Contract law Vocabulary

contract law vocab

While negotiating a contract, we come across several legal terms, many of which have a different meaning than we have known. The legal meaning of some of the most common terms which frequently come across in contract negotiation is given below. Please remember, these are not technical definitions. Rather, these are a general description of the sense of the various terms.

ADR– this is short for alternative dispute resolution, or ways to resolve disputes outside of the courtroom. The term typically encompasses negotiation, mediation and arbitration.

Arbitration– is a well-established and widely used means to end disputes. It is one of several kinds of Alternative Dispute Resolution, which provide parties to a controversy with a choice other than litigation. Unlike litigation, arbitration takes place out of court: the two sides select an impartial third party, known as an arbitrator; agree in advance to comply with the arbitrator’s award; and then participate in a hearing at which both sides can present evidence and testimony. The arbitrator’s decision is usually final, and courts rarely reexamine it.

Assignment– the transfer of rights or duties by the assignor to the assignee. This may occur only by agreement or by operation of law, for example, when someone dies or when a company is bankrupt.

Battle of the Forms– a common business situation where business parties establish their relationship by sending standardized forms to each other. Often, the terms of the forms do not agree, and it can be difficult to tell if the parties have concluded a contract, and if so, what the terms of that contract are.

Boilerplate- the clauses, generally appearing at the end of a contract, which are used to settle general matters such as choice of law, notice procedures, amendment procedures, interpretation issues, dispute resolution mechanisms and the like. The term also has a more general definition meaning any standardized or preprinted form for agreements. The term is also used to talking about the ‘small print’. For example, the small print after a TV commercial about a product or contest which list all the various restrictions.

Choice of Law or Governing  law- often, the parties to a contract will specify which rules of law should be used to resolve any dispute between them. Particularly in international transactions, the choice of law can be a significant point of negotiation among lawyers. Choice of law (what legal principles will be used to resolve the dispute) should be distinguished from the choice of forum (where the dispute should be resolved) and choice of dispute resolution method (litigation or some form of ADR).

Common Law- this term, when contrasted with Civil Law, refers to legal systems which have their origin in the British legal system. The legal system of Commonwealth countries and the United States is from the common law tradition. It may also refer to the method of analysis that a court uses to interpret a statute, regulation or other rule of law, and may include the concept of precedent.

Conciliation– is a method of Alternative Dispute Resolution for amicable resolution of a dispute. A method of ADR whereby a third party, who is usually neutral, meets with the parties and assists them to find a way to settle their dispute.

Condition Precedent– an event that must happen before a contract or a contractual obligation goes into effect.

Condition Subsequent- a happening which terminates the duty of a party to perform or do his/her part.

Consideration- a common law concept which requires (in essence) that a promise be part of an exchange to be enforceable as a contract.

Contracts of Adhesion- standardized contracts, usually presented on a take-it-or-leave-it basis, to parties of unequal bargaining strength.

Covenant- this term used in a contract means a promise which, if not carries out, will carry legal consequences. Often, covenants are divided into Affirmative Covenants (the things the promisor agrees to do) and Negative Covenants (the things the promisor agrees not to do).

Cure Periods- often, when a Default occurs under a contract, the obligor may have a certain period of time to cure the Default before the obligee is allowed to exercise Remedies. Sometimes the obligee is required to give notice before the time begins to run (in which case lawyers will speak of “Notice and Cure Periods”). Notice and Cure Periods are sometimes more casually referred to as “grace periods”.

Default- the circumstances where an obligor under a contract is considered to be in breach of the contract. Informal written contracts, Defaults often include failure of a Representation or Warranty to be true when made, failure to perform any Affirmative or Negative Covenant, insolvency or bankruptcy, as well as other enumerated situations tailored to the specific circumstances.

Delay– occurs when one party does not meet the agreed timelines. If there is no clause regarding delay and “time is of the essence” of the contract, then the parties must perform the contract in a reasonable time.

Direct loss- is a loss which arises naturally and directly from the breach of contract or negligence. Losses will be treated, by the courts, as direct losses if they were reasonably foreseeable by the parties as being a likely consequence of a breach at the time that the contract was entered into.

Entire Agreement– is a clause which attempts to limit the contract to the written document as opposed to the series of events taking place before and during the contract term which may alter the nature and terms of the contract.

Equity- this term, which is often used to mean fairness, also has a more technical legal meaning. It used to be that the Common Law system was rather rigid, and in order to obtain relief, a litigant had to fit into a limited class of situations. Sometimes, this rigidity produced results that seemed very unfair. Eventually, the second type of court was created to hear those cases – those where there was “no remedy at law” but “equity” demanded a remedy. In most jurisdictions, the separate court systems, consisting of “Courts of Equity” have been abolished, but in many areas the distinction between cases sounding in “law” and those sounding in “equity” persist. In other contexts, “equity” refers to the amount by which a property’s value exceeds the debt (or Liens) against it. The legal concept of equity in this sense is not known to the civil law (Romano-Germanic) system and can cause problems. For example, in a US or UK contract, “” equitable remedies” does not mean “fair, reasonable, and just” but refers to remedies applied under the common law concept of equity. In practice, this means remedies other than plain compensation-e.g., a court order for specific performance of the contract, or an injunction.

Estoppel– an equitable concept that prevents a party from raising an argument when the party has acted unfairly, fraudulently, or otherwise inappropriately.

Events of Default– when a Default remains uncured under any applicable Notice or Cure Period, contracts typically provide that an Event of Default has occurred. Once an Event of Default has occurred, the obligee may generally pursue Remedies.

Excuse or Waiver- something that forgives performance and bars enforcement of the contract. If the performance of a contractual obligation is excused, this relieves the nonperforming party of liability.

Exclusion– is intended to limit the liability or risk of a party to the contract in negligence and contract.

Execution- (1) signing; the parties execute the contract by signing it; (2) performance; the parties may execute a contract by carrying out their obligations and duties; (3) enforcement of a judgment, order or writ (execution of judgment); (4) in criminal law, carrying out a death sentence. This word is a good example of polysemy- words with multiple meanings – in legal language.

Force Majeure– an “act of God” which prevents one party from performing the obligations owing under a contract. Commonly such things as war, riots, earthquakes, floods, strikes and the like are included.

Frustration or Impracticability– A legal doctrine closely related to Force Majeure. If some unanticipated event makes the performance of the contract unusually burdensome, some legal systems will allow a party to be excused from the contract under the doctrine of impracticability. Different legal systems have varied requirements for invoking this doctrine.

Guarantee– is a collateral promise to answer for the debt or obligation of another. A guarantee is a secondary obligation, becoming operative only where the principal debtor is in default; because it is a secondary obligation, should the primary obligation be unlawful or invalid or unenforceable, the guarantor or surety cannot be compelled to make payment under the guarantee. A guarantee should be distinguished from an indemnity, which is a primary obligation to compensate for the loss of another; in the latter case, the unenforceability of the principal debt will not render the indemnity unenforceable.

Indemnity– an agreement in which one party agrees to reimburse another party if it is held liable. And indemnity is in the nature of a guarantee, but typically is used when the party offering indemnity has some interest in, involvement with, or control over the events leading to liability. Indemnity clauses are often found in commercial contracts and may be coupled with “hold harmless” provisions. In a “hold harmless” provision, the first party says that they will not hold the second party responsible for certain actions, even if the first party might otherwise have the right to do so under applicable law.

Independent Contractor– this term is usually used to contrast with “agent” or “employee”. The basic idea is that an independent contractor is free to do only that work that it contracts to do, in the way it contracts to do it. In contrast, an agent or an employee is subject to the discretion or control of the party for whom they are working. The chief importance of the concept is in the context of vicarious liability- a person is generally not responsible for the misdeeds of its independent contractor, while it may be liable for the misdeeds of its agents or employees.

Intellectual Property-  is a right given by law to a person in connection with intellectual, industrial or artistic work. Intellectual property includes, among other things, patents (inventions), designs (graphics), trademarks (names or marks used to identify goods) and copyrights (right of authorship), Due to the information revolution, the nature and extent of information which is protected as intellectual property is a rapidly changing field.

