continue to be the case or, if any problems arise, it will be possible to negotiate a mutually convenient way out. This is certainly one way of managing the commercial risk. It has the advantage of reducing possible time spent in initial negotiations and potential cost associated with drawing up a formal agreement, but does have some potential drawbacks. For example:

• If there are delays in delivery of products or a service to you – have you got any comeback against your supplier? 
• Have you effectively limited your liability if you are the supplier and you fail to deliver on time or to specification – if not, how much do you stand to lose? 
• What if your customer doesn’t pay on time – indeed did your informal contract even specify a timetable for payment?

Business owners are understandably keen to get on with a new deal and, in the current challenging economic climate when there is so much competition for each order, this is particularly the case. Provided all proceeds smoothly then all well and good, but if things should go wrong the result is likely to be more time-consuming and costly to resolve.

You wouldn’t run the risk of driving your car without insurance, would you? So why run the risk of running your business without the safety net of properly worded and negotiated contracts?

Sue Mann
Commercial Solicitor

Read more: Business contracts and commercial agreements