Contact Us

    The Problem with Oral Contracts

    May 21, 2021 10:03:57 AM

    Oral contracts exist everywhere. When you order a coffee or lunch, when you borrow your neighbour’s tools or when you agree to pay your friend back for that ticket to the NRL. Oral contracts are great for social settings however they are not suitable for business transactions.

    Generally speaking, unless you are a terrible friend, you will not sue your friend for the $4 you lent them when you bought them a coffee. This is largely because the costs to run the proceedings would far outweigh the ‘damage’ that has been caused by your friend not repaying you the $4.

    In business transactions it is usually the case that monetary damage is significantly more. Take for example an agreement to supply goods to a client. If those goods are worth $30,000 and the client never pays you for the goods, then your ‘damage’ may be $30,000; a sum worth pursuing.

    Whilst oral contracts are necessary for society to function, they would be completely inappropriate for the supply of any goods or service which has substantial or significant value. This is due to the following:

    1. Oral agreements do not clearly detail the ‘terms’ of the relationship

    Oral contracts rely on the memory of the parties and the ‘goodwill’ of the parties to agree as to the terms of the contract. For example, what service will be provided and for what cost. If the ‘goodwill’ breaks down, then there is no single source of truth which clearly articulates what the agreed terms were.

    In Watson v Foxman (1995) 49 NSWLR 315 notes that human memory of what was said in a conversation is fallible for a variety of reasons, and ordinarily the degree of fallibility increases with the passage of time…

    Human memory is fallible and should not be relied upon as the single source of truth.

    1. Interpreting oral agreements is expensive and risky

    Interpreting oral agreements relies on an investigation of the conduct of the parties in relation to the alleged ‘contract’. This is an expensive process and one that may not result in a clear answer.

    In County Securities Pty Ltd v Challenger Group Holdings Pty Ltd [2008] NSCA 193 it was noted that “the terms of the oral contract must be inferred from a combination of surrounding circumstances including conversations, documents and conduct none of which provide a definitive form of words. The issue is not one of interpretation as there are no words to interpret it is an issue of fact: what did the parties agree?”

    Furthermore Justice Hammerschlag in John Holland Pty Ltd v Kellogg Brown & Root Pty Ltd [2015] NSWCA 451 noted that when a party seeks to rely upon spoken words as a foundation for a cause of action…the conversation must be proved to the reasonable satisfaction of the court….Moreover the court must be satisfied that consensus reached was capable of forming a binding contract and was intended by the parties to be legally binding.

    Litigation is extremely expensive and risky. Oral contracts require the court to make determinations as to whether they exist and what the terms of the contracts are.

    1. There is a simpler, more cost effective and safer way

    Parties can enter into written agreements. The agreement does not need to be complex but should be appropriate to the goods or services or relationship you are entering into. Written contracts enable an objective view of the terms and the agreed foundations of the relationship.

    The High Court in Toll (FCGT) Pty Ltd v Alphapharm Pty Ltd (2004) 219 CLR 165 noted that the principle of objectivity by which the rights and liabilities of the parties to a contract are determined. It is not the subjective beliefs or understandings of the parties about their rights and liabilities that govern their contractual relations.

    Written contracts take many different forms whether they are generic terms of trade, specific agreements or standardised terms. No matter what their core form, they each share the same purpose which is to define the agreed rights and obligations of the parties.

    The cost of preparing and negotiating a written contract usually reflects the value of the goods or services being provided. For example, a contract for the provision of a $100 million civil contract will usually be significant and contain a vast number of terms that you would not necessarily find in a $30,000 contract to excavate a ditch. The cost of preparing and negotiating is far less than the costs of interpreting and litigating if the contract is oral.

    Summary

    • Oral contracts are risky and extremely expensive to work through the terms of the agreement.
    • They are inappropriate for business relationships.
    • All businesses no matter what the size need to establish a base line set of terms and contracting process to lower the risk and create objectivity around the terms of engagement.

    If you would like to speak to us about creating, reviewing or negotiating terms of a contract please call 02 9688 6023 or email jfrank@franklaw.com.au

    This is not legal advice.