The Paper Trail - Why Handshakes in Deals are not enough

Why do we have written contracts

Why are contracts in writing - image showing a handshake

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Have you ever wondered why the world spends so much time, efforts and resources into making contracts. The corporate world (especially business teams) doesn’t like the process, and there are so many jokes about the friction between Sales Teams and Legal Teams which are usually based on real-life stories, but still contracts are made every day; in fact, in-house legal departments are structured around this (of course subject to the changes AI might bring in the future, while we are not quite there yet).

The law does allow verbal contracts for most kinds of commercial transactions in most countries. So, why do we have written contracts in the first place.

Mandatory for some contracts

Let’s get the simple reason out of the way, some kinds of contracts require a written form and even registration, e.g. property sale purchase documents in most countries, there is no real choice there.

What about other contracts - why are they written

Mandatory written contracts, e.g. property purchase - image showing a dummy house with keys

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Here are the practical challenges with following verbal contracts, which is why over decades and centuries it’s become the norm to have written contracts:  

(1)   Contentious side - He Says She Says & Evidence in courts:

How does one prove which party is accurate, when both claim different versions. This might not even be deliberate; it could just be a gap in understanding or memory.

Or, considering that lots of communications happen by emails and messages, the parties and even the judge would have to figure out from that kind of chaotic communication what was finally agreed. What if two different people from the same organization wrote contradictory emails at the same time.

So, one of the main reasons is around evidence and enforcement.

Signed contracts support in evidence in case of a dispute - image showing a gavel with a book

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The signed contract is meant to be the final and single piece signed by both parties, which governs their relationship. It doesn’t mean that evidence (when a contract has been signed) will include just one contract and no other documents, there will still likely be some communication furnished by the parties, but it will still reduce the chaos to a large extent, and the value of the communication/emails is much less when there is a proper signed contract.

There is a clause in most contracts which is called Entire Agreement clause, which is related to this as well, covered later in this post. This clause helps separate the wheat from the chaff.

(2)   Corporate or business (non-contentious) side:

a.     Execution:

It’s important to have the details in an objective form. So, if anyone related to the project but not directly involved wants to refer to it for project execution, they can do so. For example:

(i)              the finance department wants to see whether the invoice that they received for payment is to be paid immediately or them paying after 45 days is still ok. They might want to check this because if they are late in payment, there could be late payment charges.

Or they might want to see if there is a sign-off required for a milestone before they can process the invoice. They might want to check this because if their business team has not signed off a milestone, paying might put their funds and project at risk.   

(ii)             a senior management team member who is in-charge of the company website and is waiting for a technology product managed by the IT department wants to see what is the timetable committed by the service provider and whether they are on track.  

b.     Business Continuity:

When the person who knew about the transaction and negotiated it is no longer around for any reason, it’s captured in a tangible form and can be easily referred back to. A contract should be clear enough not just to the people who made it and had the context or the project, but also to anyone else. If people in the same company and working on similar transactions can’t understand it, how will a judge who is an external person and with no relation to that company’s business comprehend. This is of course goes to a slightly different topic of having a clear and consistent contract, which I will write about in due course.

Further, it helps in some level of certainty and contingency planning, by being aware of the risks - as an example, what liability has been agreed to. 

c.     Checks & Balances and Audits:

Listed companies are subject to more stringent requirements - image showing stocks on a screen

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Yet another but very important reason is checks and balances, to prevent unethical behaviour. So, there is a workflow in place to ensure that the people approving documentation are different from the ones executing. Well-established organizations especially the ones which are listed on stock exchanges are subject to far more stringent requirements, including audits. An important part of audits is to check if adequate contracts and documentation are in place and also if what’s happening on the ground is the same as what’s mentioned in the contract, including preventing unauthorised payments. The codes of conducts of corporates are built around preventing corruption, conflict of interest, etc.

Conflict of interest of course goes to the broader topic of how vendors and other counterparties are onboarded in the first place, but at the end of the day they are all inter-connected topics.

d.    Deterrent value:

By reminding the parties that there could be repercussions if they don’t fulfil the obligations. This might not just be at the dispute stage, it might even be at the day-to-day operations stage where, as an example, one party wants to refer back to and implement committed timelines and penalties/service credits.   

e.     Upper hand during differences/issues:

This is an important point which most people tend to forget. Not every dispute goes to the court, thankfully. If parties are having challenges in the project and they sit across the negotiation table, a party having a contract supporting their position will have an upper hand, and generally if the contract is clear both parties will benefit in the long run from the point of view of not spending additional resources and time into debating about the contract provisions.

Entire Agreement clause

So now, coming back to the entire agreement clause - it’s a standard contractual clause or boilerplate clause as they are called, saying that this contract is the only document for this arrangement, and any verbal or written communications or discussions before this are replaced. The idea is the same - not go around on a wild goose chase, trying to retrieve hundreds of different emails trying to prove a case, rather, have one document, include everything relevant there and treat that as comprehensive and final. Of course in a dispute, emails might still have persuasive value to show the intention, as mentioned above - especially in case of differences in interpretation, depending on the country and the court.         

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