If you are thinking of forming healthy and cooperative business relations, then you should definitely give relational contracts a go. Such contracts have been increasing in popularity due to their ability to foster better collaboration and transparency while also legally binding the parties to match each other’s expectations and interests. However helpful, a relational contract can often be hard to make. Having to create a legally compliant contract without a lawyer can take up hours of productive time and may even get you a contract that’s not favorable.
As relational contracts become increasingly common, it’s time to learn why formal relational contracts are important and how to create them perfectly.
What is a Relational Contract?
As the name suggests, a relational contract is a legal contract built to form a long-term relationship between two or more parties. Jotting down things such as the mutual principles and goals, a relational contract helps create better understanding and expectations between collaborators.
Commonly built for business partnerships, joint ventures, or suppliers, relational contracts focus more on basic principles and combined goals rather than being a plain list of some specific obligations and outcomes.
What is a Formal Relational Contract?
Unlike a regular contract, a formal relational contract contains specific terms and conditions alongside the mutual principles and goals of the collaborators. The inclusion of some specific terms and conditions makes the formal relational contract more legally binding, thus providing collaborators with a higher sense of security and protection by the law.
A well-drafted and equitable formal relational contract can help businesses achieve greater trust, efficiency, and productivity by providing them with a legally backed framework. Hence providing risk minimization and security for both parties.
Common Features of Formal Relational Contracts
Formal relational contracts are built to foster a healthy and transparent long-term collaboration between two or more parties. It has a number of different features:
- Collaboration: At the most basic, relational contracts help create and foster a collaborative environment that benefits all parties.
- Specific terms and conditions: Offering transparency and legally binding, relation contracts contain some specific terms and conditions to be followed by both parties.
- Mutual dependency: Having a relational contract with a partner or client sets you in a position where the success of one party is linked to the other, creating a team mentality.
- General flexibility: Business circumstances can change over time; therefore, long-term contracts such as the relational contract should allow amendments and adaptability to both parties.
- Performance metrics: Before entering a relational contract, collaborators usually include a number of different performance expectations that should be met by both parties involved.
Transactional Contract vs. Relational Contract
A transactional contract, evident by its name, is a contract of transactions usually used in short-term exchanges. In contrast, a relational contract is built to form a long-term relationship between two or more parties. Here are some more of their differences:
- Higher Degree of Trust: Parties signing up for a relational contract must have a higher level of trust, whereas a transactional contract is not based on belief.
- Length of the Relationship: Transactional contracts are usually built for one specific transaction or multiple similar transactions, whereas a relational contract is built to create a long-term cooperative relationship.
- Shared Goals: When two or more parties sign a relational contract, they decide upon a series of combined goals. On the other hand, transactional contracts only include specific give-and-take agreements.
- Level of Risk: Relational contracts usually involve a higher level of risk than transactional contracts since they are long-term and bound collaborators to different duties.
Key Components of a Formal Relational Contract
Used as a tool for forming long-term relations, each relational contract should include a series of components that are key for the success of business relations. Let’s discuss these components and go through a relational contract example.
- Shared Goals: The core reason for any party to enter into a relational contract with another is the prospect of achieving shared goals that bring monetary benefits to all parties involved in the contract.
- Guiding Principles: A relational contract is a strong base for any business relationship, which is why it always contains a number of different principles that guide and drive the relationship.
- Decision-Making Processes: Clouded or mixed decision-making can negatively affect business, which is why relational contracts contain a decision-making process that strictly checks all combined decisions between the involved parties.
Example of Relational Contract between Dell & FedX
Dell and FedX are in long-term business relations, where FedX handles all of Dell’s return-and-repair processes. Previously, the two businesses had a simple agreement where both Dell and FedX had to meet certain requirements.
However, both parties were not satisfied with each other. Dell thought that FedX wasn’t driving enough growth, whereas FedX thought that the requirements set by Dell were costly. Understanding each other’s needs, the companies switched from their previous agreement to a relational agreement that strengthened business relations and helped their problems.
After just two years of forming a relational contract, Dell and FedEx were able to cut costs by 42%, making it a win-win situation.
Why Go for Formal Relational Contracts?
When entering a partnership or any other long-term business agreement, drafting and signing a formal relational contract will help you a long way. Here are just some of its benefits.
An official signing between two or more parties, the relational contract forms a strong sense of trust between both the collaborators. This is because both parties understand that they are bound by a legal document that requires them to fulfill all expectations it mentions.
Signing a formal relational contract puts both collaborators in a legally binding, where they are legally required to cooperate and adhere to the rules of the signed document. This massively improves coordination and increases the overall business efficiency for all collaborators.
Business circumstances can change over time; therefore, long-term contracts such as the relational contract should allow amendments and adaptability to both parties. Examples include economic downturns, which force almost all companies to make amendments to their relational contracts.
Businesses take up years of fostering before they can finally be sustainable. Getting into formal relational contracts helps protect financial sustainability by ensuring strong trust and commitment towards your partners and clients.
Disputes and disagreements are common in businesses; therefore, formal relational contracts contain a detailed guide to resolving disputes. Strictly following the rules written in this signed document will help both parties reach a settlement and allow them to continue working together.
Best Practices for Creating Formal Relational Contracts
When drafting a formal relational contract, you need to be mindful of a number of different things.
- Understanding Needs and Expectations: One of the most basic principles for forming stronger business relations is understanding your partners’ and clients’ needs and expectations. Doing so will help you form a fair contract for both collaborators.
- Conducting Due Diligence: Before you enter a legal agreement with any firm, organization, or person, it is important to thoroughly investigate their past activities, plans, and financial statements to ensure that you are going into business with the right person.
- Adopt Guiding Principles: There are several different guiding principles that you should be following when creating a relational contract. Once set, these guiding principles will become the base for all your future dealings.
- Creating a Framework: A strong framework will drive your collaborations forward and help you set and achieve business goals together, which is why it is important to write down a framework in your relational contracts.
Relational contracts need to be coordinated, trustful, and, most importantly, flexible – built to cater to collaborations over a long period of time. We recommend automating certain processes of your contracts since doing so will help you achieve higher efficiency.
Olga V. Mack is Vice President at LexisNexis® and CEO of CounselLink® CLM, a next-gen contract management company that has pioneered digital negotiation technology.
An award-winning general counsel and operations professional, Olga embraces legal innovation and has dedicated her career to improving and shaping the future of law. She shares her views in her columns at Above the Law, Forbes, Bloomberg Law, Association of Corporate Counsel (ACC) Docket, and more.