Permanent Machinery of Arbitration for Settlement of Disputes of Public Sector Enterprises-A critical analysis

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Introduction

Permanent Arbitration Machinery (PMA) is a mechanism under Department of Public Enterprises, Ministry of Heavy Industries and Public Enterprises, Govt. of India to settle disputes arising out of commercial contracts between a Public Sector Enterprises (PSEs) and a Government Department or between two or more PSEs. PMA was established with a view to settling these disputes, expeditiously and without the intervention of Courts. The Arbitration and Conciliation Act 1996 is not applicable to the PMA proceedings. No outside lawyer is allowed to appear on behalf of either party for presenting/defending the cases. But the parties can take help of their in-house law officers.

Historical background

Based on the Supreme Court of India’s observation  that the public undertakings of Central Government and the Union of India should not file litigation in court by spending money on counsel, court fees, procedural expenses and wasting public time, a note was submitted by Department of Legal Affairs to the Committee of Secretaries in 1987, who suggested that a Permanent Machinery of Arbitration should be set up in Bureau of Public Enterprises (now Dept. of Public Enterprises) to settle all commercial disputes (excluding disputes on Income -Tax, Customs & Excise) between PSEs inter se and between a PSE and a Government Department. The same was approved by the Cabinet in its meeting held on 24.02.1989. The PMA was set up in the Department of Public Enterprises (DPE) for resolving commercial disputes between CPSEs inter-se as well as between a CPSE and a Central Government Department / Ministry / Bank / Port Trust (excluding disputes on income -tax, customs and excise) in 1989. Later on in 2004 disputes concerning railways were also excluded from the purview of PMA.

In Oil and Natural Gas Commission and Anr. v. Collector of Central Excise 1995 Supp (4) SCC 541 the Supreme Court taking note of the fact that legal proceedings of PSEs are resulting in considerable public expense and waste of valuable Court time directed Government of India to set up a Committee consisting of representatives from the Ministry of Industry and Commerce, Bureau of Public Enterprises and the Ministry of Law to monitor disputes inter se Public Sector Undertakings and with the Government to ensure that no litigation came to the Courts and Tribunals without the matter having been first examined by the Committee for grant or refusal of clearance for litigation. The Supreme Court made it obligatory for every Court and every Tribunal where such a dispute is raised to demand a clearance from the Committee in case it has not been so pleaded, and also directed that in the absence of such a clearance the proceedings would not be carried forward.

The idea behind setting up of the Committee, initially, called a ‘High- Powered Committee’, later on, called as ‘Committee of Secretaries’ and finally termed as ‘Committee on Disputes’ was to ensure that resources of the State are not frittered away in inter se litigations between entities of the State, which could be best resolved, by an empowered Committee. The machinery contemplated was only to ensure that no litigation comes to Court without the parties having had an opportunity of conciliation before an in-house committee. However, experience has shown that despite best efforts of the Committee, the mechanism has not achieved the results for which it was constituted and has in fact led to delays in litigation. Since it was observed that this mechanism has outlived its utility, in Electronics Corporation of India Ltd. v. Union of India, (2011) 3 SCC 404 the Supreme Court after noticing various flaws in the working of the Committee of Disputes ordered the recall of its previous orders.

In the intervening period, Govt. of India consolidated into a single set of guidelines the PMA for settlement of commercial disputes and the directives issued by the Supreme Court regarding the constitution of Committee on Disputes in terms of a circular issued by the Department of Public Enterprises vide order No. DPE O.M. No.DPE/4(10)/2001-PMA-GL-I dated 22nd January, 2004 which inter alia provided for creation of PMA, stated the need for creation of such a machinery, indicated the entitlement of departments/ PSEs, CPSC, banks etc. to take resort to the said machinery, fixed monetary limits, stipulated fees payable towards arbitration, provided for an appeal against the award and also provided for clearance from the Committee on Disputes. The instructions issued to PSES, CPSEs, banks etc. stipulated the incorporation of a clause in current and future contracts/ agreements which specifically excluded the application of Arbitration and Conciliation Act, 1996 to arbitrations conducted under the Permanent Machinery of Arbitration.

Jurisdiction

Any dispute or difference relating to the interpretation and application of the provisions of commercial contracts between CPSEs, Banks, Port Trusts etc. inter se, or CPSE and the Government Department/s (except a dispute or difference concerning the Railways, Income-tax, Customs and Excise duties), may be referred by either party to arbitration to the PMA.

Though the mechanism of PMA is primarily meant for Central Government Departments/organizations/enterprise, if the contract involves a Central Government Department/Organization with any State Government Department/Organization and both the parties have signed Arbitration Clause in favour of PMA, in such a situation the PMA shall entertain such dispute(s) for arbitration. It is provided that an arbitration clause, to refer any disputes to PMA, shall be incorporated in all current and future contracts/agreements entered between CPSEs, Banks, Port Trusts etc. inter se, or CPSE and the Government Department/s.

Monetary Limit

There is no monetary limit as such for making reference of disputes to the PMA. However, as both parties to the dispute are to equally pay an initial cost of Rs. 20,000 each for making reference of the dispute to the PMA which is non-refundable, there shall not be much advantage in referring disputes of a small amount of the value of less than Rs. 50,000/- to PMA.

Fees

The Arbitration cost in respect of a commercial dispute settled through the PMA is required to be shared equally by the concerned disputing parties. The parties to a dispute will be required to make an initial deposit of Rs. 20,000/-, when a prima-facie case of dispute is established and the same is approved for referring to the Arbitrator of PMA for settlement. This initial cost will be adjusted to the final cost of Arbitration. The Arbitrator will work out the final cost of Arbitration based on the amount of dispute as per the following formula:

  1. 40,000 or 1% of the disputed amount up to Rs. 50,00,000, whichever is higher, to be equally shared by the parties.
  2. 50,000 + ½% of the disputed amount of above Rs. 50,00,000 but up to Rs. 5 crores to be equally shared by the parties.
  3. 2.5 lakh + ¼% of the disputed amount beyond Rs. 5 crore to be equally shared by the parties.

Compromise

In case both the parties decide to settle the dispute mutually before the Award is published, they can be allowed to do so.  In such case, the initial cost (Rs. 20,000 paid as a deposit by each of the parties) shall be forfeited and the case will be finally closed on receipt of details of the settlement arrived at by the parties in writing.  In case the parties do not provide requisite details, the Arbitrator may decide to publish the Award and in such a situation the parties will be required to pay the arbitration fee worked out by the Arbitrator.

Nature of Award

The Arbitrator shall make his award within six months after entering upon the reference or after having been called upon to act by notice in writing from any party to the arbitration agreement or within such extended time as the parties may allow.  The Arbitrator shall make a speaking award and the Award may be published on plain paper.

Interim Awards

The Arbitrator may also if he thinks fit, make an interim award. However, there shall be no appeal against interim awards and both the parties will have to wait for the final award by the arbitrator.

Exparte Award

The Arbitrator may make exparte Award when a party(ies) fail to furnish the particulars required from them, and/ or do not appear in person in spite of being given two chances to do so.  Even in that case, the parties shall be bound to meet the cost of arbitration equally.

Appeal

The Award of the sole Arbitrator under the PMA shall be binding upon the parties to the dispute, unless, any party aggrieved by such award make a further reference for setting aside or revision of the award to the Law Secretary, Department of Legal Affairs, Ministry of Law & Justice, Government of India. The decision of the Law Secretary/Special Secretary/Additional Secretary shall bind the parties finally and conclusively.

Drawbacks of PMA

The award made in terms of the Permanent Machinery of Arbitration being outside the provisions of the Arbitration and Conciliation Act, 1996 would not constitute an award under the said legislation and would therefore neither be amenable to be set aside under the said statute nor be enforceable as a decree lawfully passed against the judgment debtor.

The Supreme Court in a recent judgment in Northern Coalfields Ltd vs Heavy Engineering Corp.Ltd dated 13th July 2016 has held that “an arbitral award under the Permanent Machinery of Arbitration may give quietus to the controversy if the same is accepted by the parties to the dispute. In cases, however, a party does not accept the award, as is the position in the case at hand, the arbitral award may not put an end to the controversy. Such an award being outside the framework of the law governing arbitration will not be legally enforceable in a court of law……. Remedies which are available to the Government on the administrative side cannot substitute remedies that are available to a losing party according to the law of the land. The appellant has lost before the arbitrators in terms of the Permanent Machinery of Arbitration and is stoutly disputing its liability on several grounds. The dispute regarding the liability of the appellant under the contract, therefore, continues to loom large so long as it is not resolved finally and effectually in accordance with law. No such effective adjudication recognised by law has so far taken place. That being so, the right of the appellant to demand such an adjudication cannot be denied simply because it happens to be a Government owned company for even when the appellant is a government company, it has its legal character as an entity separate from the Government. Just because it had resorted to the permanent procedure or taken part in the proceedings there can be no estoppel against its seeking redress in accordance with law. That is precisely what it did when it filed a suit for declaration that the award was bad for a variety of reasons and also that the contract stood annulled on account of the breach committed by the respondents.”

Conclusion

The above judgment of the Supreme Court poses several questions on the efficacy and legitimacy of PMA as a mechanism for settlement of disputes between the instrumentalities of the state. If the PMA does not have statutory backing, in times to come, after participating in the PMA proceedings, more losing parties will question the legitimacy and authority of the awards passed by PMA. It is high time that Govt. of India revisit the PMA guidelines to give it more teeth and statutory backing.

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Top 10 tips to avoid disputes and litigation in contracts

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When entering into a contract nobody wants a dispute and even more, wants to avoid it escalating into litigation. Litigation is time-consuming, expensive, risky and stressful; it diverts precious resources and is a distraction to the normal business activity. Due to the unpredictability of events and the inability to control other parties, disputes are sometimes unavoidable. However, most of the litigation is avoidable and by applying a few prudent tips, not only one can lessen the risk of being sued or having to sue, but in the event litigation becomes inevitable, one will be in a stronger position to defend the matter in court.

Tips to avoid dispute and litigation

  1. Documentation

Put every agreement in writing. Many disputes arise due to misunderstandings and ambiguities that could have been avoided if the parties initially set forth their agreement in writing. It is very easy for things to go wrong when there is no written agreement between the parties or amendments to such agreement.

Maintain complete files and documentation of the understanding reached relating to a contract. Relying on oral testimony, memories and interpretations are less than ideal and certain to complicate resolution. It is important to ensure that the agreement not only documents the arrangement reached, but it reflects the terms and conditions agreed between parties.