Limitation of Liability– clause regulates liability that arises from a breach of contract or negligence in performing the contract. Common exclusions are all types of economic loss and indirect or consequential loss. In effect, the clause acts as an instruction to the arbitrator/court regarding the award of damages. Therefore, where a breach of contract leads to a direct loss which is permissible under the limitation of liability clause, the arbitrator/court may award damages accordingly.

Negligence-is the omission to do something which a reasonable man would do, or doing something which a prudent and reasonable man would not do. To sustain a claim in negligence, a claimant must show that (i) he was owed a duty of care by the defendant; (ii) the defendant was in breach of the duty of care; and (iii) the breach was the cause of the claimant’s loss or injury.

Novation- An agreement between parties to a contract to substitute a new contract for the old one. It extinguishes (cancels) the old agreement. A novation is often used when the parties find that payments or performance cannot be made under the terms of the original agreement, or the debtor will be forced to default or go into bankruptcy unless the debt is restructured.

Joint Venture- a very broad term used in many different contexts. In its general sense, it means more than one person getting together for the purpose of making a profit in a speculative enterprise. In this regard, it is very similar to a consortium or partnership, but it tends to be used for limited undertakings. Often, in reference to profitable activities done in cooperation with foreign governments or foreign companies.

Letter of Credit- a financing device whereby a bank, at the request of a customer, agrees to pay a beneficiary upon satisfaction of certain conditions. Typically, the conditions are limited to the presentation of specified documents. The bank makes the agreement as a service to its customer and will seek reimbursement from its customer if is required to make payment under the terms of the Letter of Credit.

License– this term has many meanings, depending on the context. Its general sense is permission to use the property of the licensor. It is often used in the context of Intellectual Property to mean the agreement by which the owner of the Intellectual Property gives someone else permission to use it, typically for a royalty or a fee. The license agreement is often used to transfer technology from one party to another. Absent the License, the licensee’s use of the Intellectual Property would be against the law. The term is also used in completely different contexts. For instance, a movie theatre ticket is often characterized legally as a “License”.

Lien- a creditor has a Lien on a piece of property owned by a debtor when the creditor has a contingent claim to that property. Sometimes, the debtor voluntarily gives the creditor a Lien as a form of security for payment; other times the creditor receives the Lien by operation of law. Usually, non-payment of the debt, or an Event of Default under any contract creating the debt, allows the creditor to Foreclose on the Lien.

Liquidated Damages-  when parties to a contract settle in advance the amount of damages which will be available should one party fail to perform. Liquidated damages clauses are generally subject to close scrutiny by Courts.

Partnership (including General Partnership and Limited Liability Partnership)- a voluntary (unincorporated) association of two or more persons for the purpose of making a profit. In a general partnership, all of the partners are personally liable for the debts of the partnership and have a management role. In a limited partnership, general partners exist alongside limited partners. General partners are personally liable and have a management role; limited partners are not personally liable and do not have a management role. Partnership as a concept is not known or recognized in all legal systems.

Recitals- in a formal written contract, the clauses, usually in the beginning, that explain who the parties are, and their purposes for entering into the contract (i.e., background). Sometimes called “Preamble”.

Remedies- the actions that can be taken upon an Event of Default. Sometimes an aggrieved party can take action on its own. Other times, the term “remedies” is used to describe the court procedures and decisions that are available to help an aggrieved party.

Representations and Warranties- statements made by a party in a contract which, if untrue, carry legal consequences. Sometimes representations and warranties need not be explicitly stated by the parties, but instead are implied by law.

Rescission- cancellation of a contract by mutual agreement of the parties prior to its performance.

Risk of Loss- who bears the risk if the goods covered by a contract are damaged or destroyed. Risk of loss is particularly important when goods are being transported long distances between the seller and the buyer. If the seller bears the risk of loss during carriage, and the goods are destroyed in transit, the seller has a responsibility to provide substitute goods. If the buyer bears the risk of loss, the buyer generally must pay for the goods, even though they never arrive. Often parties cover the risk of loss with insurance so the ultimate loss may rest with an insurance company.

Secured Transaction- a voluntary transaction in which a debtor gives a creditor a Lien on its property to secure payment or performance of an obligation.

Security- this particularly confusing term is used in at least two very different contexts. First, it is used to refer to property that is subject to a Lien. The property is “security” for the debt secured by the Lien. A more precise term for this concept would be “collateral”. “Security” is also used in the context of investment securities-such as stocks, bonds, and other evidence of ownership or indebtedness which are regularly traded.

Severability or Blue Pencil Rule- the characteristic of a contract that allows for removal of duties or portions that are incorrectly or illegally drawn up. The parties may agree that incorrect, impractical, or illegal portions be severed from the agreement and replaced by language that best reflects the intent of the parties and comes closest to the business objective of those severed portions. Severance allows the remainder of the contract to be valid and enforceable.

Specific Performance– a court orders specific performance when it requires a party to carry out its obligation, rather than merely paying damages. Specific performance is an extraordinary and discretionary remedy, that is to say not usually available under the law and can only be granted by Civil Courts.

Tender-is a bid or formal offer. A proposal of terms is extended generally (‘put out for tender’ or ‘competitive bidding’), inviting prospective parties to respond by making a bid or tender. Do not confuse with legal tender, which is money.

Termination or Cancellation– of a contract signifies the process whereby an end is put to whatever remains to be performed thereunder. It sets out a procedure for notifying of a terminable fault and/or terminating the contract.

Unconscionability–  a U.S. concept which has its roots in Equity, and which allows a court to refuse to enforce a contract or a portion of a  contract which it considers to be particularly unfair.

Void- is absolutely null, empty, having no legal force, and incapable of being ratified. In contracts, it refers to an attempt at the formation of a contract which is equivalent to no contract at all.

Voidable- is capable of being voided, or later annulled. If a contract is formed but voidable, it may either by ratified or confirmed by conduct or else it may be voided by one of the parties once ratified, the promise is enforceable. If it is voided, it is unenforceable.

Waiver or Excuse – something that forgives performance and bars enforcement of the contract. If the performance of a contractual obligation is excused, this relieves the nonperforming party of liability.

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Indemnity & Guarantee-Distinction

Indemnity

Contract of Indemnity

A contract of indemnity is a contract by which one party promises to save the other from loss caused to him by the conduct of the promisor or any other person.

Contract of Indemnity is defined in Sec. 124 of Indian Contract Act, 1872 as “A contract, by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person, is called a “contract of indemnity.”

A promise to be primarily and independently liable for another person’s conduct may amount to a contract of indemnity. In a contract of indemnity, the promisor makes himself primarily liable and undertakes to discharge the liability in any event; the liability may arise out of tort or contract; it may also be prospective or retrospective when the promise is made provided some new consideration is given.

Contract of Guarantee

A Guarantee, in simple terms, is a promise to pay if someone else fails in his obligations. A contract of guarantee is a contract between the surety and the creditor to perform the promise or discharge the liability of the principal debtor, in case of default by the principal debtor.

Contract of Guarantee is defined in Sec. 126 of the Indian Contract Act, 1872 as “a contract to perform the promise, or discharge the liability, of a third person in case of his default.  The person who gives the guarantee is called the “surety”; the person in respect of whose default the guarantee is given is called the “principal debtor”, and the person to whom the guarantee is given is called the “creditor”.  A guarantee may be either oral or written.”

In a contract of guarantee, there must always be three parties in contemplation: a principal-debtor (whose liability may be actual or prospective), a creditor, and a third party who in consideration of some act or promise on the part of the creditor, promises to discharge the debtor’s liability, if the debtor failed to do so.

It is not necessary that there must be a simultaneous tripartite contract between all the three parties, that is, the principal debtor, the creditor and the guarantor; once a contract between the principal debtor and the creditor is formed, a contract between the surety and the creditor whereby the surety guarantees the debt, can also take place; and the consideration, therefore, may move either from the creditor or the principal-debtor or both.

A contract of guarantee may be wholly written, may be wholly oral, or may be partly written and partly oral.

Distinction between Contract of Guarantee and Contract of Indemnity

A contract of indemnity is bilateral, that is it involves two parties, the promisor and promisee. A contract of guarantee involves three parties, the creditor, the surety and the principal debtor; and it involves a contract to which those parties are privy.  The contract need not be embodied in a single document, but there must be a contract or contracts to which the three parties are privy. There must be a contract first of all, between the principal debtor and the creditor.  Then there must be a contract between the surety and creditor, by which the surety guarantees the debt; and the consideration for that contract may move either from the creditor or from the principal-debtor or both.  But if those are the only contracts, then it is a contract of indemnity. In order to constitute a contract of guarantee, there must be a third contract, by which the principal-debtor expressly or impliedly requests the surety to act as surety.  Unless that element is present, it is impossible to work out the rights and liabilities of the surety under the Contract Act.  In order to imply a promise by the principal-debtor to indemnity the surety, it is necessary that the principal-debtor is privy to the contract of suretyship.

In the case of guarantee, there is an existing debt or duty the performance of which is guaranteed by surety – In indemnity, the possibility of risk of any loss happening is only contingent against the indemnifier.

Unlike the case of a contract of guarantee, there is no direct right of action on the original contract to the person who indemnifies against the person whose conduct has caused loss – He can sue only in the name of the promisee.

Under a contract of indemnity, liability arises from loss caused to the promisee by the conduct of the promisor himself or by the conduct of another person. A contract of guarantee requires the concurrence of three persons-the principal debtor, the surety and the creditor–the surety undertaking an obligation at the request express or implied of the principal debtor. The obligation of the surety depends substantially on the principal debtor’s default.

Indemnity Guarantee
1. There are two parties to the contract viz. Indemnifier (Promisor) and the Indemnified (Promisee). There are three parties to the viz. the creditor, Principal Debtor and the Surety.
2. Liability of the Indemnifier to the Indemnified is primary and independent. Liability of the Surety to the Creditor is collateral or secondary, the primary liability being that of the Principal Debtor.
3. There is only one contract in case of a Contract of Indemnity, i.e., between the Indemnifier and the Indemnified. In a contract of guarantee there are three contracts, between principal Debtor and Creditor; between Creditor and the Surety and between Surety and Principal Debtor.
4. The Indemnifier promises to compensate for the losses suffered by the Indemnified The surety gives assurance to the Creditor to discharge the liability of the Principal Debtor
5. The liability of the Indemnifier arises only on the happening of a contingency. There is usually an existing debt or duty, the performance of which is guaranteed by the Surety.
6. An Indemnifier cannot sue a third party for loss in his own name because there is no privity of contract. He can do so only if there is an assignment in his favour. A Surety, on discharging the debt due by the Principal Debtor, steps into the shoes of the Creditor. He can proceed against the Principal Debtor in his own right

 

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Joint Ventures-Explained

joint-venture-1 What is a Joint Venture?

Joint Ventures are internationally recognised as a form of cooperation in the joint fulfilment of the construction contract obligations. Joint venture undertakings come about through agreements for a combination of legally independent entities for the joint rendering of works or services limited in both time and content. Typically, they are restricted to a single project in which case the members of the group act jointly from the initial stages to the completion of the project. Joint ventures, which are also called joint adventure or joint enterprise, are generally unincorporated associations.

According to Words and Phrases, Permanent Edn., a joint venture is an association of two or more persons to carry out a single business enterprise for profit. A joint venture can take the form of a corporation wherein two or more persons or companies may join together.

In Black’s Law Dictionary, 10th Edn., page  417, a ‘joint venture’ is defined as a business undertaking by two or more persons engaged in a single defined project and a ‘joint venture corporation’ has been defined as a corporation that has joined with other individuals or corporations to accomplish some specified project.

In New Horizons Limited v. Union of India, the Supreme Court of India explained the concept of a joint venture as under. “The expression ‘joint venture’ is more frequently used in the United States. It connotes a legal entity in the nature of a partnership engaged in the joint undertaking of a particular transaction for mutual profit or an association of persons or companies jointly undertaking some commercial enterprise wherein all contribute assets and share risks. It requires a community of interest in the performance of the subject-matter, a right to direct and govern the policy in connection therewith, and duty, which may be altered by agreement, to share both in profit and losses.”

Essentials of a Joint Venture

To constitute a ‘joint venture’ certain factors are essential:

  1. Each party to the venture must make a contribution, not necessarily of capital, but by way of services, skill, knowledge, material or money;
  2. Joint property interests in the subject matter of the venture;
  3. Expectation of profits to be shared among the parties;
  4. There must be a joint proprietary interest and right of mutual control over the subject matter of the enterprise;
  5. Usually, there is a single business transaction rather than, a general or continuous transaction.

According to Black’s Law Dictionary, the essential elements of a Joint Venture are:-

  1. An express or implied agreement;
  2. A common purpose that a group intends to carry out;
  3. Shared profits and losses; and
  4. Each member’s equal voice in controlling the project.

 What is the status of Joint Venture in law?

The legal systems, in general, have not kept pace with the growing economic means of joint venture groups and there is no special legal form for this type of cooperation which has come to stay in the commercial sector.

Harry G. Henn & John R. Alexander in Laws of Corporations (3rd Edition) has remarked that “There is some difficulty in determining when the legal relationship of Joint Venture exists, with authorities disagreeing as to the essential elements… The Joint Venture is not as much of an entity as is a partnership.”

 No law on the Statute book of India or the States defines a joint venture, though Section 8 of the Partnership Act, 1932 provides that ‘a person may become a partner with another person in particular adventures or undertakings’. In the case of such ‘particular partnership,’ it has its existence only till the purpose for which said partnership or adventure or undertaking came into being. It gets dissolved the moment the purpose for which the partners joined is accomplished and liabilities of persons joining in a particular partnership for the purpose of particular adventure would only last till such undertaking completes the purpose for which it is formed. Such particular partnerships are restricted to a single project in which the members of the group act jointly both at the initial stage and during the implementation of the project.

Being unincorporated associations, common law did not recognise the relationship of co-adventures, but with the passage of time, the judicial decisions recognised what is known as ‘joint venture’ of  two or more persons/ undertakings to combine their property or labour in conduct of particular line of trade or a general business for joint profits.

In Asia Foundations and Constructions Ltd. v. State, a Division Bench of Gujarat High Court considered the legal standing of a joint venture and rights and liabilities of joint partners. The Court discussed this aspect of the matter in the following manner: “The common law did not recognise the relationship of co-adventures, but with the passage of time, the judicial decisions recognised what is known as ‘joint adventure’ of two or more persons undertaking to combine their property or labour in conduct of particular line of trade or a general business for joint profits. The Courts do not treat a joint adventure as identical with a partnership though it is so similar in nature, and in the contractual relationship created by such adventurers that the rights as between them are governed practically by the same rules that govern the partnership. This relationship has been defined to be a special combination of persons undertaking jointly some specific adventure for profit without any actual partnership. It is also described as a commercial or a maritime enterprise undertaking by several persons jointly; a limited partnership not limited in the statutory sense as to the liabilities of partners but as to its scope and duration. Generally speaking, the distinction between a joint adventure and a partnership is that former relates to a single transaction though it may comprehend a business to be to be continued over several years, while the later relates to a joint business of a particular kind.”

It is generally understood that in order to constitute a joint venture, there must be a community of interest and right to joint control. It is recognised that each of the parties must have an equal voice in the matter of its performance and control over the agencies used therein, though one authority may entrust the performance to another. A joint venture may exist although the parties have unequal control of operations. The rights, duties and liabilities of joint ventures are similar or analogous to those which govern the corresponding rights, duties and liabilities of the partners. As in the case of partners, joint ventures may be jointly and severally liable to third parties for the debts of the venture.

Rights and liabilities of members in a Joint Venture

The services to be rendered by the group are to be allocated amongst the members of the same by an internal agreement, and consequently, the rights and duties of the members inter se are also regulated by this agreement. These internal agreements are not effective vis-a-vis third parties, and they operate amongst the members’ inter-se. Thus, all the members are jointly and severally liable for performance of the work jointly undertaken irrespective of internal division of the work. If one member of the joint venture group does not fulfil his commitments, the others are under joint and several obligations to carry out such obligations vis-a-vis the customer. Such a situation may arise when a member of a joint venture group drops out prematurely because of the liquidation or insolvency or any other legal reason. When a contract is concluded with a joint venture group all members are made jointly and severally liable even if only one is capable of rendering the service in question. The joint and several liabilities of the members of a joint venture group may cover the marginal areas of the contract performance such as late performance, faults, deficiency of goods and services etc.

Whether a party has a right to withdraw from Joint Venture and what is the effect of such withdrawal?

The right of a party to withdraw and the effect of such withdrawal upon the Joint venture depend upon the terms of the agreement and/or upon the circumstances. Generally, no co-venturer has a right to withdraw from or abandon it without the consent of other co-venturers, where the joint venture has not fulfilled its purpose. In the absence of a decree of a Court or on an agreement fixing the time of termination or voluntary abandonment of the enterprise by one of the co-venturers, the joint venture agreement remains in force until its purpose is accomplished or becomes impossible for fulfilment and while it is in force, ordinarily, one co- venturer has no right to withdraw himself from the arrangement. It is only where the joint venture agreement is silent about this duration or termination, that a co-venturer has right to withdraw since it is virtually a limited partnership at will. Even the abandonment of a joint venture by one of the participants and his active opposition to its operation by his co-venturers will not forfeit his interest in the enterprise or deprive him of his right to share in the profits.

 

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All about One Person Company

Contributed by: CS Priya Garg*

opc

The concept of One Person Company is a  new introduction to the Companies Act 2013 which allows any person to incorporate a company on its own with concessional/relaxed requirements under the Act.

Definition of One Person Company

As per Section 2(62) of the Companies Act, 2013 One Person Company ‘means a company which has only one person as a member’

Restrictions on One Person Company

  1. Only a natural person who is an Indian citizen and resident in India-
    1. shall be eligible to incorporate a One Person Company;
    2. shall be a nominee
  1. No person shall be eligible to incorporate more than a One Person Company or become the nominee in more than one such company.
  1. Where a natural person, being member in One Person Company becomes a member in another such Company, by virtue of his being a nominee in that One Person Company, such person shall meet the eligibility criteria specified in point (2) within a period of one hundred and eighty days, i.e., he/she shall withdraw his membership from either of the Company’s within one hundred and eighty days.
  1. No minor shall become member or nominee of the One Person Company or can hold share with beneficial interest
  1. A One Person Company cannot be incorporated or converted into a company with a non-profit and charitable object.
  1. Such Company cannot carry on Non-Banking Financial Investment activities including investment in securities of a body corporate.
  1. No such company can convert voluntarily into any kind of company unless two years have expired from the date of incorporation of One Person Company, except when the paid up share capital is increased beyond fifty lakh rupees or its annual turnover in the immediately preceding three consecutive financial years exceeds two crore rupees.

Requirements of incorporating a One Person Company

  • A shareholder and director of One Person Company shall have Director Identification Number (DIN) issued in his name.
  • A nominee who shall become the shareholder in case of death/incapacity of the original shareholder.

Steps to Incorporate One Person Company (OPC)

1.Obtain Digital Signature Certificate [DSC] for the proposed Director(s).

2.Obtain Director Identification Number [DIN] for the proposed director(s).

3.Apply for name approval in INC 1 with the word OPC in name

4.After name approval file for incorporation in INC 2/INC 7

Documents required to be attached in INC 2/INC 7

  • MOA and AOA
  • INC 8 INC 9
  • INC 3 should be attached as scanned document
  • DIR 2
  • PAN card Id proof and residential proof
  • Utility Bill and NOC for registered office address

All documents to be attached as per Companies Incorporation Rules 2014

Some Important Points

  • Authorised and subscribed capital should be same in One Person Company
  • In case the paid up share capital of an OPC exceeds fifty lakh rupees or its average annual turnover of immediately preceding three consecutive financial years exceeds two crore rupees, then the OPC has to mandatorily convert itself into a private or public company.
  • One Person Company cannot do the object of finance or investment related services
  • No person shall be eligible to incorporate more than a One Person Company or become the nominee in more than one such company.

Penalty

If One Person Company or any officer of such company contravenes the provisions of the rules, One Person Company or any officer of the One Person Company shall be punishable with fine which may extend to ten thousand rupees and with a further fine which may extend to one thousand rupees for every day after the first during which such contravention continues.

Now One Person Company can be formed in Simplified Form for Incorporating a Company (SPICe Form), where the name can be applied along with relevant documents.

_______________________

* Priya Garg is an Associate Company Secretary having 2 years of working experience and have in-depth knowledge of Companies Act 2013. She is presently doing law. She can be contacted at gargpreeya@gmail.com
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Novation of contract

novation

What is Novation of contract?

A contract can be discharged by the parties either by entering into a new contract in substitution of the old contract or by acceptance of performance of modified obligations in lieu of obligations stipulated in the contract.  The term novation implies that there being a contract in existence some new contract has been substituted for it between the same parties or between different parties; the consideration mutually being the discharge of the old contract.  Substitution of a new contract is the core of novation.

The principle of ‘Novation’ of contract is defined under Section 62 of the Indian Contract Act, 1872, which provides as under:

“If the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed.”

‘Novation’ is defined in Black’s Law Dictionary as:

“A type of substituted contract that has the effect of adding a party, obligor or obligee, who was not a party to the original duty.  Substitution of a new contract, debt or obligation for an existing one, between the same or different parties.”

Ordinarily, under the English law novation is brought about by the introduction of new parties, or alteration between the same parties by the introduction of new terms. It is not consistent with the original debtor remaining liable in any form on the terms of the old contract. The right against the original debtor on such contract must be extinguished and there must be a substitution of another contract for the original contract.

Once novation is complete, parties are bound by the new contract and not the earlier contract.  Breach of the subsequent contract will not revive the original contract.

Essential features of novation

One of the essential requirements of ‘Novation’ as contemplated by Section 62 of the Indian Contract Act is that there should be a complete substitution of a new contract in place of the old. It is in that situation that the original contract need not be performed. Substitution of a new contract in place of the old contract which would have the effect of rescinding or completely altering the terms of the original contract has to be by agreement between the parties. A substituted contract should rescind or alter or extinguish the previous contract. But if the terms of the two contracts are inconsistent and they cannot stand together, the subsequent contract cannot be said to be in novation of the earlier contract.

A novation requires in every case that the new contracting party has consented to assume liability for the contract and also that the person on whom the correlative right resides has agreed to accept the new party’s liability in substitution of the original liability.  A contract by novation requires it as an essential element that the rights against the original contractor shall be relinquished and the liability of the new contracting party accepted in their place.

If any novation is required to be done in a contract, it has to be done in the same manner as had been done for entering into a valid and concluded contract.  The substituted contract, therefore, must be a valid and enforceable contract to be effective after novation.  In order that the promisor may become liable to a third party, it would require the consent of the promisor, the promisee and the third party so that the original contract would be discharged and a new contract between the third party and the promisor would come into existence.

The pre-requisites of a novation are a previous valid obligation, an agreement of all the parties to a new contract, the extinguishment of the old obligations, and the validity of a new one.  The basic principle behind the concept of novation is the substitution of a contract by a new one only through the consent of the parties to the same.  Such consent may be expressed as in written agreements or implied through their action or conduct.

 

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Fast Track procedure for arbitration introduced by the Arbitration and Conciliation (Amendment) Act, 2015

arbitration-defined

Introduction

The Arbitration and Conciliation (Amendment) Act, 2015 which came into effect from 23rd October 2015 has brought about several significant changes to the existing arbitration law and has been hailed as a landmark step towards ease of doing business and speeding up the process of commercial dispute resolution. One of the most important and unique provisions brought about by this amendment is the fast track procedure for arbitration.

