The days of the “napkin deal” are almost legendary. How many transactions have been sketched out on the back of restaurant napkin over lunch? It seems like some of the biggest startup companies are born in someone’s garage, with some of their initial contracts being done on a piece of scratch paper, if at all.
Sometimes these startups do well – and sometimes they become wildly successful. But certainly there are risks involved with casual, informal contract arrangements. In reality, if everyone had perfect understanding, perfect memory, and perfect honesty, then many contracts could be done on the back of a napkin, or not at all. Virtually everything could be done on a handshake. And while some major transactions may still be done on a handshake, there are many, many others that are documented in fine detail. No doubt millions of dollars are spent every day on attorneys who draft contracts and related documents for transactions of every kind.
So if deals and transactions can be done on a handshake, why spend all of the time, money, headache and hassle of preparing a written contract? There are actually several important reasons.
First, some contracts must be in writing, or they aren’t enforceable. For example, a real estate broker’s written listing agreement must almost always be in writing. A listing agreement is an agreement whereby a broker agrees to list an owner’s property for sale. If a licensed broker doesn’t get a signed, written listing agreement from the seller, then that broker may not be able to recover a real estate commission if the owner refuses to pay.
Second, written agreements help the parties focus on the transaction. Sometimes in the rush or excitement of a transaction, the Parties might talk in general terms. There can be key elements that are never discussed or agreed upon. The parties might think they have agreement on all of the important terms, but in reality they may have two different sets of expectations. Putting the terms into writing can help the parties identify any deal points that have not yet been addressed. Putting things in writing can help things seem more formal, and if there’s not actual agreement on some points, then these different perspectives can be highlighted through the process of writing them down.
Third, memories can fade over time. Some key elements may be important to one of the parties, and other key points may be more important to the other party. Therefore, after a period of time each of the parties may remember key points of the contract that were important to them, but they may not remember other portions of the contract that were not as important to them. A written contract can help everybody remember the actual terms of the agreement.
Fourth, people can be tempted to fudge. Oral contracts can be “slippery.” People can be tempted to change the terms of an oral contract – even if they know better. It’s been said that an oral contract isn’t worth the paper its written on. If one of the parties isn’t fully honest, then a written contract can be a lifesaver.
In some situations, an oral contract may be a legally binding contract that is every bit as enforceable as a written contract. But it may be harder to prove the terms of that contract if the parties disagree as to its terms.
Special rules can apply to contract involving real estate. A special rule called the “Statute of Frauds” can make some oral contracts unenforceable, especially if they concern real estate. Therefore, when it comes to real estate, it’s always best to have a valid, written, legally enforceable contract.
Even if a contract is in writing, there can still be problems. I remember one of the first law cases I ever read. In the summer of 1984, I was finished with my undergraduate degree at Brigham Young University and was getting ready for my first semester of law school. I had picked up my textbooks, and was thumbing through a book on contracts. I stopped at a case with an unusual name: Raffles v. Wichelhaus. It seemed like an odd name, and it caught my attention.
In the United States, we typically think of the five years from 1860 to 1865 as the period of the Civil War. We don’t always spend a lot of time on other world events that happened during those years. But in 1864 there was a ship named the Peerless that loaded up cargo in Bombay, India. Part of the cargo on that ship was 125 bales of Surat cotton. The quality of the cotton was guaranteed to be “middling fair.” After the cargo was loaded, the ship sailed for Liverpool, England.
It seems that a certain seller in Liverpool, England agreed to sell the 125 bales of cotton to a buyer when the ship arrived in port. The agreement was contained in a written contract between the parties. Eventually, the ship arrived in port, and the seller demanded that the buyer complete the transaction and pay for the cotton. The buyer refused.
And the reason why the buyer refused? Because there were actually two ships named “Peerless.” No kidding – what are the odds? In 1864, two separate ships named “Peerless” loaded up cotton cargo in Bombay, India and sailed for Liverpool, England. The first ship left Bombay in October, and the second ship left in December. When the contract was formed, the seller intended to sell cotton from the first ship named “Peerless.” But when they formed the contract, the buyer had intended to buy cotton from the second ship “Peerless.” Neither the buyer nor the seller knew that there were actually two ships named “Peerless” that were to be sailing from Bombay.
This is almost like two ships passing in the night. The seller claimed it didn’t matter what each of the parties had in mind. The contract only said that the cotton was to be sold from a ship named “Peerless” that sailed from Bombay to Liverpool, and whether such ship sailed in October or December was irrelevant. But the defendant disagreed, and said that no agreement had been reached because the parties never agreed on the same thing.
You be the judge. What did the English court say about such a thing back in 1864? If you guessed that the court ruled for the buyer, you’d be right. This famous old English case stands for the proposition that the parties must agree on the same thing in order for a valid contract to be formed. A contract requires that the parties have a “meeting of the minds.” The court said because the parties had not agreed on the same thing, then no contract was formed even though the plain language of the contract would have fit the description for either one of the ships.
This is not some ancient, outdated legal principle. The case of Raffles v. Wichelhaus was cited in a reported California court of appeal case as recently as 2009.
Contract formation and enforcement can involve complex legal considerations. Persons who are considering forming or enforcing a contract should consult competent legal counsel.