Disclaimer: the following story is fictional, but representative of the common mistake of not formalising verbal agreements. Any resemblance to actual persons or events is purely coincidental.
Legal disputes are often not anticipated before they occur, and time and time again we see people avoid taking the steps necessary to protect them down the line. The consequences of not doing so can be dire as seen in Adi’s case.
Adi’s been designing and building suburban hobby farm enclosures and containers for 20 years. Back in 1994, he designed and built his first vegetable garden bed out of scrap timber, corrugated iron, and chicken wire, suited perfectly to his small suburban backyard. His design was unique, cheap, sturdy, kept the vegetables healthily growing with good drainage, ample sunlight, and proper ventilation. Above all, they looked great. Amongst his family, friends and neighbours, Adi’s unique approach to growing vegetables in small spaces became popular, and he was soon making garden beds for others. It didn’t take long for him to apply his skills to building enclosures for chickens, worm farms, and compost heaps. Over the next 20 years, Adi worked hard to develop his business.
Last year, Adi was approached by his cousin, Tony, (who was actually one of Adi’s first customers!) with an idea to have his enclosure and container designs manufactured in China. Although reluctant at first, Adi saw that this idea had enormous potential. His enclosures could be made at 20% of the cost, but required an initial investment of $80,000. Adi and Tony agreed that they would both contribute to the manufacturing and importing costs but that Adi would cover the initial cost of having the designs created electronically and product moulds cast. Out of the total cost, Adi agreed to contribute $55,000, and Tony $25,000. They would split the profits, and they would run the business as partners.
Adi and Tony trusted each other. They were cousins and had been friends since birth. They saw no need to get bogged down in legal contracts, so didn’t see the need to formalise their agreement.
Initially, things proceeded well. Both Adi and Tony took an active role in marketing and selling the products, which were a hit with their customers. Adi was satisfied with how the business was run and looked forward to being able to invest the proceeds from the sale of the enclosures into a new batch for import.
An Unplanned Turn for the Worst
Unknown to Adi, however, Tony was running into personal financial difficulties. Tony was in severe debt, and in need of money to pay those debts. Adi, while sympathetic to Tony’s situation, wasn’t in a position to assist. Tony asked Adi to pay back his $25,000 contribution.
Adi was shocked. It was the first time Tony had used the word ‘loan’, and he hadn’t realised that Tony viewed the contribution this way. Adi didn’t have the money to pay back Tony without risking the next batch of imports. Tony was also upset, as he thought that he would be able to rely on Adi to pay back the contribution once things were set up and running. He felt that he should be entitled to get his money back, and after all, “the whole thing was his idea in the first place”.
The relationship quickly soured. Tony sent Adi a formal letter of demand, and Adi refused to pay. They’re now in court, trying to work out what was originally agreed, and the legal costs are mounting up.
Is their Verbal Agreement Enforceable?
What could Adi and Tony have done to avoid this situation? It may seem obvious, but their dispute could have been avoided if they had formalised their initial arrangement. Numerous questions arise, and neither Adi nor Tony can answer them satisfactorily. For example:
- If the payment is a loan, how and when was it to be repaid, and does interest apply?
- If the payment was not a loan, what (if anything) is given in exchange?
- Does Tony have any rights in Adi’s business?
- How were profits from the venture to be split?
- How are they to resolve disputes?
Although they hadn’t thought about it at the time, when Adi and Tony agreed to work together on their project, they were forming a contract. To resolve their dispute, the terms of that contract need to be identified and understood, from the intention of the parties at the time of the formation of the contract. If Tony and Adi had formalised their agreement in a written document, it would have been much easier to work out what they intended from the relationship. Instead, they are now embroiled in a legal dispute with each other, trying to work out what they originally agreed to and how it can be resolved fairly.
Adi and Tony never thought they would find themselves in their current situation. They had been friends since birth, yet fall out over a commercial dispute. If they had considered formalising their agreement at the beginning, they might have saved not only the legal fees incurred in their dispute, but also their relationship.
Questions about reducing your verbal agreement to writing? Let our contract lawyers know on 1300 544 755.