Unwritten contracts

Unwritten
agreements: I can’t see you but you can see me

You run a business that supplies on an informal basis to a distributor. Over months or even years, you have an arrangement under which you receive requests from the distributor for certain product and you deliver that product. Gradually you might even come to be ordering in advance of those sales, to meet the anticipated demand.

Nothing is in writing. While you both have occasionally discussed entering into a formal agreement that was always delayed as business got busy.

Arrangements like these are risky for both suppliers and distributors. You might have confidence and trust in that business partner, and a really good working relationship. However, such arrangements often depend on both parties working in good faith. A change in circumstances can quickly change one party’s desire to do this. Economic headwinds can make even generous business owners insist on their legal rights at the expense of the longstanding relationship.

Once a dispute emerges, things get worse. The murky nature of discussions and lack of certainty around obligations means that disputes can get protracted, as both parties scramble to remember what was said over the years at key meetings. This is further complicated by the very human tendency to remember discussions that support your point of view, and to forget details that go against that view.

Here we discuss some general issues to be thinking about when confronted with this situation. However, every arrangement is unique and those individual circumstances will significantly affect what is sensible for your circumstances. For advice on your particular circumstances, please contact us for a free initial consultation. 

Is there a contract?

There is a mistaken belief that if nothing is in writing or nothing is “formal”, then there cannot be an agreement. Alternatively, a business owner might think any agreement was just for a one-time individual supply of goods. In reality, contracts do not need to be formal. A handshake agreement over coffee is as enforceable as a 1,000-page document, so long as the intention to be bound is communicated in some way.

Whether there is a contract will be a complicated question and depend on the particular facts. This is because a contract can form in many ways, and over time in a course of dealing, even without anyone saying anything.

Ultimately, the fundamental question is whether the words or conduct of the parties show an intention to be immediately bound by a legally enforceable agreement. It doesn’t matter what their personal beliefs are. What is important is what is communicated and how an onlooker would interpret the entirety of their words and conduct. If over many months enough certainty develops around key contractual terms, and both parties show an intention to be legally bound, then a contract may have formed.

Agreement to agree?

What if two parties say they will negotiate over a formal written document, but complete sales in the meantime? This is a familiar situation for many business partners. This is entering the territory of an agreement to agree, which is a complicating factor in determining whether there is a contract.

The case Masters v Cameron discussed three (and maybe four) types of cases:

  1. The parties have reached finality in the terms of the agreement and intend to be immediately bound, but propose to have the terms restated in a more fuller and precise form later. Here there is likely a contract.
  2. The parties have agreed all the terms and do not intend to modify these terms, but intend to execute a written document prior to performing those terms. There is a contract, and the parties must execute that written document.
  3. The parties have discussed an arrangement but their intention is not to make a concluded agreement unless and until they execute a formal contract. There is no contract.

There is likely a fourth category, recognised by McLelland J in Baulkham Hills Private Hospital Pty Ltd v GR Securities Pty Ltd. This is where parties intend to be bound immediately and exclusively by the terms that they have agreed upon – while expecting to make a further contract, in substitution for the first. In this case, there is a contract.

Of course in the real world, it is difficult to fit a case neatly into any one of those categories which is why targeted legal advice is essential. However, they give some key considerations for understanding when a business relationship becomes contractual.

The situation is further complicated where Party A knows that Party B relies on an assumption, induced by Party A. Even if there is no agreement, a Court might in certain circumstances require Party A to act as though there is. These are complicated case-dependent questions, and legal professional help to resolve them is a must.

Can I change my informal agreement to formal?

It is usually a good idea to formalise something that is informal. Formal agreements allow both parties to have certainty over what is required, and prevents a recipe for disaster: one party comes to develop a certain belief while the other party develops a different belief. If one party resists formalising the relationship, you have to ask yourself whether that party can be trusted to act in good faith if the going gets tough.

The first step is to speak to a lawyer to understand your circumstances including whether there is a contract. Your words and conduct might be later used by the other party to establish certain beliefs including an intention to repudiate an agreement (and then paying damages). It is important that you don’t do anything without proper guidance.

The best advice is always have a mutual agreement to formalise the relationship. If there is an informal agreement and the other party does not agree to supersede that with a formal agreement, you might consider terminating that informal agreement.

Does your informal agreement specify a fixed period of time for it to run? Maybe you both agreed “we’ll do it this way for 5 years and then decide where we go from there”. If so, depending on what specifically was said, the parties might be required to honour that agreement.

However, where there is no fixed period and the agreement is perpetual, Courts might consider a different approach. They might imply a term that allows a party to terminate once reasonable notice has been given.

The case Crawford Fitting Co v Sydney Valve & Fittings Pty Ltd (1988) 14 NSWLR 438 is the gold standard for looking at so-called perpetual agreements. An Ohio based supplier of specialised fittings used a distributor in Victoria, providing an initial supply and then smaller but more regular supplies over the years. Initially this agreement was very profitable for all parties. However, the relationship between the parties broke down. The Ohio based company tried to terminate the agreements.

The judge called this a question of “considerable commercial importance”. Essentially, there is no presumption of permanency in the case of commercial agreements unless the parties clearly intended this. However, circumstances have to be looked at: subject matter of agreement, circumstances of the making of the agreement and provisions agreed. These will indicate whether a term to terminate on reasonable notice exists, and will also indicate how long a reasonable notice period is. The period has to be enough so that the parties have “reasonable opportunity to enter into alternative arrangements and to wind up matters which arise out of their relationship”.

Conclusion

Informal arrangements are everywhere in business and sometimes necessary to get a relationship started. It might seem costly for the relationship and for the hip pocket to convert those agreements to a formal contract, but our experience is businesses will avoid costly disputes in the future by getting certainty today.

Invariably, parties form their own view of an informal agreement over time. When legal rights hinge around conversations rather than documents, proving these claims is very expensive.

If this article has made you think about your circumstances, we recommend you seek legal advice. It is crucial to obtain this advice on any unwritten arrangements that you may have at the earliest possible opportunity. This is especially the case when they are agreements to agree and you want to formalise a business relationship.

Once a business relationship sours, solving these issues becomes significantly harder.

Francis Maxwell

 

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