Why Do Contracts Exist in Business?

//Why Do Contracts Exist in Business?

Why Do Contracts Exist in Business?

legal updateWhilst you’ve been drawing up a contract with a business partner, have you ever got to a point where you just stop and think, “do I really need to be going through all of this, wouldn’t an email be sufficient?” Hopefully, you have lots of healthy business relationships where everyone just keeps doing what they should and it’s all happiness and sunshine. Don’t become complacent, as some business partner deals can become weak as each of you independently develop expectations of the relationship.

Why are we telling you this?

In a recent case to come out of the courts, a business relationship based on everyone doing their bit (and little more) shows how quickly and easily things can break down, potentially destroying your business in the process.

In Re Capital Finance One Ltd (2017), Capital Funding One (“CFO”, and not to be confused with Capital One!) had an informal relationship with King Street Bridging Limited (“King Street”) for providing high interest bridging loans to customers that CFO had identified as suitable clients. There was no written contract between the two.

The way the deal worked was that CFO presented the opportunity (a potential loan customer) to King Street, who would then pay CFO the loan amount, and they paid the customer. Repayments from the customer were then fed back up the chain, with CFO taking their 50% cut of the interest along the way. The entire relationship took place between CFO and King Street through oral conversations and some emails. Only the details necessary to enabling this routine were discussed – hours were not spent arguing over the insurance or the limitations of liability.

If you’ve ever entered into any sort of credit arrangement, either through business or for yourself, you’ve probably noticed a big piece of the puzzle missing here – what happens when a customer defaults on their repayments? Well, somehow, CFO and King Street managed to avoid talking about this until 2016 – some three years after their relationship began!

When two customers defaulted in 2016, King Street took the somewhat extreme step of appointing an administrator over CFO for its ‘default’ on repaying. Naturally, CFO contested. In trying to determine whether CFO had defaulted on its repayment, or if the risk of customer non-repayment was meant to be held by King Street, the court was forced to consider past behaviour due to the lack of a contract. Previous communications between the two, and the fact that King Street had not considered CFO entirely responsible for past customer defaults meant that the court considered it inappropriate that Administrators should have become involved in this instance. This, along with several other factors, led to the court ordering the removal of the Administrators.

What does this mean for SMEs?

This judgement is a clear example of why contracts exist in business: so that you can decide how you want your commercial relationships to run in advance. This means you can cover potential uncomfortable situations, when things go wrong, whilst it’s still hypothetical. With a good contract in place, when it comes down to it, each business partner knows where they stand and what their responsibilities are. This saves everyone time, money and the stress of dealing with litigation and souring business relationships.

Be aware that your business partner contract and negotiations have a vital role to play in protecting your business. Talk to us before entering into a negotiation or do the DIY approach and register for one of our contract or negotiation workshops.

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Fraser Gleave
Junior Commercial Contracts Consultant

2018-06-19T14:21:08+00:00

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