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Updated on Jun 18, 2024
Reading time 4 minutes

Implicit contract

An implicit contract is an unwritten, unspoken agreement between parties based on mutual understanding, expectations, and trust rather than formal documentation.
Written by
Reviewed by
Updated on Jun 18, 2024
Reading time 4 minutes

3 key takeaways

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  • Implicit contracts are informal agreements based on mutual expectations and trust.
  • They play a significant role in employment relationships and long-term business dealings.
  • These contracts rely heavily on the good faith and reliability of the involved parties.

What is an implicit contract

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An implicit contract is an agreement between parties that is not formally documented but is understood through actions, behaviors, and established norms. These contracts are formed based on the expectations and trust that both parties will fulfill their obligations, even in the absence of a written or verbal agreement. Implicit contracts often arise in situations where formal agreements are impractical or unnecessary, relying on the history of the relationship and the conduct of the parties involved.

Importance of implicit contracts

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Implicit contracts are important for several reasons:

  • Flexibility: They allow for adaptable and flexible agreements that can evolve with changing circumstances without the need for formal renegotiation.
  • Trust and Cooperation: They foster a high level of trust and cooperation between parties, essential for long-term relationships.
  • Efficiency: They reduce the need for constant formal agreements and documentation, saving time and resources.

How implicit contracts work

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Implicit contracts operate based on the established norms, behaviors, and expectations of the involved parties:

  • Employment Relationships: In many workplaces, implicit contracts exist where employees expect job security and steady wages in exchange for their loyalty and consistent performance. This understanding, although not formally written, guides the employer-employee relationship.
  • Long-Term Business Relationships: Businesses that have worked together for a long time often operate under implicit contracts. For instance, a supplier may provide goods on credit based on the implicit understanding that the buyer will pay within a reasonable time frame, even if no formal agreement outlines the terms.
  • Social Norms and Customs: In many cultures, social norms and customs act as implicit contracts. For example, tipping in restaurants is an implicit contract where customers understand that servers expect a gratuity for their service, even though it is not mandated by law.

Example of implicit contracts

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A common example of an implicit contract is in the employer-employee relationship. Suppose an employee consistently receives a bonus at the end of each year despite no formal agreement stating this. The employee might expect this bonus as part of their compensation, and the employer, recognizing the employee’s expectation, continues to provide it.

Another example is a landlord allowing a tenant to stay in a property on a month-to-month basis after a lease has expired. Although there may not be a new formal lease, the continued payment and acceptance of rent imply an understanding that the rental relationship continues.

Real world application

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Implicit contracts are prevalent in various aspects of business and personal interactions:

  • Customer Service: Businesses often have implicit contracts with their customers regarding the level of service and product quality. For example, a restaurant implicitly agrees to provide a certain standard of food and service in exchange for the customer’s patronage.
  • Professional Relationships: In professional settings, implicit contracts can govern expectations about work hours, performance standards, and professional conduct. These are often based on industry norms and the specific culture of the organization.
  • Economic Transactions: In economic theory, implicit contracts explain phenomena like wage rigidity and employment stability, where businesses and employees develop mutual expectations that influence their behavior, even without formal contracts.

Implicit contracts, while not legally binding in the same way as explicit contracts, play a crucial role in fostering trust, cooperation, and stability in both professional and personal relationships. Understanding and managing these unspoken agreements can significantly impact the success and sustainability of long-term interactions.


Sources & references

Arti

Arti

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Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000 Invezz related data points, has read every piece of research, news and guidance we\'ve ever produced, and is trained to never make up new...