You might not realize it yet, but informal contracts are an indispensable part of our daily lives.
While we all can recognize their formal counterparts, informal contracts are how most agreements take place.
To learn more about informal contracts and how they affect you, check out our comprehensive guide.
Key takeaways
- Informal contracts don’t follow the formal regulations of most legal agreements.
- They’re mainly used when ordering a purchase or agreeing to a sale.
- Informal contracts are rarely legally binding.
What is an informal contract?
Contracts are an agreement between two or more parties. They’re often written down and are, therefore, legally enforceable.
However, informal contracts aren’t formalized in this way.
This means most informal contracts aren’t legal agreements. Instead, they’re based on trust between the two parties.
Informal contracts largely deal with agreements between two individuals who know each other.
That’s because, if you enter into one, you have to rely on the other party to uphold their side of the bargain.
Think of an informal contract as a handshake agreement. Most people see shaking hands with someone as a sign of a confirmed deal.
If I shake your hand and agree to buy something, you can expect I’ll go through with it.
However, this is not a legally binding agreement, and I can back out of it. Although I might lose your respect, you won’t be able to take me to court.
What are the differences between an informal contract and a formal contract?
Although it can be easy to think of informal contracts as verbal agreements and formal contracts as written ones, this isn’t strictly the case.
Formal contracts can be verbal in nature and an informal contract can be written down.
Therefore, the key difference between an informal contract and a formal agreement is that the latter has to fulfill certain legal requirements (an informal agreement doesn’t have to worry about this as it doesn’t qualify for legal liability).
This means informal contracts don’t follow the regulated format of a formal contract, and the process of agreeing to them won’t include procedures such as signing and dating a document, finding a legal witness, or including proper contract terminology.
Another important difference is the level of risk involved.
Formal contracts are designed to be watertight, so you can enter into them without worrying about your legal status.
However, informal contracts carry more risk as they often aren’t legally valid.
You should be able to recognize a formal contract when you see one. This is because they all follow a specific set of rules and use a similar format.
An informal contract, on the other hand, can come in a range of guises, from promises made over the phone to written agreements scribbled on a piece of paper.
The differences between an informal and formal contract should be pretty clear now—but what about some actual examples of what an informal contract looks like in the real world?
Sales agreements
One of the most widespread examples would be a sales agreement.
Let’s say you’re looking to buy a car and you take one for a test drive. After checking it out, you tell the owner you’re going to purchase it and shake their hand.
Before the day comes to hand over the money and sign the formal purchase contract, the seller will need time to get the paperwork together.
This is why the initial informal agreement is important—because you shook the seller’s hand, they can take the car off sale and trust you’ll complete the purchase at a later date.
These sorts of sales agreements might be informal, but they can still be legally enforceable in certain cases.
That’s why you should be careful about which informal contracts you enter into.
Purchasing services
Similarly, purchasing services can create an informal contract.
If you come home late from work and decide to order takeout over the phone, you’re entering into an informal agreement that the company will deliver your food and you’ll pay when they arrive.
Although no formal agreement was signed and no handshake took place, this is still an informal contract built on trust between the customer and seller.
If either party fails to execute an agreement like this, it won’t end in a court case, but it’s unlikely either will do business with the other in the future.
Agreements or promises
A final example of an informal contract is an agreement or promise between two individuals.
While not relating to a business transaction, these are still important.
Maybe you’re watching a sports game and decide to take out a bet with your friend. Alternatively, you agree to help them clear their garage at the weekend.
Although it might not seem like it, these are informal contracts—after all, they’re often bound by a handshake.
Of course, these sorts of agreements and promises don’t carry the same level of risk as an informal contract relating to a business transaction or purchase, as it’s unlikely you’ll fail to uphold a promise to a friend.
However, it’s important you recognize the huge range of informal contracts that are out there.
How to make an informal contract
A key feature of an informal contract is that they don’t follow the same rules and legal expectations as their formal counterparts.
This means there isn’t any set way to create one.
However, a contract is a contract regardless of whether it’s formal or informal and must thus include certain fundamental elements.
1. Proposal
This is the first mention of making an agreement.
In an informal contract, you’ll probably make a verbal proposal pertaining to it.
2. Consideration
Consideration is the main part of a contract and usually details an exchange of money or goods.
For an informal contract, this probably won’t be written down.
However, you still have to be clear about the consideration before you shake hands.
3. Legality
Both informal and formal contracts have to be legal, even if you don’t intend for your agreement to be binding.
4. Intention
When it comes to formal contracts, the intention of both parties to fulfill them is an important element in making sure they’re legally valid.
Intention is even more important with informal contracts. This is because you have to trust that the other party will follow the terms of the agreement.
Once you’ve got the main elements in place, an informal contract can be made simply by both parties verbally agreeing to it.
This is usually followed by a shake of hands, but this isn’t necessary.
When can an informal contract become legally binding?
If you don’t trust the other party and are concerned about entering into contract disputes with them, it’s probably best to avoid informal contracts.
This is because they aren’t automatically legally binding, while formal contracts (if written correctly) are.
That’s not to say no informal contract is legally binding.
Sales agreements, especially for expensive items, include an expectation that the purchase will be made, as the seller will potentially miss out on other customers if they take the item off sale only for the prospective customer to back out.
This means some informal sales contracts can result in legal action.
For an informal contract to be legally binding, it must include all the main elements of a formal contract without being formally recorded.
Both parties have to mutually assent and be legally able to enter a contract, while the agreement has to follow the laws and regulations in your state or country.
Ideally, an informal contract should also be witnessed by a third party to be legally enforceable.
This is because a court won’t be able to produce a judgment if it’s one party’s word against another’s.
This means that while it’s not impossible for an informal agreement to be legally binding, you should use a formal contract if you want to guarantee its enforceability.
Let PandaDoc handle all of your contract needs
Informal contracts might seem like an easy way to get around the paperwork and bureaucracy that comes with contract management.
They’re certainly useful for some purposes, such as sales agreements and promises between trusting individuals, but they’re not a replacement for formal contracts.
This means you need a solution to help manage these. Enter PandaDoc’s contract management software.
With automated contract production, eSignature tools, and cloud-based collaboration, it’s a great way to make handling contract admin painless.
With the help of PandaDoc, keep informal contracts in the world of takeouts and friendly promises, and confidently and easily manage formal contracts in the workplace.
Disclaimer
PandaDoc is not a law firm, or a substitute for an attorney or law firm. This page is not intended to and does not provide legal advice. Should you have legal questions on the validity of e-signatures or digital signatures and the enforceability thereof, please consult with an attorney or law firm. Use of PandaDocs services are governed by our Terms of Use and Privacy Policy.