  1. Read and review the agreement

Once you have got the agreement drafted, there is nothing more important than reading and understanding the agreement before signing it, to confirm that they reflect your intentions. Ensure that all offers and promises are accurate and the terms and conditions are not deceptive. It is vital to ensure that the timelines mentioned are realistic and that there are no chances of delay or cost overrun.

Review the terms of the agreement, surrounding facts and all related written communications, including emails, letters and messages to ensure you truly understand all relevant facts. It is also important to regularly review the terms and conditions of standard agreements, to ensure that they reflect the changes in governing laws and current business practices.

  1. Communicate and maintain relationships

Establish and maintain good relationships with clients and business partners and treat them fairly, because people are less willing to ruin an existing good relationship by litigating.

One of the best ways to avoid conflict and misunderstanding is to ensure your clients know what is going on. This may include informing them about increases in costs, budgets and scheduling. Discontent can often arise when you fail to communicate or attend to seemingly minor things like returning emails and notices promptly. Respecting your client and keeping them well informed can go a long way towards avoiding litigation. Even when a dispute arises, gather all information related to the dispute and speak with all involved participants in order to adequately evaluate it.

  1. Act before a dispute escalates

A stitch in time saves nine. A prompt step to address a hindrance when it arises can go a long way to prevent it from developing into a major problem and positions becoming entrenched. It is no use ignoring a glitch or complaint and hoping it will go away. Respond promptly to potential problems before they escalate, because litigation often arises simply because problems were not addressed in a timely manner.

It is best either to take up the issue immediately or to seek professional advice to resolve it. Obtain feedback from trusted and impartial individuals on your position and the dispute itself so that you may evaluate the situation objectively and unemotionally.

You should also ensure that your management team is effectively trained to identify and resolve disputes and is comfortable enough to raise them at appropriate levels. Implement procedures that ensure a potential dispute is communicated up the chain of command so suitable resources and attention may be dedicated to resolving it before it is too late.

  1. Identify other party’s strengths and weaknesses

Often the easiest way to avoid litigation is to avoid doing business with individuals and companies with bad reputations, a history of litigation, and other red flags. It is also important to fully understand the opposite party’s point of view and evaluate the strengths and weaknesses of their position.

A search on the internet can help in checking out potential client’s strengths and weaknesses. Similarly, a check of court websites where the party has its principal office can throw up the cases pending in its name. Check whether they appear to be an individual or company with which you can do business. Are they frequently involved in disputes and litigations?

If they appear to be embroiled in disputes, it is best to steer clear. Some organisations and individuals have a tendency to attract trouble. You likewise need to think about whether your own company fits the profile of the one that is always involved in disputes.

  1. Stand in the shoes of the opposite party

Putting yourself into the other party’s position and understand what is motivating the decision to raise the dispute or refuse to negotiate. Is it simply personal animosity, or does the other party have a genuine reason for commencing litigation? Try to look at things from the opposite party’s viewpoint and it may show the dispute in an entirely new angle and chances are that you may find merit in their argument and ultimately agree to a settlement.

  1. Negotiation

Open a dialogue regarding a settlement and use your best efforts to maintain professional and cordial communications throughout the dispute. Disputes that are not resolved immediately can often still be resolved prior to litigation if the channels of communication remain open and productive.

  1. Dispute resolution clause

Though, when you enter into a contract, you don’t want to think about a dispute arising, it is important that the parties should focus on any unforeseeable events, which may put the contract into trouble. It is advisable to have properly drafted dispute resolution clause incorporated in the agreement. A clearly drafted dispute resolution clause can minimise the cost of resolving a dispute which may arise.

This clause should preferably provide for mediation and conciliation before escalating the dispute for arbitration or litigation.

  1. Mediation 

Mediation differs greatly from arbitration in that the mediator, who is a neutral third party, does not impose a solution. The object of mediation is to help the parties resolve their own dispute, so a mediator’s functions can vary depending on the personalities and wishes of the parties and their attorneys, the nature and history of the dispute, and the personality and skills of the mediator. Mediation has been used to settle conflicts of every kind, from international political disagreements and labour disputes to landlord-tenant, consumer, and medical malpractice contests. There has been a rapid increase in business use of mediation over the past few years.

  1. Get proper advice and evaluate the chances of success

Engage a legally qualified person to understand your legal rights, potential liabilities and the strengths and weaknesses of your arguments before you sue or are sued. Evaluate the likelihood of actually recovering damages from the other side and obtaining a satisfactory resolution. Determine alternative solutions for a satisfactory resolution without resorting to litigation. Frequently a win-win resolution is possible.

If you are wrong, take responsibility promptly and work diligently to correct the problem and mitigate damages of all parties. If you are right, even 100% right, think long and hard before instituting litigation, because litigation should be the final choice.

Conclusion

There may, of course, be instances where litigation is advisable or unavoidable, but if you follow these 10 basic tips, you have a much better chance of resolving your dispute amicably or avoiding litigation altogether. It is always better to remember that even if you win in the court, ultimately, you may still feel like you lost.

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The immortal trail of Socrates

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Socrates, the Greek philosopher, whose way of life, character, and thought exerted a profound influence on ancient and modern philosophy, was a widely recognised and controversial figure in his native Athens. He is portrayed as a man of great insight, integrity, self-mastery, and argumentative skill. The impact of his life was all the greater because of the way in which it ended: at age 70, he was brought to trial on a charge of impiety and sentenced to death by poisoning by a jury of his fellow citizens.

The trial and execution of Socrates in Athens in 399 B.C puzzles historians.  Why in a society enjoying more freedom and democracy than any the world had ever seen, would a seventy-year-old philosopher be put to death for what he was teaching?  What could Socrates have said or done that prompted a jury of 500 Athenians to send him to his death just a few years before he would have died naturally?1

Finding an answer to the mystery of the trial of Socrates is complicated by the fact that the two surviving accounts of the defence of Socrates both come from disciples of his, Plato and Xenophon.  Historians suspect that Plato and Xenophon, intent on showing their master in a favourable light, failed to present in their accounts the most damning evidence against Socrates.

What appears almost certain is that the decisions to prosecute and ultimately convict Socrates had a lot to do with the turbulent history of Athens in the several years preceding his trial.  An examination of that history may not provide final answers, but it does provide important clues.2

BACKGROUND

Socrates, the son of a sculptor and a midwife, was a young boy when the rise to power of Pericles brought on the dawning of the Golden Age of Greece.   As a young man, Socrates saw a fundamental power shift, as Pericles-perhaps history’s first liberal politician-acted on his belief  that the masses, and not just property-owning aristocrats, deserved liberty.  Pericles created the people’s courts and used the public treasury to promote the arts.  He pushed ahead with an unprecedented building program designed not only to demonstrate the glory that was Greece, but also to ensure full employment and provide opportunities for wealth creation among the lower class.

Growing to adulthood in this bastion of liberalism and democracy, Socrates somehow developed a set of values and beliefs that would put him at odds with most of his fellow Athenians.  Socrates was not a democrat or an egalitarian.  To him, the people should not be self-governing; they were like a herd of sheep that needed the direction of a wise shepherd.  He denied that citizens had the basic virtue necessary to nurture a good society, instead equating virtue with a knowledge unattainable by ordinary people.  Striking at the heart of Athenian democracy, he contemptuously criticised the right of every citizen to speak in the Athenian assembly.

Diogenes Laertius  in, The Lives of Eminent Philosophers,  reported that Socrates discussed moral questions in the workshops and the marketplace. Often his unpopular views expressed disdainfully and with an air of condescension, provoked his listeners to anger.  Laertius wrote that “men set upon him with their fists or tore his hair out,” but that Socrates “bore all this ill-usage patiently.”

THE TRIAL

In ancient Athens, criminal proceedings could be initiated by any citizen.  In the case of Socrates, the proceedings began when Meletus, a poet, delivered an oral summons to Socrates in the presence of witnesses.  The summons required Socrates to appear before the legal magistrate, or King Archon to answer charges of impiety and corrupting the youth.  The Archon determined after listening to Socrates and Meletus (and perhaps the other two accusers, Anytus and Lycon)-that the charge was permissible under Athenian law, set a date for the preliminary hearing and posted a public notice.

The preliminary hearing before the Magistrate began with the reading of the written charge by Meletus.  Socrates answered the charge.  The Magistrate questioned both Meletus and Socrates and then gave both the accuser and the defendant an opportunity to question each other.  Having found merit in the accusation against Socrates, the Magistrate drew up formal charges.  Diogenes Laertius reports the charges as recorded in the now-lost document:

“This indictment and affidavit sworn by Meletus, the son of Meletus of Pitthos, against Socrates, the son of Sophroniscus of Alopece: Socrates is guilty of refusing to recognise the gods recognised by the state, and of introducing new divinities.  He is also guilty of corrupting the youth.  The penalty demanded is death.”

The trial of Socrates took place over a nine-to-ten hour period in the People’s Court, located in the Agora, the civic centre of Athens.  The jury consisted of 500 male citizens over the age of thirty, chosen by lot.  Most of the jurors were probably farmers. The jurors sat on wooden benches separated from the large crowd of spectators, including Plato, one of the disciples of Socrates, by some sort of barrier or railing.

Guilt Phase of Trial

The trial began in the morning with the reading of the formal charges against Socrates by a herald.  The prosecution presented its case first.  The three accusers, Meletus, Anytus, and Lycon, had a total of three hours, measured by a water clock, to present from an elevated stage their argument for guilt.  No record of the prosecution’s argument against Socrates survives.

Easily the best known and most influential of the three accusers, Anytus, is widely believed to have been the driving force behind the prosecution of Socrates.  Plato’s Meno offers a possible clue as to the animosity between Anytus, a politician coming from a family of tanners, and Socrates.  In the Meno, Plato reports that Socrates’ argument that the great statesmen of Athenian history have nothing to offer in terms of an understanding of virtue enrages Anytus.  Plato quotes Anytus as warning Socrates: “Socrates, I think that you are too ready to speak evil of men: and, if you will take my advice, I would recommend you to be careful.” Anytus had an additional personal gripe concerning the relationship Socrates had with his son. Plato quotes Socrates as saying, “I had a brief association with the son of Anytus, and I found him not lacking in spirit.”  It is not known whether the relationship included sex, but Socrates-as were many men of the time in Athens-was bisexual and slept with some of his younger students. Anytus almost certainly disapproved of his son’s relationship with Socrates.  Adding to the displeasure of Anytus must have been the advice Socrates gave to his son.  According to Xenophon, Socrates urged Anytus’s son not to “continue in the servile occupation [tanning hides] that his father has provided for him.”  Without a “worthy adviser,” Socrates predicted, he would “fall into some disgraceful propensity and will surely go far in the career of vice.