The Amendment Act has inserted Section 29B to the 1996 Act, to provide for fast track arbitration. The concept of fast track arbitration was introduced in order to expedite the arbitration process where the arbitration tribunal shall have to make an award within a period of 6 months from the date of reference of the dispute to the arbitration tribunal.  Further, it is also provided that the tribunal shall decide the dispute on the basis of written pleadings, documents and submissions filed by the parties without any oral hearing, unless the parties request for oral hearing or if the tribunal considers it necessary for clarifying the issues pertaining to the arbitration process.

Highlights of the Fast Track procedure for arbitration

  1. Fast track arbitration by agreement

The new section provides the parties to a dispute with an option to choose fast track procedure, even if they do not wish to subject their arbitration to any institutional rules. The parties can agree to fast-track procedure at the time of entering into arbitration agreement or at any stage either before or at the time of the appointment of the arbitral tribunal. It is also noteworthy that the enabling provision in Sec 26 of the amendment Act provides for fast track arbitration to be applied to the existing disputes if the parties mutually agree to apply this procedure.

  1. Sole arbitrator for fast track arbitration

The parties to a dispute, while agreeing to the resolution of a dispute by fast track procedure, may choose a sole arbitrator to act as an arbitration tribunal.

  1. Arbitration tribunal may decide on the basis of pleading, etc

The fast track arbitration procedure does away with the need for oral hearing since the dispute is settled on the basis of written pleadings, documents and submissions filed by the respective parties.  But the need of oral pleadings is not completely eradicated in fast-track proceedings since it may be held at the request of the parties or if it is considered necessary by the tribunal to clarify certain issues. It is completely at the discretion of the tribunal to dispense any further technical formalities and adopt any such procedure that is suitable for the expeditious disposal of the dispute.

  1. Arbitration award to be made within six months

It is provided that the arbitration award shall be made within six months from the date the arbitral tribunal enters upon the reference. In case, the tribunal fails to make an award within six months, the parties can exceed the time period mutually to an additional period of 6 months.  Further, if the award is not made within such extended time period, the mandate of the tribunal shall automatically terminate and any additional extension can only be granted by the court on sufficient cause being shown and on such terms and conditions as may be imposed.

  1. Arbitrator’s fees to be agreed by the parties

Though the amendment Act under Sec. 11(14) has prescribed the fees of arbitrators in the fourth Schedule, in the case of fast track arbitration, the fees and the manner of payment of fees shall be as agreed by the parties.

Fast Track Procedure in Institutional Arbitrations

Fast track procedures for dispute resolution were available in Institutional Arbitrations since long. These have been beneficial in cases where a minor dispute has cropped up or where parties don’t want the process to be very long. Rule 9A of the LCIA Arbitration Rules 2014 and Rule 5 of the SIAC Rules, 2016 provide for an expedited procedure of Arbitration in order to resolve the dispute.

In India also, arbitration institutions like Delhi International Arbitration Centre and the newly established Mumbai Centre for International Arbitration have incorporated provisions in their Rules that allow for parties to opt for fast track procedure.

Conclusion

The process of fast track arbitration is still new in India and needs to be actively practised to lessen the burden on the judicial system. By introduction of fast-track procedure in the Arbitration Act itself, fast track process has been granted statutory recognition and this will go a long way in legitimising and making fast track procedure an accepted mode of dispute resolution.

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Principle of ‘equal pay for equal work’- Judgment of Supreme Court of India in  State of Punjab vs Jagjit Singh

Commercial Court

The Supreme Court in a landmark judgment on the principle of equal pay for equal work, in the case of State of Punjab vs. Jagjit Singh, has held that temporary employees would be entitled to draw wages at the minimum of the pay scale ( at the lowest grade, in the regular pay scale), extended to regular employees, holding the same post. The Court held that the principle of ‘equal pay for equal work’ would be applicable to all the temporary employees, so as to vest in them the right to claim wages, at par with the minimum of the pay scale of regularly engaged Government employees, holding the same post.

Court has held that where duties, responsibilities and functions were shown to be similar, the principle of ‘equal pay for equal work’ would be applicable, even to temporary employees and has held that:

“…..it is fallacious to determine artificial parameters to deny fruits of labour. An employee engaged in the same work, cannot be paid less than another, who performs the same duties and responsibilities. Certainly not, in a welfare state. Such an action besides being demeaning strikes at the very foundation of human dignity. Anyone, who is compelled to work at a lesser wage, does not do so voluntarily. He does so, to provide food and shelter to his family, at the cost of his self-respect and dignity, at the cost of his self-worth, and at the cost of his integrity. For he knows, that his dependents would suffer immensely if he does not accept the lesser wage. Any act, of paying less wages, as compared to others similarly situate, constitutes an act of exploitative enslavement, emerging out of a domineering position. Undoubtedly, the action is oppressive, suppressive and coercive, as it compels involuntary subjugation.”

However, the Court pointed out that it is the responsibility of the employees to establish, that they were rendering similar duties and responsibilities, as were being discharged by regular employees, holding corresponding posts.

The Court further held that the principle of ‘equal pay for equal work’ constitutes a clear and unambiguous right and is vested in every employee, whether engaged on a regular or temporary basis. While discussing the issue, the Court referred to various case laws on the subject and has summarised the principles ‘equal pay for equal work’ as follows:

  1. The ‘onus of proof’, of parity in the duties and responsibilities of the subject post with the reference post, under the principle of ‘equal pay for equal work’, lies on the person who claims it. He who approaches the Court has to establish, that the subject post occupied by him, requires him to discharge equal work of equal value, as the reference post;
  2. The mere fact that the subject post occupied by the claimant is in a “different department” vis-a-vis the reference post, does not have any bearing on the determination of a claim, under the principle of ‘equal pay for equal work’. Persons discharging identical duties, cannot be treated differently, in the matter of their pay, merely because they belong to different departments of Government;
  3. The principle of ‘equal pay for equal work’, applies to cases of unequal scales of pay, based on no classification or irrational classification;
  4. For equal pay, the concerned employees with whom equation is sought should be performing work, which besides being functionally equal, should be of the same quality and sensitivity;
  5. Persons holding the same rank/designation (in different departments), but having dissimilar powers, duties and responsibilities, can be placed in different scales of pay, and cannot claim the benefit of the principle of ‘equal pay for equal work’.). Therefore, the principle would not be automatically invoked, merely because the subject and reference posts have the same nomenclature;
  6. In determining equality of functions and responsibilities, under the principle of ‘equal pay for equal work’, it is necessary to keep in mind, that the duties of the two posts should be of equal sensitivity, and also, qualitatively similar. Differentiation of pay-scales for posts with a difference in the degree of responsibility, reliability and confidentiality, would fall within the realm of valid classification, and therefore, pay differentiation would be legitimate. The nature of work of the subject post should be the same and not less onerous than the reference post. Even the volume of work should be the same. And so also, the level of responsibility. If these parameters are not met, parity cannot be claimed under the principle of ‘equal pay for equal work’;
  7. For placement in a regular pay-scale, the claimant has to be a regular appointee. The claimant should have been selected, on the basis of a regular process of recruitment. An employee appointed on a temporary basis, cannot claim to be placed in the regular pay;
  8. Persons performing the same or similar functions, duties and responsibilities, can also be placed in different pay-scales. Such as ‘selection grade’, in the same post. But this difference must emerge out of a legitimate foundation, such as merit, or seniority, or some other relevant criteria;
  9. If the qualifications for recruitment to the subject post vis-a-vis the reference post are different, it may be difficult to conclude, that the duties and responsibilities of the posts are qualitatively similar or comparable. In such a cause, the principle of ‘equal pay for equal work’, cannot be invoked;
  10. The reference post, with which parity is claimed, under the principle of ‘equal pay for equal work’, has to be at the same hierarchy in the service, as the subject post. Pay-scales of posts may be different, if the hierarchy of the posts in question, and their channels of promotion, are different. Even if the duties and responsibilities are same, parity would not be permissible, as against a superior post, such as a promotional post;
  11. A comparison between the subject post and the reference post, under the principle of ‘equal pay for equal work’, cannot be made, where the subject post and the reference post are in different establishments, having a different management. Or even, where the establishments are in different geographical locations, though owned by the same master. Persons engaged differently and being paid out of different funds, would not be entitled to pay parity;
  12. Different pay scales, in certain eventualities, would be permissible even for posts clubbed together at the same hierarchy in the cadre. As for instance, if the duties and responsibilities of one of the posts are more onerous, or are exposed to higher nature of operational work/risk, the principle of ‘equal pay for equal work’ would not be applicable. And also when, the reference post includes the responsibility to take crucial decisions, and that is not so for the subject post;
  13. The priority given to different types of posts, under the prevailing policies of the Government, can also be a relevant factor for placing different posts under different pay-scales. Herein also, the principle of ‘equal pay for equal work’ would not be applicable;
  14. The parity in pay, under the principle of ‘equal pay for equal work’, cannot be claimed, merely on the ground, that at an earlier point in time, the subject post and the reference post, were placed in the same pay-scale. The principle of ‘equal pay for equal work’ is applicable only when it is shown, that the incumbents of the subject post and the reference post, discharge similar duties and responsibilities;
  15. For parity in pay scales, under the principle of ‘equal pay for equal work’, the equation in the nature of duties, is of paramount importance. If the principal nature of duties of one post is teaching, whereas that of the other is non-teaching, the principle would not be applicable. If the dominant nature of duties of one post is of control and management, whereas the subject post has no such duties, the principle would not be applicable. Likewise, if the central nature of duties of one post is of quality control, whereas the subject post has minimal duties of quality control, the principle would not be applicable;
  16. There can be a valid classification in the matter of pay scales, among employees even holding posts with the same nomenclature i.e., between those discharging duties at the headquarters, and others working at the institutional/sub-office level;
  17. The principle of ‘equal pay for equal work’ would not be applicable, where a differential higher pay-scale is extended to persons discharging the same duties and holding the same designation, with the objective of ameliorating stagnation, or on account of lack of promotional avenues;
  18. Where there is no comparison between one set of employees of one organisation and another set of employees of a different organisation, there can be no question of an equation of pay scales, under the principle of ‘equal pay for equal work’, even if two organisations have a common employer. Likewise, if the management and control of two organisations, is with different entities, which are independent of one another, the principle of ‘equal pay for equal work’ would not apply.

