When people make agreements, they don’t always look the same. Some are written down in detail, signed, and follow strict rules—these are called formal contracts. Others can be more relaxed, sometimes even made with just a handshake or spoken words—these are informal contracts.
Gitnux states that some 70-80% of B2B transactions and other business processes are supported somewhere by a contract. These two are very common in life and business, but they differ in certain important aspects, such as formation, enforcement, and interpretation.
Let’s tackle the major differences between a formal vs. informal contract so you can make an informed decision.
Definition of Formal Contracts
An enforceable contract meets some legal requirements but, more often than not, may involve a written document formally drafted and signed by the parties. A legally binding contract delineates the duties and rights of both parties concerning all matters affecting them.
Such contracts have to be precise and concise, signed by agreeing parties, and in some cases, notarized for the enforcement action. Real estate, employment, and other situations that prioritize clarity and security often utilize them. With respect to an agreement, trust is founded since each party equally acknowledges that one is binding oneself in honor of their commitments.
Formal contracts help create a spirit of cooperation and respect in the relationship. Through formal contracts, you continue to feel secure in whatever transaction you enter.
According to business transactions lawyer William R. Reigel Jr., creating, reviewing, and negotiating contracts are vital when starting in the industry to set the stage for success. They include contracts with clients, suppliers, and vendors.
Definition of Informal Contracts
Informal contracts are casual agreements that may not oblige strict legal formalities, unlike formal contracts that necessitate following specific legal protocols. These contracts are often born out of everyday life situations. A handshake with a friend to seal a deal or an oral agreement with someone to come help move furniture around is considered an informal contract.
Informal contracts have an existence based largely on trust and mutual understanding rather than elaborate documentation. They might be just as binding as formal ones even though they lack their actual structure.
Being less rigid allows for building social channels so one can enter into agreements without the intimidation of legal jargon. The lack of formalities in informal contracts might sometimes cause difficulties between parties, so explicit communications remain an important factor.
Advantages of Formal Contracts
Formal contracts provide the parties involved in an agreement with several benefits that help build confidence between them. It gives clear expectations and actions to be taken by each of the involved parties, which further discourages misunderstanding and builds confidence.
Such types of contracts would be substantiated more before the courts, which provide an extra blanket of security for both involved parties when there is a breach. Contracts made orally or informally have greater problems in enforcement since both parties will tend to have their own understanding of the terms of the agreement, which can lead to differences or to things being forgotten about what was actually agreed upon.
A written contract is another way of protecting one’s interests and of forming goodwill between both parties, as each will know that the other will be fair and honest.
Advantages of Informal Contracts
Informal contracts exhibit surprising flexibility, adapting to a wide range of situations. They allow one to come to an agreement in a short period. This means that you can immediately launch into a partnership or collaboration without spending time negotiating every little clause.
This flexibility tends to foster trust and goodwill among the parties involved. Informal agreements also tend to bypass the usual red tape, so you can concentrate instead on what’s truly important: goal achievement as a team. Another aspect is saving time and money that you might spend for a lawyer’s consultation.
This accessibility opens the communication so that it will be easy for parties to clarify the terms and expectations. In an era where connection is another name for networking, an informal contract may work to form a conducive environment in which everyone feels valued and heard.
Potential Risks and Pitfalls of Each Type
You should be aware of the risks that apply to both kinds of contracts. Any complicated formal contract might give rise to misunderstandings regarding the intention or cause unintentional mistakes in the language, which in turn causes disputes. Legal problems arising from these misunderstandings or failures to fulfill terms can lead to lengthy and expensive proceedings.
Informal contracts lack the framework and support of law that a formal contract might enjoy and so they will be more difficult to enforce. Trust here plays a critical role. When your partner defaults in the fulfillment of his or her duties under the contract, your remedies may be limited.
Equal importance should be given to an acknowledgment of the risks involved therein, as such recognition will assist in settling out agreements and developing relationships on a mutually good basis.
