Skip to content

What is a contract?

February 21, 2017

It may seem amazing to ask, but what is it that constitutes a contract? More specifically, how would the average person in business answer this question?

Every day, there are millions of transactions around the world, each covered by some form of contract, but often no clear view of the elements that formally constitute part of the binding agreement. I have even heard a lawyer say “Oh, you mean the scope of work …. I was talking about the contract”.

Or take this example, which comes from one of the world’s biggest business software companies, which claims to cover the contracting process: “Typically contracts are focused on language and wording.  Although there is negotiation on some terms, the primary focus of contract negotiation is to finalize the wording.  In Sourcing, the primary focus is to get agreement on pricing, terms, and what is being sourced.”

I understand there are different sections of ‘the contract’, but ultimately it needs to operate as a coherent basis for performance. The driver for establishing an agreement is economic, because there is a belief that mutual value can be achieved. A contract defines that value, it sets the terms under which it is to be delivered, the responsibilities the parties have to each other and the consequences if they fail. Negotiation may or may not be needed – but shared understanding and commitments are essential. That is about far more than ‘finalizing the wording’.

Today’s confusion creates a wide range of problems – many of which are outlined in IACCM’s ‘ten pitfalls’ and analysis of the cost of poor contracting. It leads to absence of understanding, late engagement of commercial resources, a focus on risk transfer rather than risk management …. the list goes on.

Contracts are a reflection of business intent and capability. In my experience, organizations that place little value on contracts are often among those that experience low growth and margin, quite simply because they lack internal discipline and cooperation. While this may have limited impact in the world of commodities and catalog buying, it spells potential disaster for more significant acquisitions.

 

 

 

2 Comments
  1. Rahul Khasnis permalink

    Tim,

    Your recent posts on collaboration, what is a contract and agile contracts all get intertwined in the real world. I guess anything to do with relationships gets intertwined. If i go back into the days of barter then contracts used to be based much on trust. Contracts, for me, are written translation of that trust – between every interconnected party. Without that inherent trust, every word of the document will be viewed with bias and suspicion of being written to favour one party or the other. I have seen failed projects where contact language that reflects trust and at the same time projects where contact language is as clear as it possibly can. I guess there is no right or wrong answer to what constitutes a contract that translates into a successful outcome, but in my view successful outcome of a contract will only come with trust.

    • Hi Rahul
      I guess we can never entirely predict or control behaviour, so there will always be failed projects and many reasons for them – for example, dishonesty, over-commitment, dramatic changes in need or circumstances. Contracts will never overcome every problem, but they can help – and that is largely through ensuring and testing common understanding, providing clarity over expectations and methods and offering methods to deal with the unexpected. If they are not used in this way, the risk of failure is increased.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: