Contracted formal requirements - more than legal superstition?
Jon Kihlman's article about formal requirements and legal superstition is published in the January issue of e-finance & payment law & policy. Read it here:
Once upon a time, form was everything and matter was nothing. In ancient Rome, a contract was not binding unless certain ritual formalities were observed. In more recent times, certain contract needed to be proclaimed publicly or witnessed by e.g. Notarius publicus. Such formal requirements have to a relatively great extent been abandoned in modern times.
Thus, the direction of the contractual evolutionary road is clear: It leads from form to matter and substance. Today, most jurisdictions uphold as valid contracts regardless of form. The evolution from form to matter is almost completed. Here and there, it is true, do we still see formal requirements, but they are primarily not for contractual reasons, but rather either for the protection of weaker parties, e.g. consumers, or to protect other interests that the parties’, e.g. fiscal interests.
Formal requirements in contracts
Why is it then that parties still – when the legislator has accepted the non-formal contract – often insist on formal requirements? Frequently, contracts state that changes to the contract are invalid, unless they are made in writing. Quite often, they also state that notices must be sent by registered mail or the equivalent. I would not be surprised if we will see a rising demand for electronic signatures in future contracts. And we see a shift from regular invoices on paper to electronic invoices, without anyone questioning if invoices are needed at all. The probable answers to the question why this is happening are most often superstition and tradition. Parties believe – without any reasonable ground – that the chosen form is better than its alternatives, or even that it is necessary.
Contract legislation hardly ever regulates what a party shall do in its own interest. One example is that it does not specify how a buyer of goods shall handle the goods after the risk has passed from the seller. Another example is that it does not specify how a party shall handle the fact that it may be liable to pay damages if it is in breach of contract. The legislator leaves it to either party to decide how it shall deal with its contractual risks.
Procedural legislation usually requires a party to back its claims by evidence for it to succeed. Consequently, a party that claims that a contract has been altered must usually support its claim. One efficient way to do that would be to provide the court or arbitral tribunal with a document where both parties confirm the alteration. Without such a document, it is very likely that the party will lose its case. A contractual requirement that changes are invalid unless they are made in writing does not do more than point out what any prudent party would do even without the requirement: Secure evidence when it has the burden of proof. And the requirement is most probably not even true: No sensible court or arbitral tribunal would uphold the clause’s formal requirement if a party could prove – although in another form than writing – that the parties had actually agreed on the alteration.
Registered mail or e-mail?
Registered mail has two benefits and at least one major drawback: It enables the one who sends a message to prove that the message has been received by the addressee and when that occurred, but it does not enable that person to prove anything about the content of the message. Why do parties insist on registered mail, when e-mail not only is easy to use, but also has the added benefit that a party can show the content of the message? Is it, perhaps, because e-mails are so common that it does not seem right to use them for notices that usually are needed when the other party is in breach of contract and a more ceremonial way of communication seems adequate? Or is it only because registered mail had benefits that regular mail lacked, at the time when all messages were sent by mail and e-mail was unknown (i.e. some odd fifteen years ago) and nobody has bothered to change to more efficient means of communication?
How often have you asked if you can see the other party’s ID (passport, driver’s license or other such documentation) before you agree to contract with it? That is what electronic signatures are. We have done just fine without such demands for a long time. We will probably do just as fine without them in the future, at least for contracts between parties who have actual contact with each other. Electronic signatures may, on the other hand, be efficient in situations where a party contracts frequently with many different counter parties, e.g. when goods or services are purchased on the Internet.
Although usually not prescribed in contracts, parties still use invoices as the trigger for one party’s obligation to pay to the other. The new ways of communication has influenced how we invoice, but has not – which is quite natural since it is not a matter of technology – influenced the use of invoices as such. In its simplest form, an “electronic invoice” is only a scanned document sent by e-mail. Slightly more advanced – in the sense that no paper need to be involved – is a document produced in a computer that is sent, still by e-mail, from that computer. Today, there are numerous companies that provide solutions that are far more advanced than such simple electronic reproductions of the paper invoice. All such companies, and as far as I have seen all discussions about electronic invoices, are based on the assumption that invoices are needed. What if they are wrong? What if invoices are unnecessary?
The purpose of an invoice is to provide information. It shall inform the person who shall pay why, how much and when it shall pay. It shall provide auditors, tax authorities and others with correct information about the company’s business. To the extent that such information can be obtained elsewhere, the need for invoices may be questioned.
Contracts are the origins of almost all invoices. Goods or services have been sold and bought. For almost all goods and for many services, the price to be paid follows already from the contract. Nothing prevents the parties to add payment instructions to the contract as well: The price shall be paid to the seller’s account # no later than 30 days after the delivery of the goods. If that is done, the buyer has all the information it needs to fulfil its obligation to pay. The parties’ need for invoices – or similar functions – is limited to situations where when the price cannot be deducted from the contract without any additional information, e.g. the amount of hours provided. So most often, parties do not need invoices.
Auditors need verifications of the transactions that they audit. But the verifications need not be in the form of an invoice. For all transactions, the contract is the true source of the obligation to pay and, consequently, the true verification. And again, if the contract provides the paying party with all necessary information, the contract can also be the verification. On the other hand, a contract is often more extensive than an invoice. Therefore, it can be practical to use an “executive summary” of the contract to verify the execution of the obligation to pay.
For some reason, VAT regulation – at least in Sweden – require that invoices are used. I haven’t seen any good reason for the requirement, but it is there. On the other hand, Swedish VAT regulations often allow the buyer to invoice itself, so the invoice need not come from the seller.
So to some extent, invoices seem to be needed, although one may question if the legal requirements are based on practical grounds. To a great extent, on the other hand, they need not be sent from a supplier to its buyer. All information to parties and auditors may be communicated in other ways. As an example, I see no problem with parties arranging a system where they contract for the supply of goods, store the contract electronically (not scanned, but “truly electronically”), the buyer scans goods when they are delivered, the scanning process identifies the goods to the correct contract and triggers payment of the contracted amount and the system at the same time produces the documentation required by legislation on auditing, taxation etc.
There are few formal requirements and great liberty for parties to contract in a way that supports their business. Law is usually not an obstacle for parties who wish to arrange their business efficiently. More often the real obstacle is the belief that law is an obstacle.