Verbal Contracts: 14 Reasons to Avoid Oral Agreements in Business

We're not talking about why you should have written contracts here.

We're talking about why you shouldn't rely on verbal contracts.

It's a health risk to your business.

Beginning a conversation with someone with the question, "Is a verbal contract enforceable?" is not an optimal starting point.

As the saying goes, an oral contract is worth the paper it is written on.

In a more fully informed world, everyone knows it.

But many businesses don't bother with written terms of business.

 

Are verbal contracts worth the risk?

Small businesses sometimes think written contracts are not worth it.

Avoid the unwanted administrative overhead. 

The distraction isn’t worth it. Focus on the work that generates the revenue, don't worry about the boring admin.

It means you have more time to generate revenue and enjoy your work.

A more trouble-free business life. 

On the other hand, the higher the value of the business not agreed in writing, the greater the business risk with the approach.

Especially if you’ve been incurring the cost of supplying your customer.

If you've bought in services thinking that an oral contract will do, you've got a series of unpalatable risks.

 

Legal Position

Many businesses operate on the basis that if there is no written contract, then there is no contract.

Not so.

Just because nothing has been recorded in writing, doesn't mean that there is no contract.

If goods or services have been supplied in a business context, there must be a contract of some sort. It could an oral contract which may be evidenced partially in writing, such as heads of terms or a series of emails.

In the unlikely event that there isn’t, there are legal claims for payment of a “reasonable sum” for the goods or services - quantum meruit. Good luck recovering using that head of claim.

If the terms of the contract are not recorded in writing, enforcement of the contract terms (such getting paid) can be out of reach.

The questions start with:

• What is the Contract?
  Top of the list is that you can’t prove what the terms of the contract are with any certainty.
• How can you prove what was agreed?
  Using written contracts disposes of relying on what said what when.
  Avoiding all the fuss and bother of assessing competing recollections of what was to be done, what was to be paid, when payment due to be made, what the qualifying conditions before the obligation to pay arises. Amongst others.

If you're not able to show what the contract is, you're not able to show what was agreed.

That means that you've got a major problem proving a breach a contract to enforce the contract, or defending a claim for breach of contract.

Different lawyers will give different reasons why contracts of supply of goods or services should be in writing. Below we set out our take of some of the reasons in three tiers of problems.

But you can put the problems into different categories of seriousness.

 

Three Tiers of Problems with Verbal Contracts

The risk associated with oral agreements varies from contract to contract. If you're buying a newspaper, there's not much risk.

In enterprise or business contracts, risk can be graded by a series of factors:

1. the type of goods or services supplied
2. the industry in which your business operates
3. the level of risk associated with failures to perform contracts generally
4. the likely damages awards for breach of contract, and
5. the reliance of third parties on delivery of contractual obligations

These factors will be more important from one business to another.

Some shortfalls will be fatal in some cases.

Others increase the risk profile for the work to be done, and the exposure to liability.

 

Tier 1 – The Basics

1. Statement of Work:

• • Products: When products are to be supplied, how many, when they are required to be delivered, and where are they to be delivered?
    Is delivery ex-works or to some specific place? Who pays for shipping? Are costs of shipping to be reimbursed?
  • Services:
    • What precisely are the services to be provided?
    • What do they include and not include?
    • What happens if they say that what has been provided is not up to scratch? Do they have you on a leash to be paid because what you understood to be delivered doesn’t match what they thought, and isn’t written down anywhere?
    • Are you entitled to get your expenses spent on the project back, after you’ve paid them?

 

2. Payment:

• • How did you say you were told you were going to be paid? What can you point to, to say how much you should be paid?
  • Are you meant to get paid monthly, or at the end of the job? What if it is a long project?

 

3. Cooperation:

• Contracts are rarely a straight matter of supplying a product or service and then getting paid for it.
• You usually need to cooperate.
• What if they don’t give you what you need to perform the contract? Does that mean that you aren’t meant to be paid, because you can’t perform the services?
• How do you show that you actually need the materials, or that the materials which you have received weren’t up to scratch? Who pays for the extra-time that it takes to correct what they have provided you?

 

4. Data Protection/GDPR:

These days service providers can’t receive and process personal data without a written agreement. Check out Article 28 of the GDPR for the basics.

There’s no right or ability to waive the obligations. As a data processor, you  can’t comply with the GDPR without a written agreement.

 

5. Businesses selling to consumers:

When businesses sell to consumers, they have obligations to inform consumers of their statutory rights and a whole host of other things. If these notices are not given, severe (and for most businesses) unexpected consequences arise for the business as a result. Like the consumer having an unqualified right to return the goods and get their money back for up to 12 months.

 

6. Ownership of property:

What if intellectual property is created? Is ownership meant to pass as soon as it’s created, at the end of the job, or when you’re paid?

If it’s not provided for, the starting point is that the service provider retains the intellectual property rights in what they have been paid to produce for you.

Ownership of intellectual property must be in writing.

So, the only way to transfer ownership of intellectual property rights is by evidencing the assignment… in writing. 

It can't be done with an oral agreement.

 

Tier 2 – Promises, Termination and Damages

7. Exception clauses, exclusion clauses and limitations of liability:

These sorts of clauses (basically) set out to either exclude or cap the damages which may be awarded in the event of a breach of contract.

When a breach of contract takes place in verbal agreement, the theoretical limit of the damages that can be awarded is unlimited.