Piety had, for Athenians, a broad meaning.  It included not just respect for the gods, but also for the dead and ancestors.  The impious individual was seen as a contaminant who, if not controlled or punished, might bring upon the city the wrath of the gods-Athena, Zeus, or Apollo-in the form of plague or sterility.  The ritualistic religion of Athens included no scripture, church, or priesthood.  Rather, it required-in addition to belief in the gods-observance of rites, prayers, and the offering of sacrifices.

Any number of words and actions of Socrates may have contributed to his impiety charge.  Preoccupied with his moral instruction, he probably failed to attend important religious festivals.  He may have stirred additional resentment by offering arguments against the collective, ritualistic view of religion shared by most Athenians or by contending that gods could not, as Athenians believed, behave immorally or whimsically.  Xenophon indicates that the impiety charge stemmed primarily from the contention of Socrates that he received divine communications (a voice or a sign) directing him to avoid politics and concentrate on his philosophic mission.  A vague charge such as impiety invited jurors to project their many and varied grievances against Socrates.

Dozens of accounts of the three-hour speech by Socrates in his defence existed at one time.  Only Plato’s and Xenophon’s accounts survive.  The two accounts agree on a key point.  Socrates gave a defiant-decidedly unapologetic-speech.  He seemed to invite condemnation and death.

Plato’s Apology describes Socrates questioning his accuser, Meletus, about the impiety charge.  Meletus accuses Socrates of believing the sun and moon not to be gods, but merely masses of stone.  Socrates responds not by specifically denying the charge of atheism, but by attacking Meletus for inconsistency: the charge against him accused him of believing in other gods, not in believing in no gods.  If Plato’s account is accurate, Socrates could have been seen by jurors offering a smokescreen rather than a refutation of the charge of impiety.

Socrates provocatively tells his jury that he is a hero.  He reminds them of his exemplary service as a divine soldier in three battles.  More importantly, he contends, he has battled for decades to save the souls of Athenians-pointing them in the direction of an examined, ethical life.  He reportedly says to his jurors if his teaching about the nature of virtue “corrupts the youth, I am a mischievous person.” He tells the jury, according to Plato, he would rather be put to death than give up his soul-saving: “Men of Athens, I honour and love you; but I shall obey God rather than you, and while I have life and strength I shall never cease from the practice and teaching of philosophy.”  If Plato’s account is accurate, the jury knew that the only way to stop Socrates from lecturing about the moral weaknesses of Athenians was to kill him.

What is strikingly absent from the defence of Socrates, is the plea for mercy typically made to Athenian juries.  It was common practice to appeal to the sympathies of jurors by introducing wives and children.  Socrates, however, did no more than remind the jury that he had a family.  Neither his wife Xanthippe nor any of his three sons made a personal appearance.   On the contrary, Socrates, according to Plato, contends that the unmanly and pathetic practice of pleading for clemency disgraces the justice system of Athens.

When the three-hour defence of Socrates came to an end, the court herald asked the jurors to render their decision by putting their ballot discs in one of two marked urns, one for guilty votes and one for votes for acquittal.  With no judge to offer them instructions as to how to interpret the charges or the law, each juror struggled for himself to come to an understanding of the case and the guilt or innocence of Socrates.  When the ballots were counted, 280 jurors had voted to find Socrates guilty, 220 jurors for acquittal.

Penalty Phase of Trial

After the conviction of Socrates by a relatively close vote, the trial entered its penalty phase.  Each side, the accusers and the defendant, was given an opportunity to propose a punishment.  After listening to arguments, the jurors would choose which of the two proposed punishments to adopt.

The accusers of Socrates proposed the punishment of death.  In proposing death, the accusers might well have expected to counter with a proposal for exile- a punishment that probably would have satisfied both them and the jury.  Instead, Socrates audaciously proposes to the jury that he be rewarded, not punished.  According to Plato, Socrates asks the jury for free meals in the Prytaneum, a public dining hall in the centre of Athens.  Socrates must have known that his proposed “punishment” would infuriate the jury.  Socrates acts more like a picador trying to enrage a bull than a defendant trying to mollify a jury.  Why, then, propose a punishment guaranteed to be rejected?  The only answer is that Socrates was ready to die.

To comply with the demand that a genuine punishment be proposed, Socrates reluctantly suggested a fine of one mina of silver, about one-fifth of his modest net worth, according to Xenophon.  Plato and other supporters of Socrates upped the offer to thirty minae by agreeing to come up with the silver of their own.  Most jurors likely believed even the heftier fine to be far too light of a punishment for the unrepentant Socrates.

In the final vote, a larger majority of jurors favoured a punishment of death than voted in the first instance for conviction.  According to Diogenes Laertius, 360 jurors voted for death, 140 for the fine.  Under Athenian law, an execution was accomplished by drinking a cup of poisoned hemlock.

In Plato’s Apology, the trial concludes with Socrates offering a few memorable words as court officials finished their necessary work.  He tells the crowd that his conviction resulted from his unwillingness to “address you as you would have liked me to do”.  He predicts that history will come to see his conviction as “shameful for Athens”, though he professes to have no ill will for the jurors who convict him.  Finally, as he is being led off to jail, Socrates utters the memorable line: “The hour of departure has arrived, and we go our ways–I to die, and you to live.  Which to the better fate is known only to God.”  

Socrates spent his final hours in a cell in the Athens jail.  The hemlock that ended his life did not do so quickly or painlessly, but rather by producing a gradual paralysis of the central nervous system.

Most scholars see the conviction and execution of Socrates as a deliberate choice made by the famous philosopher himself.  If the accounts of Plato and Xenophon are reasonably accurate, Socrates sought not to persuade jurors, but rather to lecture and provoke them.

The trial of Socrates, the most interesting suicide the world has ever seen, produced the first martyr for free speech.  As I. F. Stone observed, just as Jesus needed the cross to fulfil his mission, Socrates needed his hemlock to fulfil his.

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1Richard Kraut, Encyclopaedia Britannica
2 Doug Linder-The Trial of Socrates

 

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Lease and Licence-Explained and distinguished

Lease & licence

Lease and licence are legal modes in which right to enjoy or do something in an immovable property are granted by a person to another person. Both have many similarities and are used interchangeably in the normal course. However, there are many features, which differentiate them and make them distinct.

What is a Lease?

A lease of immovable property is a transfer of a right to enjoy such property in consideration of a price paid. By way of lease, a right and interest are created on the property, by the lessor, which stands transferred in favour of the lessee.

A lease creates a right or an interest in the enjoyment of the demised property and a tenant or a sub-tenant is entitled to remain in possession thereof until the lease is duly terminated, and eviction takes place in accordance with law.

Section 105 of the Transfer of Property Act, 1882 (TP Act) defines lease as follows:

A lease of immovable property is a transfer of a right to enjoy such property, made  for a certain time, express or implied, or in perpetuity, in consideration of a price  paid or promised, or of money, a share of crops, service or any other thing of value, to be rendered periodically or on specified occasions to the transferor by the transferee, who accepts the transfer on such terms.

Lessor, lessee, premium and rent defined. —The transferor is called the lessor, the transferee is called the lessee, the price is called the premium, and the money, share, service or other thing to be so rendered is called the rent.”

This section defines a lease as a partial transfer, i.e. a transfer of a right of enjoyment for a certain time.  When the agreement vests in the lessee a right of possession for a certain time, it operates as a conveyance or transfer and is a lease.  The essential elements of a lease are:

  • The parties;
  • The subject-matter, or immovable property;
  • The term, or period;
  • The consideration, or rent.

The rights and obligations of the lessor as contained in the TP Act are also subject to the contract to the contrary.  Even the right of assignment of leasehold property may be curtailed by an agreement.

An agreement to lease or an agreement merely defining the terms of the tenancy, is not a lease; nor is it a licence.

Licence defined

A licence is defined in Sec. 52 of the Indian Easements Act 1882 as a right to do or continue to do, in or upon the immovable property of the grantor, something which would in the absence of such right be unlawful, and such right does not amount to an easement or an interest in the property.  A mere licence does not create any interest in the property.  A licence creates a right in the licensee to enter into a land and enjoy it.  A lease, on the other hand, would amount to the transfer of property.  The distinction between a licence and a lease is marked by the last clause of the definition, for a licence does not create any estate or interest in the property to which it relates.

A licensee is not entitled to notice to quit before eviction.

Accordingly, a licence-

  • Is not assignable (Sec.56, Indian Easements Act 1882);
  • Does not entitle the licensee to sue strangers in his own name;
  • Is revocable by the grantor (Sec. 60, Indian Easements Act 1882);
  • Is determined when the grantor makes an assignment of the subject-matter.

Lease or licence-Distinguished

In The Law of Landlord and Tenant (4th Edition) Evans and Smith states as under:-
“A lease, whether fixed-term or periodic, confers a right in property, enabling the tenant to exclude all third parties, including the landlord, from possession, for the duration of the lease, in return for which a rent or periodical payment is reserved out of the land. A contractual licence confers no more than a permission on the occupier to do some act on the owner’s land which would otherwise constitute a trespass.” 

In Halsbury’s Laws of England, Volume 23, pages 427, 428 and 429, the crucial considerations in a lease versus licence situation have been stated as follows:

“PRINCIPLES FOR DETERMINING WHETHER AGREEMENT CREATES LEASE OR LICENCE. In determining whether an agreement creates between the parties the relationship of landlord and tenant or merely that of licensor and licensee the decisive consideration is the intention of the parties. The parties to an agreement cannot, however, turn a lease into a licence merely by stating that the document is to be deemed a licence or describing it as such. The relationship of the parties is determined by law on a consideration of all relevant provisions of the agreement; nor will the employment of words appropriate to a lease prevent the agreement from conferring a licence only if from the whole document it appears that it was intended merely to confer a licence. In the absence of any formal document the intention of the parties must be inferred from the circumstances and the conduct of the parties.

