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Informal vs. Formal Contracts: Examples, Differences & Definitions

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  • 0:05 Formal Contracts
  • 2:08 Informal Contracts
  • 3:52 Lesson Summary
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Instructor: Kat Kadian-Baumeyer

Kat has a Master of Science in Organizational Leadership and Management and teaches Business courses.

The distinct difference between a formal contract and an informal contract is its enforceability in a court. An enforceable contract is one that contains certain elements, like offer, acceptance, and consideration, and is in written form. An informal contract does not contain the same elements and can be oral.

Formal Contracts

After a day's worth of hardball negotiations over the sale of a high-rise condo, Jen and Aldo finally reached a price. Jen offered Aldo $200,000 for the classy condo and Aldo accepted the offer.

Quick to the typewriter, Aldo typed up a written agreement, including:

  • Jen's offer of $200,000
  • Aldo's acceptance of the offer
  • The collection of Jen's $200,000, also known as consideration
  • The actual description, including lot, block, city, state, and anything included in the sale
  • Date and signature lines, and
  • Transfer of the title, changing owners from Aldo to Jen

Both Jen and Aldo were, of course, of sound mind (meaning both parties were free of mitigating factors like mental illness or intoxication), and the contract contained terms that were lawful. What they had was a formal contract, which is legally binding and enforceable. If Jen changed her mind and decided not to pay for the condo, Aldo would have a strong breach of contract case against her for failing to take action on the promises of a contract.

The elements of a legally binding contract include an offer, like the price Jen was willing to pay for the condo and acceptance of the offer when Aldo agreed to the price. Once this occurs, there must be consideration. Consideration is the exchange of something of value. In this case, that was $200,000. Both parties must be of sound mind, and the terms of the contract must not violate any laws.

The last and most important element of a formal contract is in the recording of the contract. The sale is officially recorded by the change in title indicating the new owner's name.

A typical formal real estate contract may look like this. Another type of contract is a marriage license. When two lovebirds make a legal commitment, the marriage license is registered with the court. Not every contract requires such legal mumbo-jumbo. Some contracts are as simple as giving one's word and a handshake. Let's explore a few.

Informal Contracts

An informal contract, sometimes called a parol contract, is one that does not require a record and does not have to be signed, like ordering pork-fried rice at your favorite Chinese delivery restaurant. To elaborate, when you pick up the phone and call your order in and the order-taker at the other end agrees to accept the order, what you are really doing is entering into an oral agreement.

The terms are simple. You want Chinese food in exchange for payment. There is a mutual trust that both parties will perform as promised in the oral agreement. When the doorbell rings, you pay for the food, check the order and then you and the delivery guy part ways, contract promises satisfied.

Now, it is important to note that while you probably won't find yourself in breach of contract if you fail to answer the door for your pork-fried rice, placing an order is still an informal agreement between two parties. It's just that easy!

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