It takes 'clear words' for exclusion clauses to work. If those words aren't in writing, you have a hard time proving what the clear words were. Especially, when you try to exclude liability for negligence.

If you don’t have a written contract, it’s pretty tough to show (1) you agreed to contractual exclusions, (2) what the terms of of the exclusion clause where, and (3) when the exclusion clause would bite and protect you.

 

8. Termination:

If a contract is not working out, you want a clear way out of the contract for breach. Without any fuss.

Unless if have a clear right to terminate, you expose your business to all sorts of arguments (which may be fictional, or not) that there is no right to terminate, and certainly without giving proper notice.

Termination clauses allow a party to end the contract in defined circumstances, gracefully and with a minimum of risk, provided the circumstances fit the contract.

This means that disputes relating to the ongoing supply of goods and services and payment are narrowed.

 

9. Warranties:

Warranties are promises which are made to other party. They set the groundwork that underlies the legal relationship. They might:

• record a specific state of affairs at the time the contract was signed
• set up important duties which are required for the contract to operate such as:
  • • set out the prerequisites which are required by the service provider to supply services
    • establish response times when a problem is encountered
    • require information provided by the customer to be accurate in all material respects.

Warranties which would ideally be incorporated into contracts depend upon the products or services to be provided.

When a customer does not comply with a warranty, the service provider is not entitled to terminate the contract, but is entitled to damages for the loss suffered as a result of the breach of the warranty.

No written contract, and basically you only have statutory warranties. Sometimes, they just won’t help you. It depends on the problem that you have.

 

10. Variations:

The legal obligations in a contract can be varied any time the parties agree to it.

Properly written contracts contain clauses that prevent variations to agreements without confirming it in writing.

It's done with a variation clause.

 

11. No restrictive covenants:

You won’t be able to protect customers, suppliers, contractors or employees from being poached. It takes restrictive covenants to do that.

 

12. Excluding representations:

Pre-contractual misrepresentation is fertile ground for legal claims. Well drafted contracts lay the groundwork to limit the claims that can be made.

 

Tier 3:  Predictability of interpretation the Contract; Avoiding Unenforceable Terms

13. Boilerplate clauses:

Boilerplate clauses serve several purposes.

They include to:

• enhance the predictability of the interpretation of contract
• displace undesirable parts of the general law, such as when you want to:
  • not waive your legal rights
  • not be liable when something out of your control interferes with your ability to perform the contract
• exclude previous agreements and arrangements from your agreement
• avoid ambiguity and uncertainty when contractual notices need to be sent
• change the rules of interpretation of the contract to suit your purposes
• set up an alternative regime to the operation of the general law in cases of delay

Without clauses such as these, questions of fact and law which are highly relevant to disputes may be unanswerable. That creates all sorts of uncertainty in payment claims.

Also preliminary issues can arise which get in the way of the main (or “substantive”) dispute.

These preliminary issues can blow your costs out of all proportion with the value of the claim.

In the worst cases, those uncertainties mean that a payment claim cannot be pursued economically, putting recovery of payment out of reach.

It may also tank your negotiating position, and put you in a weak position.

 

14. Avoid agreements to agree:

Contracting parties are entitled to agree something in the present. You can't agree to agree something in English law.

So, “Agreements” that the parties will agree to something in the future are not enforceable under English law. Having a written contract draws these out so that they can be restructured so that the contractual commitment is binding or removed.

 

A Better View

No-one needs a written contract until something goes wrong.

Setting up a legal relationship in writing between the parties from the outset means that the arguments are about (if any) what the contract means, and not what the contract was.

It is harder to back away from written contractual commitments.

You avoid disputes, minimise the scope and extent of disputes in the unfortunate event they arise.

If a dispute arises, it is more manageable and the issues to obtain payment are clearer and more easily pursued.

Believe it or not, it makes for a more structured and trouble-free business life.

Predictability of Outcome

Hundreds of cases have been decided over the years by courts to clarify how the general default position at law applies in different circumstances.

Although this provides predictability in future cases, it is not a situation that small businesses wish to encounter themselves.

When these matters are not dealt with, solicitors acting for potential defendants have an easier time creating roadblocks, uncertainties and barriers to resolving the dispute. And blowing out your prospects of getting a good result.

You may say: But I have emails threads…

That isn’t really a solution. You just end up with a less difficult problem to deal with. Better to have a contract that records what the agreement is and contract review process.

If you do have email threads, you need to work out whether:

1. the terms for your verbal agreement (evidenced by your email threads) were agreed before or after the contract itself was formed
2. what else was said
   1. when, and
   2. by whom, and
3. if it was said before or after the contract was formed.
   If afterwards, they do not form part of the contract. They have no legal effect.
   They’re not legally binding because they do not form part of the contract.

Also, email threads sometimes are hard to unravel, reconstruct and establish the relevant turn of events. Especially when there were conversations taking place at the same time.

Working all of that out in an investigation adds cost that can be avoided.

It may be obvious that if a payment dispute arises, the value of the services provided will be more difficult to recover. It can be entirely uneconomical to recover the debt. It’s aggravation you don’t need. Especially when you’ve gone that extra mile to provide an excellent service.

You can't pull yourself out of the uncertainties that will plague your business until you sort out your terms and conditions: in writing.

If you need to recover from a bad experience with a verbal contract, we can help you out. Here's some of the ways to handle written contracts.