NATURE OF GRANT OF EXCLUSIVE POSSESSION. The fact that the agreement grants a right of exclusive possession is not in itself conclusive evidence of the existence of a tenancy, but it is a consideration of the first importance. In deciding whether a grantee is entitled to exclusive possession regard must be had to the substance of the agreement. To give exclusive possession there need not be express words to that effect; it is sufficient if the nature of the acts to be done by the grantee requires that he should have exclusive possession. The grant of an exclusive right to a benefit can, however, be inferred only from the language which is clear and explicit. If an exclusive right of possession is subject to certain reservations or to a restriction of the purposes for which the premises may be used, the reservations or restriction will not necessarily prevent the grant operating as a lease.

WHEN GRANT CONFERRING EXCLUSIVE POSSESSION OPERATES MERELY AS LICENCE. A grant which confers the right to exclusive possession may operate as a licence in the following circumstances which negate the intention to create a lease:

INSTANCES OF AGREEMENTS CREATING LICENCES. A licence is normally created where a person is granted the right to use premises without becoming entitled to exclusive possession thereof, or the circumstances and conduct of the parties show that all that was intended was that the grantee should be granted a personal privilege with no interest in the land. If the agreement is merely for the use of the property in a certain way and on certain terms while the property remains in the possession and control of the owner, the agreement will operate as a licence, even though the agreement may employ words appropriate to a lease”.

In Associated Hotels of India v RN Kapoor, the Supreme Court set out the following propositions as well established for ascertaining whether a transaction is a lease or licence:

  1. To ascertain whether a document creates a lease or a licence, the substance of the document must be preferred to its form;
  2. The real test is the intention of the parties – whether they intended to create a lease or a licence;
  3. If the document creates an interest in the property, it is a lease; but, if it only permits another to make use of the property, of which legal possession continues with the owner, it is a licence; and
  4. If under the document a party gets exclusive possession of the property, prima  facilities, he is considered to be a tenant; but circumstances may be established which negate the intention to create a lease.

Exclusive Possession

There is no simple litmus test for distinguishing a lease from a licence.  The character of the transaction turns on the operative intent of the parties. If permission to use the land without the right to exclusive possession is alone granted, the transaction is a licence.  The test of exclusive possession, though not decisive, is of significance.  Exclusive possession coupled with the transfer of a right to enjoy the property is an important test and indicates an intention to create a lease.  It may create a lease even though the sum is described as a ‘licence fee.’

A finding on the question whether the defendant is a tenant or a licensee is a finding of fact.  The Supreme Court has held that exclusive possession would not be conclusive evidence of the existence of a tenancy though that would be a consideration of first importance.  It has further been held that exclusive possession itself is not decisive in favour of a lease and against a mere licence, for, even the grant of exclusive possession  might turn out to be only a licence and not a lease where  the grantor himself  has no power to grant the lease.  Exclusive possession of the premises in the hands of a party is always crucial for ascertaining as to whether a lease has been created, but even in the case of exclusive possession, sometimes, the court may upon consideration of the terms and conditions of documents and conduct of the parties, hold that the parties never intended to create a lease, and only leave and licence was granted.  Thus, exclusive possession by itself will not amount to the creation of interest, and it will  not militate against the concept of a licence if the circumstances negates any intention to create any interest.

Interest in the property

It is the creation of an interest in immovable property or a right to possess it that distinguishes a lease from a licence.  For the purpose of deciding whether a particular transaction is a lease or a licence, the question of intention of the parties is to be determined, and the intention has to be inferred from the circumstances of each case.  It is essential, therefore, to look to the substance and essence of the agreement, and not merely to the form.

The crucial test in each case is whether the instrument is intended to create or not to create an interest in the property and the subject-matter of the agreement.  If it is in fact intended to create an interest in the property it is a lease, if it does not, it is a licence.

Intention of the Parties

In cases where courts are required to consider the nature of transactions and the status of parties thereto, one cannot go on mere nomenclatures.  In order to ascertain the substance of the transaction, one has to ascertain the purpose and substance of the agreement.  In such cases, the intention of the parties is the deciding factor.  In order to ascertain the intention, the surrounding circumstances including  the conduct of the parties have be to examined.  In case of determining  whether the transaction  is a lease or licence, an effort should be made to find out whether the deed confers a right to possess exclusively coupled with transfer of a right to enjoy the property or what has been parted with is merely a right  to use the property  while  the possession is retained by the owner.  The conduct of the parties before and after the creation of relationship is of relevance for finding out their intention.  The line between lease and licence is very thin.  Mainly the intention is to be gathered from the meaning and the words used in the document, except where it is alleged and proved that the document is a camouflage.  If there be a formal document, the intention is inferred from its terms.  If the document is ambiguous, the question is to be decided with reference to evidence and attendant circumstances.  However, parties to an agreement cannot contract out of the Rent Acts, as if they were able to do so, the Acts would be a dead letter.   A document which expresses the intention genuine, or bogus, of both parties or of one party to create a licence will nevertheless create a tenancy if the rights and obligations enjoyed and imposed satisfy the legal requirements of tenancy.  Whether a transaction is a licence depends on the intention of the parties, and the nature of the possession granted.  

The following circumstances,  were held to establish the transaction as a lease:

  • Exclusive possession of the premisespecially;
  • The grantor had no access to the portion of the premises occupied by the person in possession;
  • The portion occupied by the person in possession was provided with a sub-meter for electricity;
  • The monthly payment, though termed as ‘compensation and commission’, was, in reality, rent for the  premises occupied by person in possession;
  • The demise was for a fixed term of five years;
  • No power was reserved for cancelling the contract before the expiry of the fixed term;
  • Provision was also made for extending the term of the contract by mutual agreement;
  • Penal provisions were incorporated, providing for enhanced payment of rent in case the person in possession continued after the term of five years.

However, in the following circumstances, the transaction is held as a license:

  • Premise was to be run only for sale of a particular product;
  • Premise was to cater to the needs of a particular group of people;
  • License would not be heritable and assignable;
  • On expiry of two years and on expiry of any renewed period, possession was to be handed back;

Conclusion

Where the question arises as to whether an agreement is a lease or a licence, the intention of the parties must be gathered from the terms of the agreement, examined in the light of the surrounding circumstances.  The  description given by the parties may be evidence of the intention, but is not decisive.  The mere use of words appropriate to the creation of a lease will not preclude the agreement from operating as a licence.  A recital that the agreement does not create a tenancy is also not decisive.   The crucial test in each case is, whether  the  instrument is intended to create an interest in the property, is a lease; if it does not, it is a licence.

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S4A or Scheme for Sustainable Structuring of Stressed Assets

debt_restructuring

Background

The Reserve Bank of India (RBI) in its efforts to strengthen the lenders’ ability to deal with stressed assets, has been issuing, from time to time, guidelines and prudential norms on stressed assets for resolution by lenders. Towards the resolution of stressed assets of Banks and FIs, RBI has formulated various schemes like the Corporate Debt Restructuring Scheme and Strategic Debt Restructuring Scheme. In continuation of these efforts and in order to further strengthen the lenders’ ability to deal with stressed assets and to put real assets back on track by providing an avenue for reworking the financial structure of entities facing genuine difficulties, the RBI has on 13th June 2016 issued guidelines for a Scheme for Sustainable Structuring of Stressed Assets (S4A).

Banks have been representing to RBI for a regulatory framework which would facilitate lenders taking up the exercise of reworking of the liability structure of companies to which they have significant exposures, in the context of asset quality stress currently faced by them. The S4A is based on the consideration that resolution of large loan accounts which are facing severe financial difficulties may, interalia, require co-ordinated deep financial restructuring which often involves a substantial write-down of debt and/or making large provisions. Often such high write-downs act as a disincentive to lenders to effect a sustainable change in the liability structure of borrowers facing stress.

RBI has now formulated the Scheme for Sustainable Structuring of Stressed Assets as an optional framework for the resolution of large stressed accounts. The S4A envisages determination of the sustainable debt level for a stressed borrower and bifurcation of the outstanding debt into sustainable debt and equity/quasi-equity instruments which are expected to provide upside to the lenders when the borrower turns around.

In order to make sure that that the entire exercise is carried out in a transparent and prudent manner, S4A envisages that the resolution plan will be prepared by credible professional agencies, while an Overseeing Committee, set up by the Indian Banks Association (IBA) in consultation with the RBI, comprising of eminent experts will independently review the processes involved in preparation of the resolution plan, under the S4A, for reasonableness and adherence to the provisions of the S4A guidelines.

Scheme for Sustainable Structuring of Stressed Assets (S4A)

For resolution of large loan accounts which are facing severe financial difficulties may, interalia, require co-ordinated deep financial restructuring which often involves a substantial write-down of debt and/or making large provisions. Citing the case of the Strategic Debt Restructuring mechanism which provides 18 months for banks to make prescribed provisions for the residual debt and mark-to-market (MTM) provisions on their equity holding arising from conversion of debt, banks have represented to RBI, for allowing more time to write down the debt and make the required provisions in cases of resolution of large accounts.

In order to ensure that adequate deep financial restructuring is done to give projects a chance of sustained revival, the RBI, after due consultation with banks, has decided to facilitate the resolution of large accounts, which satisfy the conditions set out in the following paragraphs.

Accounts Eligible for S4A

For being eligible under this S4A Scheme, the account1 should meet all the following conditions:

  1. The project has commenced commercial operations;
  2. The aggregate exposure (including accrued interest) of all institutional lenders in the account is more than Rs.500 crore (including Rupee loans, Foreign Currency loans/External Commercial Borrowings,);
  • The debt meets the test of sustainability as stated herein below.

Debt Sustainability

A debt level will be deemed sustainable if the Joint Lenders Forum (JLF)/Consortium of lenders/bank conclude through independent techno-economic viability (TEV) that debt of that principal value amongst the current funded/non-funded liabilities owed to institutional lenders can be serviced over the same tenor as that of the existing facilities even if the future cash flows remain at their current level. For the scheme to apply, sustainable debt should not be less than 50 percent of current funded liabilities. This is referred to as Part A herein below.

Sustainable Debt

The resolution plan may involve one of the following options with regard to the post-resolution ownership of the borrowing entity:

  1. The current promoter continues to hold majority of the shares or shares required to have control;
  2. The current promoter has been replaced with a new promoter, in one of the following ways:
    • Through conversion of a part of the debt into equity under SDR mechanism which is thereafter sold to a new promoter;
    • In the manner contemplated as per Prudential Norms on Change in Ownership of Borrowing Entities (Outside SDR Scheme);
  3. The lenders have acquired majority shareholding in the entity through conversion of debt into equity either under SDR or otherwise and
    • allow the current management to continue or
    • handover management to another agency/professionals under an operate and manage the contract.

