Also known as “side letters” or “secret agreements,” are additional agreements made by parties involved in a transaction that are not disclosed or included in the main or formal contract. These side agreements can modify, add, or negate terms and conditions of the main contract, and they are often kept confidential or shared only among a select few involved in the transaction. These agreements can be verbal or in writing.
Here’s a detailed explanation of side agreements with an example:
Example of Side Agreements:
Imagine you run a company called Amir Furniture Manufacturing, and you’re selling a large quantity of furniture to a retail chain, Ali Furniture Emporium.
Main Contract:
- The main contract states that Amir Furniture Manufacturing will sell 1,000 pieces of furniture to Ali Furniture Emporium at $100 per piece, totaling $100,000.
- The payment is due within 30 days of delivery.
Side Agreement:
- However, to make the deal more appealing, you have a side agreement with Ali Furniture Emporium’s purchasing manager, John.
- In this side agreement, you promise a 20% discount on the total invoice if they pay within 15 days instead of the standard 30 days. This offer is not mentioned in the main contract and is only known to you and John.
Outcome:
- Ali Furniture Emporium agrees to the main contract, but the real motivation is the undisclosed side agreement.
- When the transaction is completed, Ali Furniture Emporium pays within 15 days and receives a $20,000 discount (20% of $100,000), paying only $80,000 for the furniture.
In this example, the side agreement altered the payment terms in a way that benefited Ali Furniture Emporium without the knowledge of other parties involved. It was a verbal agreement between Amir Furniture Manufacturing and John, which wasn’t disclosed in the main contract.
Importance and Implications:
- Side agreements can create an unfair advantage or benefit for one party over another, potentially impacting the negotiation process and the overall fairness of the deal.
- They can lead to disputes or legal issues if the undisclosed terms conflict with the main contract or if one party feels deceived or disadvantaged.
Regulatory bodies and auditors may view undisclosed side agreements as unethical or fraudulent, affecting the company’s reputation and legal standing.
Auditing for dummies — Maire Loughran