 

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Tenders & Contracts-Judicial review of administrative actions and Wednesbury principle

judicial-review

The Supreme Court and High Courts in India enjoy the powers of judicial review of administrative actions and this is recognised as one of the basic features of the Constitution. It is settled law that a public authority cannot act arbitrarily even in the matter of awarding contracts, or distributing largesse.  There is a public element in all its activities and it must conform to the mandates of Constitution and observe tenets of equality and the principle of fair action. It cannot be denied that the principles of judicial review would apply to the exercise of contractual powers by Government bodies in order to prevent arbitrariness or favouritism. However, it must be noted that there are inherent limitations in the exercise of that power of judicial review.

Even in the matter relating to State’s contract with the private parties, fair play in action must be the basis of the policy.  State for good and sufficient reasons has the right not to accept the lowest tender of all the tenders, but it is obligatory upon the Government to act fairly and at any rate, it cannot act arbitrarily.  The Government while granting a contract is not free like an ordinary individual to deal with any person it pleases.

Similarly, the exercise of contractual power by the Government or its authority is subject to judicial review for being tested by the application of Wednesbury principle of reasonableness, and for ensuring that it is free arbitrariness, favouritism, irrationality, illegality etc.

Scope of Judicial Review

 While  exercising  the power of judicial review, in respect of a contract entered on behalf of the State, the court is concerned  primarily as to whether there has been any infirmity in the “decision-making process”.  By way of judicial review, the court cannot examine the details of the terms of the contract which have been entered into by the public bodies or the State. Courts have inherent limitations on the scope of any such enquiry.  But at the same time, the courts can certainly examine whether “decision-making process” was reasonable, rational, not arbitrary and violative of the principles of equality enshrined in the Constitution.  If the contract has been entered into without ignoring the procedure which can be said to be basic in nature and after an objective consideration of different options available taking into account the interest of the State and the public, then court cannot act as an appellate authority by substituting its opinion in respect of selection made for entering into such contract.  But once the procedure adopted by an authority for purpose of entering into a contract is held to be against the mandate of the Constitution, the court cannot ignore such action saying that the authorities concerned must have some latitude or liberty in contractual matters and any interference by court amounts to encroachment on the exclusive rights of the executive to take such decision.

 Lord Scarman in Nottinghamshire county Council v. Secretary of State for the Environment [1986] AC 240 proclaimed:

Judicial review is a great weapon in the hands of the judges, but the judges must observe the constitutional limits set by our parliamentary system upon the exercise of this beneficent power.  Judicial review is concerned with reviewing not the merits of the decision in support of which the application for judicial review is made, but the decision-making process itself. Judicial review does not mean the court should take over the contracting powers.

Judicial review is not intended to take away from those authorities the powers and discretions properly vested in them by law and to substitute the courts as the bodies making the decisions. It is intended to see that the relevant authorities are exercising their powers in a proper manner.

When Courts can review administrative actions

Generally, courts do not interfere with the policy decisions of the state or its authorities.  They are also loath to interfere with the State’s freedom to contract including the laying down of the conditions of the tender and the notice inviting tenders.  But where the action of the policy decision of the Government is vitiated by arbitrariness, unfairness, illegality and irrationality, courts can interfere in its jurisdiction.

The Court could interfere in the following three categories of cases:

  1. Quasi-judicial;
  2. Administrative, for example, price fixing;
  3. Award of contracts.

The parameters for interference in such matter would be:

  1. Mala fide;
  2. Bias;
  3. Arbitrariness to the extent of perversity.

If none of these is present, the court may not interfere. The government is the guardian of the finances of the State. It is expected to protect the financial interest of the State.  Judicial quest in administrative matters has been to find that right balance between the administrative discretion to decide matters and the need to remedy any unfairness.

Restriction on Courts power of judicial review

In Chief Constable of the North Wales Police v. Evans [1992] 3 All ER 141 Lord Brightman said:

Judicial review, as the words imply, is not an appeal from a decision, but a review of the manner in which the decision was made. Judicial Review is concerned, not with the decision, with the decision-making process. Unless that restriction on the power of the court is observed, the court will, under the guise of preventing the abuse of power, be itself guilty of usurping power.

The duty of the court is to confine itself to the question of legality. Its concern should be:

Whether a decision-making authority:

  1. exceeded it’s powers?
  2. committed an error of law;
  3. committed a breach of the rules of natural justice;
  4. reached a decision which no reasonable tribunal would have reached; or
  5. abused its powers.

Therefore, it is not for the court to determine whether a particular policy or particular decision taken in the fulfilment of that policy is fair. It is only concerned with the manner in which those decisions have been taken. The extent of the duty to act fairly will vary from case to case, shortly put, the grounds upon which an administrative action is subject to control by judicial review can be classified as under :

  1. Illegality: This means the decision-maker must understand correctly the law that regulates his decision-making power and must give effect to it.
  2. Irrationality, namely, Wednesbury unreasonableness;
  3. Procedural impropriety.

Wednesbury principle

 A decision of a Public authority will be liable to be quashed or otherwise dealt with by an appropriate order in judicial review proceedings where the Court concludes that the decision is such that no authority properly directing itself on the relevant law and acting reasonably could have reached it (Associated Provincial Picture Houses Limited v. Wednesbury Corporation [1948] 1 K.B. 223;[1947] 2 All E.R. 680, Lord Green M.R.)

It is open to the court to review the decision maker’s evaluation of the facts. The court will intervene where the facts taken as a whole could not logically warrant the conclusion of the decision-maker. If the weight of facts pointing to one course of action is overwhelming, then a decision the other way cannot be upheld. A decision would be regarded as unreasonable if it is biased and unequal in its operation as between different classes.

