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Five reasons why a formal contract is good business at every stage

An informal agreement between two businesses or with a friendly customer might seem like the quicker/easier option when you are building your business. You know and trust each other, so what can go wrong? 

But, in practice these informal arrangements are at often verbal and deal only with the overarching principles – skimming through (if at all) the “nitty-gritty” of the deal leaving you open to problems as you scale. 

Here are five reasons why getting a formal contract is worth the effort at every stage:

  1. You’ve verbally agreed to let a prospective customer try new software that you have developed – some informal testing perhaps. But, how long is the testing period, when does that informal testing period become a paid for contract? Can they share access with their wider business or contacts? Will they get upgrades and support like other clients? These missing details could cause problems further down the line if they aren’t contractually clear from the outset.
  2. Humans aren’t elephants - we forget things, particularly in the fast-paced and pressured world of scaling a business. Without notes you may not be able to recall exactly what was agreed – particularly if that verbal agreement was a year or more ago. Better to have a formal contract in place that all parties have agreed to and can refer back to when needed.
  3. Our brains interpret facts and events differently. So even when the parties share the best intention and good faith, a year later your version of the agreement may be “slightly” different from your client’s. And if you can’t settle the difference, a dispute can follow.
  4. It’s true that under English law, contracts do not always need to be in writing. They can be formed verbally or via the course of dealing and still be legally binding if they meet certain ‘formation’ criteria; there must be an offer, acceptance, consideration and the intention to create legal relation.

    Where formation criteria has been satisfied, courts can uphold a non-written agreement. This can lead to an unexpected bill as was the case in Corporate Oil and Gas Ltd v Marshall Aviation Services Ltd, where the claimant ended up with close to a £1 million bill even though they argued that the informal discussion was ‘subject to the CEO’s approval’ and therefore not binding. So, although most informal arrangements usually lack the certainty to establish the required elements in the courts, surely it is better for all to agree a formal contract at the outset to avoid any differences of opinion!
  5. Finally, dispute resolution including litigation is a lengthy, uncertain, costly and usually relationship-damaging process. For this reason, spending time at the outset to iron out the details for a written contract will in the long run ensure the deal runs smoothly, relationships are maintained and your scale up journey is blown off course by an unexpected disagreement of difficult conversation.

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