Informal Contract

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Informal Contract

A Brief Introduction About the Informal Contract

An informal contract is otherwise called an informal business contract or social contract or parole contract. It is considered informal because it may or may not be written; it does not have a seal, and it is not witnessed. The element of trust is the most important factor for entering into such a contract. In case of disputes, it is difficult to enforce any legal action against the party who has breached the terms. 

If legal enforcement is required, the contract has to have offer and acceptance, mutual assent, and consideration. Any contract to have the power of legal enforcement requires consensus ad idem (meeting of minds). i.e., the parties to the agreement shall agree to understand the terms of the agreement in the same manner and spirit it is written. The contract is not governed by any specific law. Leases and employment contracts are also a form of informal contract.

Who Takes the Informal Contract- People Involved

An informal contract is entered between two parties. The following are the various combinations in which the contract can be entered.

  • Organization/Business/Supplier and the customer – Sales contracts entered in the ordinary course of business
  • Employer and employee – Employment contracts
  • Lessor and lessee – Lease contract entered to leasehold the property, plant, or equipment.

Purpose of the Informal Contract- Why Do You Need It

An informal contract is entered involuntarily every day in business. It differed with every client and changed on case to case basis. The terms of sale for a client buying in cash, and for another client who takes regular credit from the supplier differ entirely. Hence an informal contract is required to be made as per the demands of the business. 

Similarly, an employment contract cannot be standard for all employees. It differs according to the cadre, designation, and scope of employment. As long as the parties to the agreement keep complying with the terms of service, the informal agreement is firmly held in good faith. If the situation requires an informal contract to be turned to a formal contract, it can be done by providing measurable consideration to the contract, and it is executed in writing under a seal. 

When a contract clearly explains as what, how, when, by whom the activities are to be carried, and how much is payable for carrying on such activities, and they are mutually agreed, it becomes a legally binding formal contract. In an informal contract, signatures are not recorded, and the agreement is established by the actions of the two parties.

Contents of the Informal Contract- Things to Include

An informal contract shall broadly include the following

  • Any business document like an invoice, purchase order, quotation, etc., carries an informal agreement with the customers that they act in good faith and trust. Both the supplier and the customer shall act within the scope as agreed.
  • Name, address and tax details of the supplier, and the customer
  • The subject of contract – goods or service
  • Consideration for the contract – cash or kind or products or service
  • Terms and mode of payment
  • Scope and terms of delivery of the product, and or service
  • Policy for return of goods
  • A letter of agreement (LoA) shall be a simple but best variant of an informal contract. It includes the benefits of both formal and informal contracts. It may be used between an employer and employee detailing the employment offer as far as possible or to define upcoming business plans with outsiders. The signature of parties to the agreement is required to make the letter of agreement legally binding. It shall contain an opener explaining the purpose of such a letter, services rendered, fees for such service, additional cost, timeline, and payment terms.
  • The main objective of entering into these contracts is it offers flexibility and saves time and money considerably. A business with a large number of regular customers chooses to have informal contracts rather than spending more time drafting legally enforceable contracts. Where a business does not foresee any requirement to exercise its legal muscle, the informal contract serves the purpose. The trust is directly or indirectly imposed on each other.

How to Draft an Informal Contract- Points to Consider While Preparing the Contract

The following aspects must be considered before preparing an informal contract.

  • Consideration – The price payable for entering into any business relationship. It must be measurable, and it is in return for the goods offered or services performed. It need not be money; it may be a transfer of right, interest, or benefit as well. The adequacy of consideration is never a question of law, but the existence of consideration is always looked out in a contract.
  • Two or more parties entering the contract – It takes two or more persons to form an agreement or contract.  
  • Parties must have legal rights to contract – People without sound mind, minors, insolvent persons, prisoners are not eligible to enter any contract. The parties to the contract must have legal capacity.
  • No statute or rules declaring the contract as void – Any contract entered to carry illegal activities is always void.  Also, contracts that oust the court jurisdiction, and contracts prejudicial to the status of marriage, public safety, administration of justice, and contracts that impose unreasonable restraint of trade are void contracts.

Negotiation Strategy

Negotiation of an the contract also happens in the ordinary course of business. A supplier may not hold a record of the negotiation of prices he has made. It is advisable to have mail communications for the price and other negotiations in an informal contract. Any discrepancy can be sorted out easily by referring to the mails.

Benefits & Drawbacks of an Informal Contract

The benefits of an informal contract are as follows;

  • It offers flexibility – The terms and scope of service, and payment can be altered, modified, or changed any number of times to suit the growing business needs.
  • It fosters client relationship – A business not only lives on the customer but also on trust. The element of trust, which is not forced on the client by entering into formal contracts, can help to strengthen the relationship. The client/customer tends to act in good faith involuntarily.
  • It saves time and money – A small business may find it challenging to prepare and execute lengthy contracts where the order volumes are plentiful, and the frequency is higher. An informal agreement plays a fair game of saving time and money of small businessmen.

The drawbacks of an informal contract are

  • It is not legally enforceable – All said and done, an informal contract cannot be taken to court of law. For an informal contract to be legally enforceable, it requires signatures of parties to the agreement under a seal.
  • There is always room for misinterpretation and misrepresentation of the supplier and his products/service.
  • The parties to the agreement are under the pressure of default by each other.

What Happens in Case of Violation of Informal Contract?

An informal contract is not legally binding. Hence violation of the contract does not attract legal prosecution. But when an informal contract is changed as one containing an offer, acceptance of that offer, and conditions associated with such offer, it becomes a formal contract. 

The violation of a contract can be sorted by parties to the contract by themselves. The damages, if any, can be mutually agreed, and compensated. Any non-performance or underperformance of the contract shall be brought to the attention of each other appropriately. If the violation is dangerous and has caused severe damages to the parties to the agreement, the business may consider turning it into a formal contract and seek the court of law for justice. Such violations need to be analyzed on case to case basis, and the business shall consider entering into formal contracts in writing as and when required. 

An informal contract may be flexible and simple on its own, but it fails to address the issues of dispute resolution, remedies available to the parties in case of violation of the contract. Thus, a formal contract has the upper hand in such situation. It is prepared and executed based on specific language required by law.

Any contract that speaks the language of law holds a special position in the business. In the era of technology and innovation, information has become the order of the day. It becomes important to record all the information and make them available as and when the need arises. Hence an oral agreement does not serve the purpose anymore. Anything agreed between the parties to the business must be executed in writing. 

Informal contracts are part and parcel of everyday business. It provides a smooth transition for the conversion of products/services to revenue of the business. Navigating through an informal contract is quite simple; you just set up or sort out things over a call. The disputes, if any, are brought to the attention of the parties to the agreement in advance to protect the trust. But when a business senses need to enter into a formal contract, the same should be done without a second thought.