Conclusion

There has been considerable development and tremendous changes in the administrative law. It can be seen that the Courts have now set certain principles for judicial review, which are:

  • The modern trend points to judicial restraint in administrative action.
  • The Court does no sit as a court of appeal but merely reviews the manner in which the decision was made.
  • The Court does not have the expertise to correct the administrative decision. If a review of the administrative decision is permitted it will be substituting its own decision, without the necessary expertise which itself may be fallible.
  • The terms of the invitation to tender cannot be open to judicial scrutiny because the invitation to tender is in the realm of contract. Normally speaking, the decision to accept the tender or award the contract is reached by a process of negotiations through several tiers. More often than not, such decisions are made qualitatively by experts.
  • The Government must have freedom of contract. In other words, a fair play in the joints is a necessary concomitant for an administrative body functioning in an administrative sphere or quasi-administrative sphere. However, the decision must not only be tested by the application of Wednesbury principle of reasonableness but must be free of arbitrariness, not affected by bias or actuated by malafides.
  • Quashing decisions may impose a heavy administrative burden on the administration and lead to increased and unbudgeted expenditure.

 

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Know all about the changes made by Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016

Commercial Court

The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 (Act) seeks to amend four laws, including (i) Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act), (ii) Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDDBFI Act); (iii) Indian Stamp Act, 1899 and (iv) Depositories Act, 1996. The Act has been published in the Gazette of India on 12.08.2016; however, the date of coming into effect of the Act is yet to be notified.

The amendments in the SARFAESI Act inter alia,  include (i) registration of creation, modification and satisfaction of security interest by all secured creditors and provision for integration of registration systems under different laws relating to property rights with the Central Registry so as to create Central database of security interest on property rights; (ii) conferment of powers upon the Reserve Bank of India to regulate Asset Reconstruction Companies in a changing business environment; (iii) exemption from stamp duty on assignment of loans by Banks and Financial Institutions in favour of Asset Reconstruction Companies; (iv) enabling non-institutional investors to invest in security receipts; (v) Debenture Trustees as secured creditors; (vi) specific timeline for taking possession of secured assets; and (vii) priority to secured creditors in repayment of debts.

The amendments in the RDDBFI Act inter alia, include (i) expeditious adjudication of recovery applications; (ii) electronic filing of recovery applications, documents and written statements; (iii) priority to secured creditors in repayment of debts; (iv) Debenture Trustees as Financial Institutions;(v) empowering the Central Government to provide for uniform procedural rules for conduct of proceedings in the Debts Recovery Tribunals and Appellate Tribunals.

Major amendments to the SARFAESI Act 

Sections 12, 12B, 12C & 12D-Enhanced powers to Reserve Bank of India (RBI): In addition to the existing powers of RBI to examine the statements and any information of Asset Reconstruction Companies (ARCs) related to their business, the Act empowers the RBI to issue directions to ARCs for regulation of the fee and other charges which may be charged, to carry out audit and inspection of ARCs and to remove the Chairman or any director or appoint additional directors on the board of directors of the ARCs. The Act further authorises RBI to penalise ARCs if they fail to comply with any directions issued by it.

Section 13(2)(i) Proviso-Debenture Trustees empowered to take action without classifying debt as NPA: The Act empowers debenture trustees to take action for enforcement of security interest, against borrowers who have raised funds by issue of debt securities, without classification of the debt as Non-Performing Asset, which is  a mandatory requirement for other secured creditors.

Section 14(1)-Time-limit for passing orders by Magistrate on the application for assistance: The SARFAESI Act allows secured creditors to take possession of the secured asset, against which a loan had been provided, upon a default in repayment. In the case of difficulty in taking over possession, the secured creditor can take the assistance of District Magistrate/Chief Metropolitan Magistrate. The Act further provides that this process will have to be completed within 30 days by the Magistrate. However, if the Magistrate is unable to pass an order within this time limit due to reasons beyond his control, he shall do so, within such further period not exceeding 60 days.

Section 15(4) Proviso- Secured creditor not required to restore possession in certain cases: In case the secured creditors have acquired controlling stake in a Company by conversion of debt into shares, then secured creditors shall not be liable to restore the management of the business to such borrower, even after realisation of the entire outstanding due of the borrower.

Section 17- Right to challenge enforcement of security interest by a tenant or person claiming interest in the property: The Debt Recovery Tribunals (DRT) have been empowered to examine the application of a person claiming any tenancy or right over the property against which the secured creditors have taken action for the purposes of enforcement of security interest.

Section 20A- Creation of database and Integration of registration system: The Act creates a Central Registry to maintain records of transactions related to secured assets. The Act creates a central database to integrate records of property registered under various registration systems of State and Central Governments with this Central Registry. This includes integration of registrations made under Companies Act, 2013, Registration Act, 1908 and Motor Vehicles Act, 1988.

Section 26B & 26C – Registration of charges by Secured Creditors and other charge holders: These new sections provide for extending the provision of registration to all lenders other than secured creditor for creation, modification or satisfaction of any security interest over any property of the borrower with a Central Registry.  It further provides for registration of attachment order of courts and by government authorities like revenue, tax etc. of Central, State Government or any other local authority. Such registration shall be deemed to constitute a public notice from the date and time of filing of particulars of such transaction with the Central Registry.

 Section 26D – Restriction on right to enforce securities: This new section mandates that the Secured Creditors can enforce securities under the SARFAESI Act only if the security interest created by the borrower in favour of the secured creditor has been registered with the Central Registry.

Section 26E-Priority for debts of secured creditors: On registration of the security interest with the Central Registry, the Act provide priority to debts due to Secured Creditors over all others debts, revenues, taxes, cesses and rates payable to Central Government, State Government or any other local authority.

Sections 30A, 30B, 30C & 30D:  Constitution of Adjudicating Authority: The Act provides for an Adjudicating Authority and Appellate Authority for imposing penalty and also the procedure for recovery of such penalty, on ARCs or any other persons found not complying with the directions of the RBI.  The Adjudicating Authority and Appellate Authority shall consist of a committee of officers of the RBI.

Amendments to the RDDBFI Act 

Section 11-Presiding Officer and Chairman: The RDDBFI Act established Debt Recovery Tribunals (DRTs) and Debt Recovery Appellate Tribunals (DRATs). The Act increases the retirement age of Presiding Officers of Debt Recovery Tribunals from 62 years to 65 years. Further, it increases the retirement age of Chairpersons of Appellate Tribunals from 65 years to 70 years. It also makes Presiding Officers and Chairpersons eligible for reappointment.

Section 19-Filing of Application: The Act provides that Banks and Financial Institutions will be required to provide along with the Original Application, all documents and evidence, which it relies on for expeditious adjudication of the recovery application. The Original Application can be filed before the tribunal having jurisdiction over the area of bank or branch where the debt claimed is for the time being maintained.

Section 19(3A)- Application to contain details of assets: An application for recovery  to be filed by  the Bank or Financial Institution before DRT shall state the particulars of debt secured by the security  interest or property or assets and the estimated value  of such securities.  Further, if the estimated value is not sufficient to satisfy the claim, the application shall also state other properties or assets owned by the defendants  and the value  of such other assets.

Section 19(4)-Show cause notice to the defendants: The Act provides for issue of a Show Cause Notice to the defendants directing them to show cause within 30 days of service of the summons as to why reliefs claimed by the applicant should not be granted and also for a direction to the defendants to disclose any other properties or assets held by them. It further empowers the DRT to pass an ex-parte order restraining the defendant from dealing or disposing of properties.

Section 19(4A)-Bar on dealing with properties: On receipt of the summons of DRT, the defendants are barred from transferring or dealing with the properties or asset without prior approval of DRT.

Section 19 (22A):- Recovery Certificate  to be deemed as a decree for initiation of winding up proceeding: The Act provides that the Recovery Certificate issued by the Presiding Officer  shall be deemed to be a decree or order of the Court for the purposes of initiation of winding up proceedings against a company registered under the Companies Act, 2013 or Limited Liability Partnership registered under the Limited Liability Partnership Act, 2008 or insolvency proceedings against any individual or partnership firm and stipulates that Presiding Officer shall take every effort to complete the proceedings in two hearings.