It is pertinent to note that this Scheme will not be applicable where malfeasance on the part of the promoter has been established, through a forensic audit or otherwise and there is no change in the promoter or the management is vested in the delinquent promoter.

In any of the circumstances mentioned above, the JLF/consortium/bank shall, after an independent TEV, bifurcate the current dues of the borrower into Part A and Part B as defined below:

Part A

Determine the level of debt (including new funding required to be sanctioned within next six months and non-funded credit facilities crystallising within next 6 months) that can be serviced (both interest and principal) within the respective residual maturities of existing debt, from all sources, based on the cash flows available from the current as well as immediately prospective (not more than six months) level of operations. For this purpose, free cash flows (i.e., cash flow from operations minus committed capital expenditure) available for servicing debt as per latest audited/reviewed financial statement will be considered. Where there is more than one debt facility, the maturity profile of each facility shall be that which exists on the date of finalising this resolution plan. For the purpose of determining the level of debt that can be serviced, the assessed free cash flow shall be allocated to servicing each existing debt facility in the order in which its servicing falls due. The level of debt so determined will be referred to as Part A in the Scheme.

Part B

The difference between the aggregate current outstanding debt, from all sources, and Part A will be referred to as Part B in the Scheme.

The lenders shall not dilute the security available and Part A portion of the loan will continue to have at least the same amount of security cover as was available prior to the resolution under S4A scheme.

Features for the Resolution Plan for stressed assets under S4A

The Resolution Plan shall have the following features:

  1. There shall be no fresh moratorium granted on interest or principal repayment for servicing of Part A.
  2. There shall not be any extension of the repayment schedule or reduction in the interest rate for servicing of Part A, as compared to the repayment schedule and interest rate prior to the resolution.
  3. Part B shall be converted into equity/redeemable cumulative optionally convertible preference shares. However, in cases where the resolution plan does not involve a change in the promoter, banks may, at their discretion, also convert a portion of Part B into optionally convertible debentures.

Valuation and marking to market

In the S4A scheme, the fair value for Part B instruments will be arrived at as per the following methodologies:

  • Equity – The equity shares in the lenders’ portfolio should be marked to market preferably on a daily basis, but at least on a weekly basis. Equity shares for which current quotations are not available or where the shares are not listed on the stock exchanges, should be valued at the lowest value arrived using the following valuation methodologies:
    • Break-up value (without considering ‘revaluation reserves’, if any) which is to be ascertained from the company’s latest audited balance sheet (which should not be more than one year prior to the date of valuation). In case the latest audited balance sheet is not available the shares are to be valued at Re.1 per company. The independent TEV will assist in ascertaining the break-up value.
    • Discounted cash flow method where the discount factor is the actual interest rate charged to the borrower plus 3 percent, subject to a floor of 14 percent. Further, cash flows ( cash flow available from the current as well as the immediately prospective (not more than six months) level of operations) occurring within 85 percent of the useful economic life of the project only shall be reckoned.
  • Redeemable cumulative optionally convertible preference shares/optionally convertible debentures – The valuation should be on discounted cash flow (DCF) basis. These will be valued with a discount rate of a minimum markup of 1.5 percent over the weighted average actual interest rate charged to the borrower for the various facilities. Where preference dividends are in arrears, no credit should be taken for accrued dividends and the value determined on DCF basis should be discounted further by at least 15 percent if arrears are for one year, 25 percent if arrears are for two years, so on and so forth (i.e., with 10 percent increments).

Where the resolution plan does not involve a change in the promoter or where the existing promoter is allowed to operate and manage the company as minority owner by lenders, the principle of proportionate loss sharing by the promoters should be met. In such cases, lenders shall require the existing promoters to dilute their shareholdings, by way of conversion of debt into equity /sale of some portion of promoter’s equity to lenders, at least in the same proportion as that of Part B to total dues to lenders. JLF/Consortium/bank should also be required to obtain promoters’ personal guarantee in all such cases, for at least the amount of Part A.

The upside for the lenders will be primarily through equity/quasi-equity if the borrowing entity turns around. The terms for the exercise of the option for the conversion of preference shares/debentures to equity shall be clearly spelt out. The existing promoter or the new promoter, as the case may be, may have the right of first refusal in case the lenders decide to sell the share, at a price beyond some predetermined price. The lenders may also include appropriate covenants to cover the use of cash flows arising beyond the projected levels having regard to quasi-equity instruments held in Part B.

Other important principles of S4A Scheme:

  1. The JLF/Consortium/bank shall engage the services of reputed and independent professional agencies having the expertise to conduct the TEV and prepare the resolution plan.
  2. The resolution plan shall be agreed upon by a minimum of 75 percent of lenders by value and 50 percent of lenders by number in the JLF/consortium/bank.
  3. At individual bank level, the bifurcation into Part A and part B shall be in the proportion of Part A to Part B at the aggregate level.
  4. An advisory body called Overseeing Committee (OC), comprising of eminent persons, will be constituted by IBA in consultation with RBI. The members of OC cannot be changed without the prior approval of RBI.
  5. The resolution plan shall be submitted by the JLF/consortium/bank to the OC.
  6. The OC will review the processes involved in the preparation of resolution plan, etc. for reasonableness and adherence to the provisions of these guidelines, and opine on it.
  7. Once the resolution plan prepared/presented by the lenders is ratified by the OC, it will be binding on all lenders. They will, however, have the option to exit as per the extant guidelines on Joint Lenders’ Forum (JLF) and Corrective Action Plan.
  8. The IBA will collect a fee from the lenders as a prescribed percentage of the outstanding debt of the borrower entity to the consortium/JLF/consortium/bank and create a corpus fund. This fund will be used to meet the expenses of the OC.

Asset Classification and Provisioning

  1. Where there is a change of promoter–

In case a change of promoter takes place, i.e. a new promoter comes in, the asset classification and provisioning requirement will be as per the ‘SDR’ scheme or ‘outside SDR’ scheme as applicable.

  1. Where there is no change of promoters –
  2. Asset classification as on the date of lenders’ decision to resolve the account under the guidelines will continue for a period of 90 days from this date. This standstill clause is permitted to enable JLF/consortium/bank to formulate the resolution plan and implement the same within the said 90 day period. If the resolution is not implemented within this period, the asset classification will be as per the extant asset classification norms, assuming there was no such ‘stand-still’.
  3. In respect of an account that is ‘Standard’ as on the reference date, the entire outstanding (both Part A and part B) will remain Standard subject to provisions made upfront by the lenders being at least the higher of 40 percent of the amount held in part B or 20 percent of the aggregate outstanding (sum of Part A and part B). For this purpose, the provisions already held in the account can be reckoned.
  4. In respect of an account that is classified as non-performing asset on the date of this resolution, the entire outstanding (both Part A and part B) shall continue to be classified and provided for as a non-performing asset as per extant IRAC norms.
  5. Lenders may upgrade Part A and Part the B to the standard category after one year of satisfactory performance of Part A loans. In the case of any pre-existing moratorium in the account, the upgrade will be permitted one year after completion of the longest moratorium, subject to satisfactory performance of Part A debt during this period. However, lenders will continue to mark to market Part B instruments as per the norms stated herein.
  6. Any provisioning requirement on account of difference between the book value of Part B instruments and their fair value, in excess of the minimum requirements, prescribed, shall be made within four quarters commencing with the quarter in which the resolution plan is actually implemented in the lender’s books, such that the MTM provision held is not less than 25 percent of the required provision in the first quarter, not less than 50 percent in the second quarter and so on. For this purpose, the provision already held in the account can be reckoned.
  7. If the provisions held by the bank in respect of an account prior to this resolution are more than the cumulative provisioning requirement prescribed in the applicable subparagraphs above, the excess can be reversed only after one year from the date of implementation of resolution plan (i.e. when it is reflected in the books of the lender, hereinafter referred to as ‘date of restructuring’), subject to satisfactory performance during this period.
  8. The resolution plan and control rights should be structured in such a way so that the promoters are not in a position to sell the company/firm without the prior approval of lenders and without sharing the upside, if any, with the lenders towards the loss in Part B.
  9. If Part A subsequently slips into NPA category, the account will be classified with slippage in the category with reference to the classification obtaining on the reference date and necessary provisions should be made immediately.
  10. Where a bank/NBFC/AIFI chooses to make the prescribed provisions/write-downs over more than one quarter and this results in the full provisioning/write down remaining to be made as on the close of a financial year, banks/NBFCs/AIFIs should debit ‘other reserves’ [i.e., reserves other than the one created in terms of Section 17(2) of the Banking Regulation Act 1949] by the amount remaining unprovided/not written down at the end of the financial year, by credit to specific provisions. However, bank/NBFC/AIFI should proportionately reverse the debits to ‘other reserves’ and complete the provisioning/write down by debiting profit and loss account, in the subsequent quarters of the next financial year. Banks shall make suitable disclosures in Notes to Accounts with regard to the quantum of provision made during the year under this scheme and the quantum of unamortised provisions debited to ‘other reserves’ as at the end of the year.

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1 In respect of Securitisation Companies/ Reconstruction Companies (SCs/RCs), only those accounts are eligible which, in addition to meeting the listed criteria, have been acquired against consideration in cash only, i.e. not by issuing any Security Receipts.

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Highlights of the proposed amendments to RDDBFI Act & SARFAESI Act

judge gavel with money closeup

To read a detailed article on the amendments, click: Know all about the changes made by Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016.

Background

The Recovery of Debts due to Banks and Financial Institutions Act, 1993 (RDDBFI Act) and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) were enacted for expeditious recovery of loans of banks and Financial Institutions (FIs).  However, due to various reasons, these laws were unable to give the desired outcome, resulting in the bad debts of Banks and FIs mounting day by day.  In order to facilitate quick disposal of recovery applications and thereby speed up the recovery process, Government has initiated steps to amend the RDDBFI and SARFAESI Acts and also to make consequential amendments to the India Stamp Act, 1899 and the Depositories Act, 1996.

Coming on the heels of the enactment of the Insolvency and Bankruptcy Code, 2016, these amendments aims to improve ease of doing business and facilitate investment leading to higher economic growth and development.

New Law

The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016 was passed by the Lok Sabha on 01.08.2016 and the Rajya Sabha on 09.08.2016. The President of India has given his assent on 12.08.2016 and the Act has been published in the Gazette of India for information on 16.08.2016. The date of coming into force of the Act is yet to be notified.

