What is a contract?

Let's have a go at a definition.

A contract is a written record of an agreement between two or more parties, specifying what each side should do in order to fulfil the terms of the agreement and normally containing some clauses to deal with contingencies and stating how conflicts will be resolved. This might be through the exercise of penalty or through conciliation at a named court or arbitration body.

Will that do?

Assuming that it is acceptable as a basic definition, how do business people around the world see contracts? What are their attitudes to them? At a seminar held a few years ago, a former colleague of mine asked a large multicultural group of managers the simple question that is the title of this article. An American manager raised his hand and offered his definition: "It's my bible: I take it everywhere I go". A colleague from Italy expressed his horror: "For me, a contract is a prison!" Finally, a Dutchman contributed to the discussion: "It's an insurance policy. I hope I don't need it, but it's there in case things go wrong".

In all these cases, there is an implicit assumption about the nature of a contract: it is something that regulates; it stops one or other side going too far in any given direction. It constrains movement. It defines the outer limits of the relationship (perhaps that's why the Italian doesn't like it!); in effect, it says "thus far and no further". The contract is the skin of the relationship.

Asian attitudes to contracts are different. In terms of importance to the business process, let's compare the size of the documents: typically, what would be a twenty-page tome in Europe or North America ends up as a three-pager in an agreement between two Japanese companies. Penalty clauses are replaced by statements like: "Any conflict will be resolved with sincerity". In China, the underlying infrastructure is missing in large part: there are few safeguards for companies, especially foreign companies, when agreements go wrong; the legal system is less developed, the rule of law more arbitrary and the courts offer little hope for any speedy resolution. In Korea, we are reminded in this context of the well-known story of the hoejang (chairman) of one of the major chaebol (conglomerates). In front of television cameras, there to witness the signing of a joint venture contract with an American company, he simply ripped up his newly-signed copy, stating that "we do not need this document in order to keep our part of the bargain; we trust our new partners".

Also, the fact of writing such agreements down is typically seen in Asia as the equivalent of the minutes of a meeting; in other words, a particular agreement on particular terms at a particular moment in time between particular people. Change any one of these variables and the agreement is no longer so valid. Markets may change dramatically; people may move on (less likely in Asian companies until quite recently). Ultimately, if things change, so can the terms of the agreement. Anyway, it may be that both parties intend to develop their business together. In that light, the contract is just the starting-point, the skeleton on which to continue building. It constrains no-one. As long as there is the trust.

And perhaps trust is the key. If you trust your partner completely, why bother with a contract? Or at least why bother with a long and complicated one? In general, these looser attitudes to contract are normally to be found in so-called "shame-cultures" like those in East Asia; and this suggests that the loss of face involved in litigation through public courts is a serious deterrent. The corollary of this looseness is that for any kind of complex deal to take place there needs to be trust before trade can be done. Looking at that from the other side, it means you can't do business with strangers. This explains why I was so apparently unsuccessful as a young salesman in Japan in the 80's, when I expected to be able to go in for a first meeting and walk out with an order. Once finally we were trusted as an organisation, then the business came very thick and very fast. They wouldn't do much more than put the odd toe in the water until they were sure we were planning to stick around. "We wouldn't dream of doing business with people we didn't know" seems to sum up the approach.

Unfortunately, there are numerous famous stories about Asian companies seeking to re-negotiate deals with Western companies when circumstances (normally world commodity markets) turn violently against them: several decades ago, a Japanese importer of sugar, working on a ten-year deal with an Australian supplier, were horrified when the world price of sugar plummeted, whilst they were on a fixed price contract for at least half of the ten years. Naturally, the Australians felt that they had in all sincerity and after hard bargaining secured the fixed price and that it was tough luck on the Japanese and good negotiating on their part: caveat emptor. The Japanese appealed to the spirit of the business relationship and sought to re-negotiate. That was when they discovered that the Australians were not their "friends" and did not see that as a pre-requisite for doing business. As Tom Hanks said so memorably in the movie "You've got mail", "Business is not personal"1. A long way from the Asian stance of "Everything is re-negotiable between friends".

This Australian example is reminiscent of a value commonly adhered to in Northern Europe and North America: "I won't bother to get to know you personally unless there is a good business reason for doing so". Business before personal. We might argue that cultures that adhere strongly to the rule of law and to contracts, like the USA and the UK, are in fact in a better position to grow their business if they don't have to invest time in relationship-building. They can do business with strangers. Indeed, it was common knowledge that one of the major department store companies in the UK, now going through hard times, had a policy of moving buyers around from section to section precisely to avoid the development of relationships with their suppliers.

How can we reconcile the two views? Perhaps we can't. But the instinct to trade makes all things possible. Of course, deals between Asian and western companies are conducted through the medium of contracts. There are teams of lawyers at work. What does happen when things go wrong?

Let's go back to the Dutch manager's view of contracts: a contract is an insurance policy. In the event of default, will Western companies in fact seek immediate resort to the courts? No, they probably won't. Firstly, if the relationship is good, there will be no sudden surprises, and forewarning will take place; most likely they will seek to discuss the matter with their business partner and see what can be done. If they took a long view, they might realistically be prepared to make concessions if they truly believed that the partner could be an excellent supplier/customer well into the future, The present difficulties should be seen in proper perspective. So, using the "insurance policy" analogy, no claims are made. And we come back to an earlier question: if in fact we are probably going to re-negotiate in the event of default, why bother with a contract in the first place? Or at least, why spend so much time and money on a document, the real value of which is questionable. Perhaps we in the West do it because the bank manager insists on it!

Bill Reed
Managing Partner, EAB

What do you think? Send us your experiences and views on the subject of contracts and the differing perceptions of them amongst business cultures around the world. We'll post a summary of the responses next month.

1 By the end of the movie, he discovered that in fact it is.