Relational Contract

A Relational Contract is a special contract needing a long-term relationship among parties where they must commit substantially and work with confidence and trust. It serves to teach partnership thinking, get ready for unpredictable eventualities, set mutually profitable objectives, and build longer-term business relationships.

Parties use it to reduce the cost of transactions by avoiding modification of contracts in changing market scenarios. It emphasizes fostering trust-based relationships, so it curtails opportunistic behavior. It makes communication between parties open-ended while relying on their field of expertise. They derive risk and profit of business equally.

A relational contract or formal relational contract can be defined as a legally binding contract prioritizing the relation amongst parties over strict transaction terms. It works on the principle of building cooperation and trust amongst parties. It does so by incorporating vital relational traits like joint problem-solving, shared objectives, and open communication. It emphasizes these traits to provide parties with a way to adapt to dynamic circumstances and dispute resolution while minimizing the necessity for litigation.

The relational contract theory sets up flexible guidelines for collaboration, using mutual goals and ongoing interest alignment instead of fixed terms and conditions. It improves the overall efficiency of a business through centering on relationship-building. As such, it mitigates risks related to conflicts and misunderstandings, resulting in sustainable outcomes. It outperforms traditional contracts with its adaptability to dynamic and complex environments. As a result, various sectors use it, like public services and relational contracting in construction and finance, requiring continuous trusted relationships.

Also, it can transform institutions in the financial sector engaged in clients and partners. Moreover, it promotes accountability and transparency, creating trust amongst parties, leading to exceptional investment consequences and minimizing transaction costs. Furthermore, with evolving financial markets, the approach of contracts based on relation has been becoming more crucial for navigating unpredictability.

It has the following characteristics;

• The length of the contract must be long-term, having mutual intention of the parties involved.
• The essence of duty of good faith must not be blocked or prevented in the contract.
• All parties have the intention to perform their duties and roles with fidelity and integrity to the negotiation.
• The contract fails to capture the full objective and spirit of the venture.
• The working of the contract could be the prioritized commitment of all the parties.
• The confidence & trust posed amongst the parties differ from that of a fiduciary relationship.
• Loyalty, confidence and mutual trust would be the pillars of the highest degree of predictable work efficiency, cooperation and communication.
• The venture arising out of the contract has substantial investment from all the parties involved.
• There must be the presence of relationship exclusivity in the contract.

Nevertheless, all the above characteristic has no determinative nature. However, the implied good faith of duty could not be incoherent with the clear terms of the agreement.

The concept of contract based on relationship has a 5-step process as shown below:

Step 1 - First, a partnership mentality must be used to form a solid foundation. It can be done through engendering trust consciously and communicating one's concerns and expectations freely.

Step 2 - All parties must share their vision to work towards a common goal, aligning expectations in a dynamic environment.

Step 3 - One can expect misalignment to happen even after having a shared vision. So, one must prevent opportunistic actions by adopting a guiding framework like integrity, reciprocity, and honesty concerning unexpected occurrences.

Step 4 - The last three steps set the platform for the phase of contracting. The current step helps one lay out extensive details of the relationship-based contract. Hence, one should conserve terms & conditions in line with the guiding framework.

Step 5 - Lastly, one has to create governance teams, allowing parties to uphold the guiding framework. Hence, one needs teams like best-valued, excellent, sustainable and relationship teams. All these teams have to conduct regular meetings to push for aligning parties towards shared goals and vision.

Let us use a few examples to understand the topic.

Example #1

An online article published on September 8, 2019, discusses the High Court of the United Kingdom ruling regarding relations between the post office and hundreds of sub-post-masters (SPMs) being that of contract of relation. The judgment has been hailed as the landmark decision by the high court's justice, as detailed in his 336-page report. The judgment made clear that even if a contract does not mention about contract based on a relation, then also based on its nature, like having mutual trust, long-term relationship, and duty of good faith makes it so.

The case focused on the errors caused by Horizon's flawed computerized system used by SPMs. The ruling has also emphasized that the integrity and intent of parties could be upheld legally. Hence, it made significant strides in advancing relation-based contracts in the last five years.

Example #2

Let us assume that a healthcare provider- Medata, has agreed with 100 local clinics in Old York City to execute its new healthcare service package. Their contract has a tenure of more than 10 years, necessitating regular collaboration, having the characteristic of a relations-based contract. Both parties of the agreement agree to provide the best medical tests at an affordable price, laced with excellent medical services and hospitality from staff.

Although good faith in duty has not been added explicitly in the agreement, it needs to be sorted out sooner rather than later. Plus, the feedback must be provided on an urgent basis by the 100 clinics. Then only, the collaboration would succeed and provide quality medical checkups to all.

It helps parties entering into a contract over time as follows:

• It builds solid trust amongst parties by binding them legally to achieve their expectations.
• Parties involved in these contracts have increased coordination amongst them for better cooperation within the legally binding agreement.
• They provide flexibility in making amendments to changing business circumstances in the long term.
• It fosters commitment and trust in business relationships, leading to long-term sustainability.
• It minimizes disputes amongst parties as it provides clear-cut guidelines for the resolution of disagreements that ensure continuous collaboration between them.