It seeks to amend four laws:

Amendments to the SARFAESI Act

The amendments in the SARFAESI Act, are proposed to suit changing credit landscape and augment ease of doing business which, inter alia, include:

  1. 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;
  2. Creation of a central database to integrate records of property registered under various registration systems with the Central Registry. This includes integration of registrations made under Companies Act, 2013, Registration Act, 1908 and Motor Vehicles Act, 1988.
  3. Secured creditors will not be able to take possession of the secured assets unless  the secured assets are registered with the Central Registry;
  4. After registration of security interest with Central Registry , the secured creditors will have priority over others in repayment of dues;
  5. In addition to the existing powers of the Reserve Bank of India (RBI) to examine the statements and any information of Asset Reconstruction Companies (ARCs) related to their business, the amendment further empowers the RBI to carry out audit and inspection to regulate ARCs. The RBI may penalise an ARC if the company fails to comply with any directions issued by it;
  6. To enable non-institutional investors to invest in security receipts of ARCs;
  7.  Provide a specific timeline for taking possession of secured assets;
  8. Mandates that District Magistrates shall pass suitable orders in an application for assistance for taking possession of the secured assets, under Sec. 14, within 30 days from the date of the application; and
  9. In case the secured creditors have acquired controlling interest in the borrower company by converting part of its debt into shares of the borrower company, it shall not be necessary for the secured creditors to restore the business to the borrower.

Amendments to the RDDBFI Act

The amendments proposed in the RDDBFI Act, inter alia, include:

  1. Expeditious adjudication of recovery applications;
  2. Electronic filing of recovery applications, summons, documents and written statements;
  3. Priority to secured creditors in repayment of debts;
  4. Debenture trustees are also included in the definition of financial institutions, thereby enabling them to initiate action under the RDDBFI Act;
  5. Empowering the Central Government to provide for uniform procedural  rules for the conduct of proceedings in the Debts Recovery Tribunals and Appellate Tribunals;
  6. Increase in 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 67 years. It also makes Presiding Officers and Chairpersons eligible for reappointment to their positions.
  7. Allows banks to file cases in Debts Recovery Tribunals having jurisdiction over the area of bank branch where the debt is pending, instead of filing cases in tribunals having jurisdiction over the defendant’s area of residence or business.

 Amendments to the Indian Stamp Act

The amendment provides for exemption from stamp duty on transactions undertaken for transfer of rights or interest in financial assets of banks or FIs in favour of ARCs. Financial assets include debts or receivables as defined in the SARFAESI Act.

Amendments to the Depositories Act

The  Depositories Act, 1996 is proposed to be amended 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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To read a detailed article on the amendments, click: Know all about the changes made by Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016.

 

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Confidentiality Agreements or Non-Disclosure Agreements-Explained

confidential

What is Confidentiality Agreement?

Confidentiality agreements which are also called Non-Disclosure Agreements or NDA are agreements entered between parties to protect confidential information exchanged, from being used for business advantage or being disclosed against one party’s will. These agreements, are contracts entered into by two or more parties in which some or all of the parties agree that certain types of information that pass from one party to the other or that are created by one of the parties will remain confidential. Such agreements are often used when a company or individual has a secret process or a unique technology or new product that it wants another company to evaluate as a precursor to a comprehensive licensing agreement or where one party wants to evaluate another’s existing commercial product for a new and different application.

Scope of the Confidentiality Obligation

The basic principle underlying a Confidentiality Agreement is a two-part obligation on the receiver of the information: (i) to keep the confidential information, in fact, confidential; and (ii) not use the confidential information for any unauthorised purposes.

So the first part is that the recipient of the confidential information has to keep it secret. This usually means that the recipient has to take reasonable steps to not let others have access to it. For example, reasonable steps could include that only a few people within the recipient’s organisation have access to the information and they are all informed of the nature of the confidentiality restrictions.

The second part is that the recipient can use the information only for the purpose for which the information is disclosed and not to use it for the unfair benefit of the recipient and against the interest of the discloser.

An important point that must be covered in any confidentiality agreement is the standard by which the parties will handle the confidential information. Usually, each party will treat the other’s confidential information in the same way that it treats its own.

Purpose of entering into Confidentiality Agreements

One of the foremost reasons for entering into confidentiality agreement is to protect sensitive technical or commercial information from disclosure to third parties. One or more parties in the agreement may promise not to disclose technical information received from the other party. If the information is revealed to another person, the injured party has cause to claim a breach of contract and can seek injunctive and monetary damages.

The use of confidentiality agreements can also prevent the forfeiture of valuable patent rights. Many times, the public disclosure of an invention can be deemed as a forfeiture of patent rights of that invention. A properly drafted confidentiality agreement can avoid the undesired—and often unintentional—forfeiture of valuable patent rights.

Confidentiality agreements define exactly what information can and cannot be disclosed. This is usually accomplished by specifically classifying the information not to be disclosed as confidential or proprietary.

The confidentiality agreement can also limit each party’s use of the confidential information. For example, the confidentiality agreement can specify that the confidential information is to be used only to evaluate for particular defined purposes and not for any other purposes, thereby restrict the usage of the disclosed information.

What type of information can be included in Confidentiality Agreement?

The type of information that can be included as confidential information is virtually unlimited. Any information that flows between the parties can be considered confidential viz., documents, records, data, know-how, prototypes, engineering drawings, computer software, test results, samples, models, tools, systems, and specifications. This list is certainly not exhaustive but does illustrate the breadth of items that can be deemed confidential.

What information are excluded from Confidentiality Agreement?

Most confidentiality agreements exclude certain types of information from the definition of confidential information. It is very important that the recipient includes these exceptions in the confidentiality agreement, so as to avoid future legal complications.

The commonly excluded information include that is:

  1. Already known to the recipient;
  2. Already in the public knowledge (as long as the recipient didn’t wrongfully release it to the public);
  3. Independently developed by the recipient without reference to or use of the confidential information of the disclosing party;
  4. Disclosed to the recipient by some other party who has no duty of the confidentiality to the disclosing party;
  5. Disclosure made under law, however, when a disclosure is made under compulsion of law, it is normally stipulated in the confidentiality agreement that before disclosing the information, the receiving party shall notify the disclosing party of the order, so that the disclosing party can seek an appropriate protective order from court and also that in the event that such a protective order is not obtained, the receiving party furnishes only that portion of the confidential information that is, legally required to be disclosed.

Responsibilities of the party receiving confidential information

Generally, a Confidentiality Agreement stipulates that the receiving party shall:-

  1. use the confidential information solely for the purpose stipulated in the agreement and disclose the confidential information to only those persons who are required in the course of their duties to receive and consider the same;
  2. treat and safeguard as private and confidential all the information disclosed and not disclose without the prior written consent of the disclosing party and in strict accordance with the terms of such consent;
  3. not make any commercial use of the confidential information, unless permitted by the disclosing party;
  4. ensure that any person to whom disclosure of the confidential information is to be made, agree to honour the obligations set out in the agreement.

Term of the confidentiality Agreement

The agreement must establish a time period during which disclosures will be made and the period during which confidentiality of the information is to be maintained. It is essential that the confidentiality agreement clearly specifies the time period during which confidentiality of the information is to be maintained. In order to avoid disputes, the confidentiality agreement should also specifically state the starting date for the confidentiality time period.

Though the disclosing party may like to have the term of the confidentiality agreement to last forever, it is not advisable to have such unlimited term and a definite term should be stipulated in the agreement. Depending on the industry and the type of information conveyed, a time period of 2-5 years may be reasonable.

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A beginner’s guide to Arbitration

Arbitration pic

Arbitration is a method of dispute resolution in which disputes are submitted, by agreement of the parties, to one or more arbitrators who make a binding decision on the disputes. In choosing arbitration, the parties opt for a private dispute resolution procedure instead of going to court.  Arbitrations are private in that third parties who are not a party to the arbitration agreement cannot attend any hearings or play any part in the arbitration proceedings. Arbitration as a dispute resolution technique closely resembles litigation. The object of arbitration is to obtain a fair resolution of disputes by an impartial third party without unnecessary expense or delay.

There are two forms of arbitration namely, ad hoc and institutional arbitration. Both forms have a separate mechanism for appointment of arbitrators. In ad hoc arbitrations, parties make their own arrangements for selection of arbitrators and for designation of rules, applicable law, procedures and administrative support. However, in an institutional arbitration, the arbitration agreement provides for an institution to administer the arbitral process as per the institutional rules on payment of administrative fees by the parties. The institution also allows the parties to select arbitrator(s) from the institution’s panel of arbitrators comprising experts drawn from various parts of the world.

The area where arbitration is most frequently encountered today is in international contracts. This is because where parties are from different countries they often agree to have the dispute determined in a neutral country rather than submit to the courts of the country of one of the parties.

Key features of arbitration

The essential feature of arbitration is that they are consensual, with the parties electing arbitration as the manner in which to resolve a dispute. The key features in arbitration include that:

  • the process is voluntary and consensual, but adversarial;
  • the parties agree to an arbitrator who is a neutral third party, and who may have speciality expertise or experience;
  • the process leads to a binding decision by the arbitrator;
  • the process is private, and not open to the general public, or the media, like a court hearing;
  • the process will be confidential if the dispute resolution clause in the contract states that the arbitration proceedings and any information disclosed are confidential and can only be used for the purposes of the arbitration;
  • the arbitration can be formal, like a trial in a court with evidence being given on oath and procedures similar to that involved by the court, or it can be informal (for example, when a decision is given based on agreed facts and documents);
  • an arbitral award is widely recognised by the courts and internationally (through the New York Convention); and
  • the awards are only subject to narrow grounds of appeal/challenge.

The limitation of arbitration is that it can take as long as standard court proceedings, and in some circumstances can cost more because the parties must pay the costs of the arbitrator and the physical venue of the arbitration. It should be noted that these days the distinction between litigation and arbitration is less apparent, particularly in terms of time and costs.

Who is an Arbitrator?

An arbitrator is a person selected by mutual consent of the parties or appointed by a third person or court, to settle the matters in controversy between the parties. A person appointed to adjudicate the difference is called an arbitrator. An arbitrator is a tribunal chosen by the consent of the parties. Any person who enjoys the confidence of the parties may be selected as an arbitrator. Every person is free to choose his own judge for the settlement of any matter in controversy, and the judge so chosen, if accepted by the opposite party, becomes an arbitrator. An arbitrator should be a person who stands indifferent between the parties. He should have no interest direct or remote in the subject-matter of the controversy or in the parties. Any person who is under any legal disability by virtue of statutory provision or by reason of public policy cannot act as an arbitrator.