Section 19A- Filing of original applications, documents and written statements in electronic form: The Act provides for the filing of recovery applications, documents and written statements and issue of summons and notices in electronic form and display of interim and final orders of the DRTs and DRATs on their website. It further provides that the pleading including application, written statement etc. shall be authenticated by Digital Signature.

Section 21-Reduction in amount to be deposited for filing appeal: The Act provide for deposit of fifty percent of amount of debt due, for the purpose of filing of appeal and also provide that the amount may be reduced by such amount which shall not be less than twenty-five per cent of the amount of such debt so due.

Section 22A-Unifrom procedure in DRTs and DRATs: A new section has been inserted as Sec. 22A to empower the Central Government to prescribe uniform procedural rules to be observed by the Debt Recovery Tribunals and Debt Recovery Appellate Tribunals in the conduct of their proceedings.

Section 27-Power of Presiding Officer to grant time: The Presiding Officer is empowered to grant time for payment of the amount in the Recovery Certificate, provided the defendant makes a down payment of not less than twenty-five percent of the amount claimed and gives an unconditional undertaking to pay the balance within a reasonable time, which is acceptable to the Bank or Financial Institutions for stay of proceedings under Recovery Certificate.

Section 30 (A)-Deposit of amount for filing the appeal against an order of Recovery Officer: The Act provide for the requirement of deposit of fifty percent of debt payable by the defendant/ borrowers for filing an appeal against orders of Recovery Officers.

Section 31 (B):- Priority of secured creditors: The Act provide priority to secured creditors over all other  claimants including claims of Central Government, State Government or local authority.

 Amendment to the Indian Stamp Act, 1899

Section 8F: A new section 8F is inserted to the Indian Stamp Act, whereby agreement or other document for transfer or assignment of rights or interest in financial assets of Banks or Financial Institutions in favour of any ARC shall not be liable for payment of stamp duty.

Amendments to the Depositories Act, 1996

Sections 1A & 1B- The Act has inserted two new sections to the  Depositories Act for facilitating the transfer of shares held in pledge or on conversion of debt into shares, in favour of ARCs by Banks or FIs.

 

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Beginners’ Guide to Enforcement of Security Interest under SARFAESI Act

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The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) enable Banks and Financial Institutions(FIs) to recover defaulted loan from borrowers by adopting measures for recovery or reconstruction. The SARFAESI Act provides three alternative methods for recovery of Non-Performing Assets (NPAs), namely: – 1. Securitisation; 2. Asset Reconstruction; and 3. Enforcement of Security without the intervention of a Court or Tribunal. Out of these methods, the most important and widely used is the powers for Enforcement of Security without the intervention of a Court or Tribunal, which is discussed here.

The SARFAESI Act empowers Banks and FIs to issue demand notice to the defaulting borrowers and guarantors, calling upon them to discharge their dues in full within 60 days from the date of the notice. Thereafter, Banks are empowered to take possession of the security provided for the loan and sell or assign the right to the security, manage the same or appoint any person to manage the same.

Borrower, Secured Creditor, Secured Asset, Secured Debt & Security Interest defined

  1. Borrower is defined in SARFAESI Act as any person who has been granted financial assistance by any Bank or FI or who has given any guarantee or created any mortgage or pledge as security for the financial assistance granted and includes a person who becomes borrower of a securitisation company or reconstruction company consequent upon acquisition by it of any rights or interest of any Bank or FI in relation to such financial assistance;
  2. Secured Asset means the property on which Security Interest is created;
  3. Secured Creditor means any Bank or FI or any consortium or groups of Banks or FIs and includes a Debenture trustee, Securitisation company or reconstruction company, any other trustee holding securities in whose favour Security Interest is created for due repayment by any borrower;
  4. Secured Debt means a debt which is secured by any Security Interest;
  5. Security Interest means right, title and interest of any kind whatsoever upon property, created in favour of any Secured Creditor and includes any mortgage, charge, hypothecation, assignment, other than those specified as exempted.

When can Security Interest be enforced?

A Security Interest can be enforced by a Secured Creditor without the intervention of Court or Tribunal in accordance with the provisions of the SARFAESI Act.

Such action can be taken against a borrower, who is under liability to a Secured Creditor and makes any default in repayment of Secured Debt or any instalment thereof and the account is classified as NPA by the Secured Creditor.

What Security Interest cannot be enforced?

A Security Interest cannot be enforced, if it is:

  • a lien on any goods, money or security given by or under the Indian Contract Act, 1872 or the Sale of Goods Act, 1930 or any other law for the time being in force;
  • a pledge of movables within the meaning of section 172 of the Indian Contract Act, 1872;
  • creation of any security in any aircraft as defined in clause (1) of section 2 of the Aircraft Act, 1934;
  • creation of security interest in any vessel as defined in clause (55) of section 3 of the Merchant Shipping Act, 1958;
  • any conditional sale, hire-purchase or lease or any other contract in which no security interest has been created;
  • any rights of the unpaid seller under section 47 of the Sale of Goods Act, 1930;
  • any properties not liable to attachment (excluding the properties specifically charged with the debt recoverable under this Act) or sale under the first proviso to sub-section (1) of section 60 of the Code of Civil Procedure, 1908;
  • it is an agricultural land
  • the debt due is less than Rs. 1,00,000/-
  • the debt due is less than 20% of the principal amount and interest thereon, i.e. the borrower has repaid more than 80% of the principle amount and interest.

Further, a Security Interest cannot be enforced if the debt is time barred under the Limitation Act.

Procedure of enforcement of Security Interest in case of default

When a Borrower defaults in repayment of a Secured Debt and after the Secured Creditor (Bank or FI) treats the defaulted debt as an NPA, the Secured Creditor may require the Borrower by notice in writing to discharge in full his liabilities within 60 days from the date of the notice. The notice shall give details of the amount payable by the borrower and the secured assets intended to be enforced.

The Borrower is entitled to make a representation or raise objection against the 60 days notice and it is the duty of the Secured Creditor to consider such representation or objection and communicate to the Borrower within 15 days, the decision taken on the representation or objection and if the same is not accepted, the reasons for non-acceptance.

If the Borrower fails to discharge his liability in full within the period specified, the secured creditor may take recourse to one or more of the following actions :-

  1. Take possession of the Secured Assets including the right to transfer by way of lease, assignment or sale for realising the Secured Assets.
  1. Take over management of the business of the Borrower including the right to transfer by way of lease, assignment or sale for realising the Secured Assets in cases where a substantial part of the Borrower is held as security for the debt.
  1. Appoint any person to manage the Secured Assets the possession of which has been taken over by the Secured Creditor.
  1. Require any person who has acquired any of the Secured Assets from the Borrower and from whom any money is due or may become due to the Borrower, to pay such amount to the Secured Creditor.

 Assistance in taking possession of the Secured Assets

For the purpose of taking possession or control of any Secured Asset, if found necessary, the Secured Creditor may request the Chief Metropolitan Magistrate or the District Magistrate within whose jurisdiction the Secured Asset is situated or found, to take possession and handover the Secured Assets to the Secured Creditor.

Challenging the action of Secured Creditor

Any person who is aggrieved by the action taken by the Secured Creditor in the enforcement of Security Interest may file an appeal before the Debts Recovery Tribunal having jurisdiction in the matter within forty-five days from the date of enforcement by the Secured Creditor.

The Debts Recovery Tribunal, if it concludes that the action taken by the Secured Creditor are not in accordance with the provisions of the SARFAESI Act may declare the enforcement of Security Interest by the Secured Creditors as invalid and direct restoration of the Secured Assets to the borrower.

If it is found that the enforcement of Security Interest by the Secured Creditor is invalid, the borrower shall be entitled to the payment of such compensation and costs as may be determined by Court or Debts Recovery Tribunal.

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