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Your Guide to Relational Contracts

The corporate world of contracts seems to be on the cusp of a new path, and that's where formal relational contracts are starting to emerge.

What Are Relational Contracts?

Relational contracts are agreements that rely heavily on the trust between parties, rather than solely on the explicitly documented terms of an accord. Theyrelational contracts are agreements that rely heavily on the trust between parties, rather than solely on the explicitly documented terms of an accord. could be seen as a social contract and moral obligation. They are meant to guide the business behavior of the actors and contributors who deliver on the expected obligations of the agreement.

The Harvard Business School defines relational contracts as the “collaboration sustained by the shadow of the future as opposed to formal contracts enforced by courts.” In simpler terms, HBS explains that the agreement needs to be forward-looking and help develop long-term relations, rather than merely serve as an enforceable document. An extreme case of such an agreement would be the old ‘contract by a handshake.’ Although no one is pushing for this particular extreme (and it is impossible to fully grasp or enforce this method), there is still room to improve the current state of contracts, keeping the following ideas about relational contracts in mind:

  • They represent long-term relationships between parties
  • They involve an equal agreement of commitment from both parties
  • They require lots of communication and cooperation

With that, here is your 2022 guide to relational contracts.

Why Are Relational Contracts So Important?

When it comes to holding value over years and helping to maintain good contracting relationships, relational contracts are rather important. Instead of only being about a transactional exchange, they focus on the relationship between parties in the long run. Although developing this trust can be difficult at first, relational contracts ultimately keep both parties happy by helping to create both tangible and intangible deals — and ‘win-win’ situations — that save operational costs. This goes a long way in establishing that long-term business relationship and cementing that mutual trust.

Challenges with Relational Contracts

The problem that relational contracts address is what David Frydlinger, a partner at Lindahl Law Firm, coins as the “contracting paradox”: “(There is the) delusion that we write contracts to make plans, but we cannot really plan accurately. And, as a nice twist, we trick ourselves into believing that we can plan.”a challenge that comes with relational contracts is balancing the wording of the agreement enough to appease all parties.

Nevertheless, a challenge that comes with relational contracts is balancing the wording of the agreement enough to appease all parties. Is there a reasonable representation of the agreement’s intent? Is there enough in the agreement to mitigate risk, while holding to the concept of brevity in contracts? And are these balanced against the unwritten elements of the agreement that build the business relationship. (This refers back to the HBS notion of an accord “sustained by the shadow of the future.”)

9 Tenets of Relational Contracts

In regard to the above, World Commerce & Contracting (World CC) has shown there to be nine critical tenets to making relational contracts work. These include the following:

  • Communication
  • Risk management
  • Open problem-solving
  • Avoidance of blame culture
  • Collaborative working across agreement parties
  • ‘Gain and pain’ sharing
  • Common goals & objectives
  • Clear performance metrics
  • Pursuit of continuous improvement

Although many of these tenets seem rather idealistic and philosophical, they are important for building strong relations with contracting partners.

5 Step Process for Relational Contracts

Beyond the tenets mentioned above, World CC also recommends creating relational contracts in the following five steps:

  • Focus on the relationship rather than the deal
  • Create and nurture a partnership rather than arms-length relations
  • Incorporate social norms in the relationship
  • Align interests rather than avoiding and mitigating risks
  • Create a flexible and fair agreement framework

Do Relational Contracts Make Sense for Your Team?

At the end of the day, contracts and formal agreements are never going away. They are the ‘lifeblood’ of business, allowing transactions to take place, and commerce and relationships to grow. However, there must always be some scrutiny of contract terms and a healthy level of contract negotiation. It is important to come to a consensus such that all parties agree on key parts of an accord. But there must also be elements of sensibility, moral business behavior — and the notion of building a long-term relationship based on an agreement.

So, does it make sense to test out a relational contracts approach? Without a ‘shadow of a doubt,’ yes! Relational contracts are focused on the future — on building positive relations between enterprises.

If you want to find out more about ContractPodAi Cloud — and what our One Legal Platform can do for your day-to-day contracting — contact us today and book a demo.

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 Jerry Levine
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