After the amendment of Arbitration and Conciliation Act, 1996 in 2015 an arbitrator shall not be a related party as provided in the 7th schedule of the Arbitration Act.

Appointment of arbitrator by the parties

The parties may by agreement appoint whomsoever they please to arbitrate their dispute. They are free to determine the number of arbitrators. They may appoint a sole arbitrator or more than one subject to the condition that the number of arbitrators shall not be an even number. The parties may appoint an arbitrator in the following ways:

  1. An arbitrator may be named in the arbitration agreement, or
  2. He may not be named at all, or
  3. It may be agreed that the arbitrator shall be appointed by a third party who shall be named in the agreement.

Appointment of arbitrator by Courts

Where a party fails to appoint an arbitrator within thirty days from the receipt of a request to do so from the other party or, in the case of an arbitration with three arbitrators, the two appointed arbitrators fail to agree on the third arbitrator within thirty days from the date of their appointment, on the request of a party, Court shall make the appointment of the arbitrator.

What disputes can be referred to arbitration?

Any dispute that can be decided by a civil court may be referred to arbitration. Generally, all disputes, involving private rights, can be referred to arbitration. Thus, disputes about property or money, or about the damages payable for breach of contract etc., can be referred to arbitration.

However, according to general practice, following matters are not referred to arbitration:

  1. Matrimonial matters, like divorce or restitution of conjugal rights;
  2. Matters relating to guardianship of a minor or other persons under disability;
  3. Testamentary matters, for example, questions about the validity of a will;
  4. Insolvency matters, such as adjudication of a person as an insolvent;
  5. Criminal proceedings;
  6. Questions relating to charities or charitable trusts;
  7. Matters falling within the purview of the Competition Act;
  8. Dissolution or winding up of a company;
  9. Any matter wherein exclusive jurisdiction of a Court or Tribunal is stipulated by statute.

Broadly, the reasons underlying this position is that matters involving morality, status and public policy cannot be referred to arbitration.

Arbitration in India

Arbitration was the first method of Alternative Dispute Resolution recognised by statutory law in India. Prior to 1996, the arbitration law of the country was governed by the Act of 1940. This Act was largely premised on mistrust of the arbitral process and afforded multiple opportunities to litigants to approach the court for intervention. Coupled with a
sluggish judicial system, this led to delays rendering arbitrations inefficient and unattractive.The Arbitration and Conciliation Act, 1996 (Arbitration Act) was enacted with an aim of, inter alia, consolidating and amending the law relating to domestic arbitration, international commercial arbitration and enforcement of foreign arbitral awards.  The Arbitration Act is enacted on the lines of the Model Law on International Commercial Arbitration adopted by the United Nations Commission on International Trade Law which was adopted in order to have a universally uniform law for arbitral procedures.

The statement of objects and reasons of the Arbitration Act read as follows:

  1. To comprehensively cover international commercial arbitration and conciliation and also domestic arbitration and conciliation;
  2. To minimise the supervisory role of courts in the arbitral process;
  3. To provide that every final arbitral award is enforced in the same manner as if it were a decree of a court.

The main intent of the Arbitration Act was to provide speedy justice to the parties of a contract and to prevent any further delay in such cases. If contract disputes would be heard in a civil court, then it would involve lots of formalities which would give rise to delays and many cases would remain pending.

When Can Courts Interfere in the Arbitral Awards?

The Arbitration Act makes provision for the supervisory role of courts, for the review of the arbitral award only to ensure fairness. The intervention of the court is envisaged in few circumstances only, like, in a case of fraud or bias by the arbitrators, violation of natural justice, etc. The provision aims at keeping the supervisory role of the court at the minimum level and this can be justified as parties to the agreement make a conscious decision to exclude the court’s jurisdiction by opting for arbitration as they prefer the expediency and finality offered by it.

Circumstances When Arbitral Award May Be Set Aside

 The arbitral award has been treated at par with the decree of a Court. The arbitral award is enforceable in the same manner as a decree of a civil court. This change has enabled reduction of litigation in some areas of arbitration. Before 1996, an award could not be executed in its own right unless a court ordered that award be filed and a decree issued in terms thereof. There is no provision for appeal against an arbitral award and it is final and binding between the parties. However, an aggrieved party may take recourse to the law court for setting aside the arbitration award on certain grounds specified in Section 34 of the Arbitration Act. Section 34 provides that an arbitral award may be set aside by a court on certain grounds specified therein. These grounds are:

  1. A party was in some incapacity;
  2. The arbitration agreement is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law for the time being in force or;
  3. The party making the application was not given proper notice of appointment of arbitrator or of the arbitral proceedings or was otherwise unable to present his case;
  4. The arbitral award deals with a dispute not contemplated by or not falling within the terms of the submission to arbitration, or it contains decisions on matters not submitted to arbitration;
  5. The composition of arbitral tribunal or the arbitration procedure was not in accordance with the agreement of parties unless such agreement was in conflict with a provision of Arbitration Act;
  6. The court finds the subject matter is not capable of settlement by arbitration;
  7. The arbitral award is in conflict with the public policy of India.

Conclusion

It has been two decades since the Arbitration Act was written into the statute books and courts have interpreted the provisions of the Act in such a way which defeats the main object of the legislation. Inconsistent jurisprudence has resulted in uncertainty and confusion about the state of the law and has gravely undermined the core principles on which the Arbitration Act is based. Though arbitration is meant to be an informal method of dispute resolution without the intervention of the court, in practice excessive interference by courts on trivial issues have made arbitration too technical and time-consuming. It has also given rise to concerns about India’s commitment to arbitration and severely dented its claim to be an attractive seat for international arbitration.

It is hoped that the after the amendments made in the  Arbitration Act in 2015, which are meant to introduce fairness, speed and economy in the resolution of disputes through arbitration, the arbitration practice in India will be in conformity with international principles and reduce extensive judicial intervention in arbitration matters.

 

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Landmark cases in Contract Law

Contributed by: CA Amit Talada*

The Law of Contracts as is applied today has been defined by some classic decisions of English and Indian Courts. Some of these seminal cases, which may seem minor in their actual cause of action, has shaped the world of contracts and are still quoted with approval by Courts even a century later.  Following are few of the landmark cases, which went on to lay down the principles underlying the law of contracts:

contract cases

  1. Balfour vs. Balfour (King’s Bench-1919)

Rule of Law: Where parties to the contract do not intend to create a binding agreement, the agreement cannot be enforced.

The case of Balfour vs. Balfour is a well-known illustration of a domestic agreement. In this case, Mr Balfour was working in Ceylon. He and his wife (Mrs Balfour) went to England on furlough. When Mr Balfour was to return to Ceylon, his wife was advised to remain in England, due to ill health. Mr Balfour agreed to send a sum of £30 per month for the probable expense of maintenance. For some time, he sent the amount but afterwards differences arose between them which resulted in their separation and the allowance fell into arrears. Mrs Balfour claim for recovery was dismissedAtkin on the ground that parties did not intend that it will be attended by legal consequences.

  1. Carlill vs. Carbolic Smoke Ball Co (Court of Appeal-1892)

Rule of Law: A General offer may be accepted by any person from among the public who has the knowledge of it. The performance of conditions of an offer will amount to acceptance.

The case of Carlill vs. Carbolic Smoke Ball Co. is an illustration of a contract arising out of a general offer and intention to create a legal relationship. As per the facts of the case, the company issued an advertisement in a newspaper about its product, “the smoke ball” a preventive medicine against influenza. In the advertisement, the company offered to pay a sum of £ 100 as compensation to anyone who contacted influenza or a cold after having used the smoke ball according to the printed directions. The advertisement also contained that a sum of £ 100 had been deposited with the Alliance bank to show the sincerity of the company. A lady, Mrs Carlill relying on the advertisement purchased and used the smoke balls as per directions but still caught influenza. She sued the company to claim the compensation of £100.  The Court of Appeal held that the essential elements of a contract were all present, including offer and acceptance, consideration and an intention to create legal relations. It was a general offer and Mrs Carlill had accepted it by her act, by performing the conditions for acceptance. She was therefore entitled to get the claim.

  1. Lalman Shukla vs. Gauri Dutt (Allahabad High Court-1913)

Rule of Law: Offer must be communicated. An action without the knowledge of the proposal is no acceptance.

In this case, Gauri Dutt sent his servant, Lalman to search his missing nephew. After Lalman had left in search of the boy, Gauri Dutt announced a reward of Rs. 150 to anyone who might find out the boy.  Unaware of the announcement of the reward, Lalman located the missing nephew and brought him back. It was held that Lalman was not entitled to reward since he had no knowledge of the reward, i.e the proposal.

  1. Mohori Bibee vs. Dharmodas Ghose (Privy Council-1903)

Rule of Law: A contract with a minor is void ab initio

In this case, Dharmodas a minor mortgaged his house for Rs. 20,000 and received Rs. 10,500 as mortgage money. Subsequently, the Dharmodas sued for setting aside the mortgage on the ground of his minority at the time of execution of mortgage deed. The Privy Council held that a minor is incompetent to contract and therefore, minor’s agreement was absolutely void, not merely voidable. Hence, the mortgage was cancelled. Moreover, the morgagee’s request for refund of Rs. 10,500 was also turned down on the ground that minor’s agreement was void from the beginning and therefore, the mortgagee has no right to restitution.

  1. Nash vs. Inman (King’s Bench-1908)

Rule of Law: To hold a minor’s contract for necessaries as an enforceable contract, two conditions must be satisfied, viz, (1) the contract must be for goods reasonably necessary for his support in his station in life; and (2) he must not have already a sufficient supply of these necessaries.

A minor ordered 13 fancy waistcoats from a tailor while he was already having sufficient clothes to wear. Held, the 13 waistcoats purchased were not necessities and the purchase price was irrecoverable.

  1. Chinnaya vs. Ramayya (Madras High Court-1882)

Rule of Law: It does not matter who furnishes the consideration. The consideration may be moved by the promisee himself or any other person.

A, an old lady, by a deed of gift, granted certain property to her daughter R. The terms of the deed stipulated that R will pay an annuity of Rs. 653 to A’s sister C. On the same day, R entered into an agreement with C to pay her the sum directed by A. The stipulated sum was however not paid and C sued to recover it. R contended that no consideration was moved by C to her. Madras High Court held that the words “the promisee or any other person” in Section 2(d) of the Indian Contract Act, 1872, made it clear that consideration need not move from the promisee only and C was entitled to recover the amount. The consideration furnished by C’s sister was enough to enforce the agreement between C and R.

  1. Rose & Frank Co vs. J R Compton & Bros Ltd (Court of Appeal-1924)

Rule of Law: To converts an agreement into a contract there should be an “intention to create legal relations”.

It is a glaring example of a business deal in which the parties did not intend to create legal relations. As per the facts of the case, an agreement was drawn between the American and English firms. The agreement mentioned that “this agreement is not entered into as a formal legal agreement and shall not be subject to the legal jurisdiction of law courts.” The agreement was terminated by one of the parties and other party brought an action for breach of contract. Held, the agreement was not a binding contract as there was no intention to create legal relations.

  1. Kedar Nath vs. Gorie Mohammad (Calcutta High Court-1886)

Rule of Law: An agreement without consideration will be perfectly valid and binding  if, on the faith of the promise, the promisee takes definite steps in furtherance of the object.

In order to construct a town hall at Howrah, the commissioner of Howrah Municipality started to obtain necessary fund by public subscription.  ‘A’ also promised to subscribed Rs. 100 to fund by signing his name in the subscription book for the purpose. On the faith of the promised subscriptions, the secretary of the town hall construction committee engaged a contractor for construction of town hall and thus, incurred liability. ‘A’ refused to pay his subscription. Held, engaging a contractor and starting the construction work on the faith of the promise to subscribe was sufficient consideration. Hence, ‘A’ was liable to pay the amount to the extent of the liability incurred by the promise.

  1. Damodar Murlidhar vs. Secretary of State of India (Madras High Court-1895)

Rule of Law: No one should be benefited at another’s expense.

The government repaired a village tank, which had irrigated lands belonging to other villages and zamindars. The government did not undertake the repairs gratuitously for the zamindars. Zamindars enjoyed the benefit of the repaired tank. Held, zamindars were liable to contribute to the cost of repairs.

  1. Dunlop Pneumatic Tyre Co Ltd vs. Selfridge & Co (House of Lords-1915)

Rule of Law: Doctrine of privity of contract

The doctrine of Privity of contract can be best illustrated by this English case. Dunlop & Co sold some tyre to Dew & Co with an agreement that these tyres will not be sold below the list price. Dew & Co, in turn, sold some of the tyres to Selfridge & Co with an agreement that they will observe conditions as to the price and they also promised that they will pay to the Dunlop & Co a sum of £ 5 damages, for every tyre sold below the list price. Selfridge sold some tyres below the list price and Dunlop & Co brought an action to recover the damages for the same. It was held that Dunlop & Co cannot enforce an action against Selfridge because there was no contract between them.

  1. Hadley v Baxendale (Court of Exchequer-1854)

Rule of Law: A party breaching the contract is liable for all losses that the contracting parties should have foreseen, but is not liable for any losses that the breaching party could not have foreseen on the information available to him.

Perhaps the most famous contracts case of all is Hadley v. Baxendale. A crankshaft of a steam engine at the mill had broken and Hadley arranged to have a new one made by W. Joyce & Co. The manufacturer, W. Joyce & Co required that the broken crankshaft be sent to them in order to ensure that the new crankshaft would fit together properly with the other parts of the steam engine. Hadley contracted with Baxendale, who were operating as common carriers under the name Pickford & Co., to deliver the crankshaft to engineers for repair by a certain date at a cost of £2.40. Baxendale failed to deliver on the date in question, causing Hadley to lose business. Hadley sued for the profits he lost due to Baxendale’s late delivery, and the jury awarded Hadley damages of £25. Baxendale appealed, contending that he did not know that Hadley would suffer any particular damage by reason of the late delivery. The question raised by the appeal, in this case, was whether a defendant in a breach of contract case could be held liable for damages that the defendant was not aware would be incurred from a breach of the contract.

The Court of Exchequer declined to allow Hadley to recover lost profits, in this case, holding that Baxendale could only be held liable for losses that were generally foreseeable, or if Hadley had mentioned his special circumstances in advance. The mere fact that a party is sending something to be repaired does not indicate that the party would lose profits if it is not delivered on time. The court suggested various other circumstances under which Hadley could have entered into this contract that would have presented such dire circumstances, and noted that where special circumstances exist, provisions can be made in the contract voluntarily entered into by the parties to impose extra damages for a breach.

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*About the author: CA Amit Talda is a Chartered Accountant having cleared his CA in the first attempt at the Age of 21 with All India Rank of 48 in CA IPC. Currently, he is a faculty at Talda Learning Centre, Amravati and has teaching experience of 3 years. He can be contacted at amittalada@gmail.com

 

 

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Termination of Contract

contract-cancelled-520x245

Contracts are entered into by parties with an intention to bind together in a legal obligation and thereby to serve the interest of the parties.  The parties, in order to govern themselves and to safeguard their interest, make their own terms and conditions.  Termination is an important stage in the life of any contract and therefore it is important that the parties should focus on the end of the contract before it has even begun, i.e., while the relationship between them is positive, for the parties to negotiate and agree on when and how to terminate a contract and deal with its consequences.

Meaning and Scope

When the parties enter into a contract, they become liable under law to perform their contractual obligations.  Failure to perform the terms stated in the contract can result in a breach of contract, litigation or other legal liabilities.  However, there are some conditions under which a contract can be legally terminated before the contractual duties have been fulfilled.  This is known as “termination of contract” and may occur for many different reasons.  To terminate a contract means to end the contract prior to it being fully performed by the parties. In other words prior to the parties performing all of their respective obligations required by the contract, their duty to perform these obligations ceases to exist.

In general, the effect of termination of a contract is to discharge the parties from their unperformed obligations under the contract. However, termination does not affect liabilities of the parties for breaches of the contract that occurred prior to the contract being terminated. And, despite the fact that future obligations to perform under the contract terms have been extinguished, if appropriate, the parties remain entitled to pursue claims for damages under the law and as provided by any termination provisions that may be contained within the contract.

Circumstances in which contract can be terminated

The decision to terminate a contract may be due to frustration, where it is not possible for the parties to perform the contract due to circumstances that are beyond their control and out of their realm of responsibility.  More often it is due to breach or non-performance, in which case it may be appropriate to terminate the contract.  A contract is said to be discharged when the rights and obligations created by it come to an end.

When is Termination of Contract Lawful?

Termination of a contract is considered to be lawful when a legitimate reason exists to end the contract before performance has been completed.  As per the Indian Contract Act, 1872, (Contract Act) a contract may be discharged by following modes:

1. Termination by Breach

Section 39 of the Contract Act, provides that if a person indulges in any fundamental breach of the contract and the other party does not acquiesce to the breach, then the party not breaching is not bound under the liabilities of the contract.  This would, therefore, enable a party to terminate a contract on the ground of substantial failure by the other party which goes to the root of the contract.

The breach of contract by one party does not automatically terminate the obligation under the contract; the injured party has the option either to treat the contract as still in existence or to regard himself discharged.

2. Termination by Frustration

According to Section 56 of the Contract Act, an agreement to do an impossible act in itself is void. The doctrine of frustration provides that if in a contract, certain events which are beyond the control of the parties take place and which make the performance of the contract impossible, then the contract is said to have been ‘frustrated’.

Conditions for the application of the Doctrine of frustration:

  • There must be a valid and subsisting contract between the parties.
  • Some part or whole of the contract must be unfulfilled.
  • The contract becomes impossible to perform after it is made due to some supervening event.

3. Termination by novation,  rescission, and alteration of contract

Section 62 of the Contract Act, states as follows:

“Effect of novation, rescission, and alteration of contract.- 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.- 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.”

The parties to a contract are free to substitute or rescind the entire contract, or to modify, alter, vary or rescind some of its terms.  Novation or modification of a contract can take place in the same manner as the conclusion of a contract.  If one party proposes a novation and the other party accepts this proposal in a qualified manner, there is no novation.  Where, after the contract, one party made a suggestion to the promisee that in view of certain difficulties he should cancel his contract at par and receive back his advance, and that suggestion was accepted by the other party, a new contract was made.

4. Contractual Termination Clause

Commercial contracts often contain express termination clauses which provide for termination for breaches other than repudiatory breaches.   Some contractual termination clauses work by expressly classifying terms as conditions or warranties so as to make clear those circumstances in which the contract can be brought to an end and those which only give a right to claim damages.  Some contractual provisions attempt to give rights to terminate for “material or “substantial” breaches or for “any breaches (however minor) or for repeated breaches”.  Termination clauses require to be drafted carefully and regard must be had to the way in which the courts approach such provisions.

5. Termination by Notice

If a contract contains a provision  that one of the parties thereto may determine the contract by notice at the option of one of the parties or either of the parties,  and may be made exercisable upon breach of contract by one of the parties (whether the breach amounts to repudiation or not), or on occurrence of any other specified event, or without requiring any reason simply at the will of such party entitled, such provisions may be express, or may be implied in the contract, or incorporated by usage or custom of trade.

6. Termination on Happening of an Event

The parties may stipulate that the contract shall be determined or shall be ‘void’ on the happening of a certain event.  If the event is such over which the parties have no control, the contract will cease to bind on the happening of the event.  If such an event is within the control of any of the parties, such party cannot insist upon the stipulation who, by his own wrongful act or omission brings about that event, nor can he compel to other party to insist upon it, since it is a universal principle of law that a party may never take advantage of his own wrong.

Effect of termination on party at whose instance termination was affected

The termination of contract means the contract ceases to operate, i.e. the rights and obligations created by it come to an end.  It might also amend or rescind completely such rights and obligations of both the parties.   The effect of termination on the party at whose instance such termination was affected are as follows:

  • If the contract was terminated on the basis of fraud or any other act which makes the contract voidable, the right to file a suit for the same is available.
  • If the contract was terminated on the basis of non-performance by the party, liable to pay compensation and damages to the other party.
  • If a contract of agency has been terminated, the obligation to indemnify.

Effect of termination on party against whom termination was affected

  • Termination of the contract releases both parties from their obligation to effect and to receive future performance. But the party if aggrieved can file a suit for such grievance.
  • A claim for damages for non-performance.
  • Termination does not affect any provision in the contract for the settlement of disputes or any other term of the contract which is to operate even after termination.

Remedies available on termination of contract

  1. Specific Performance: Specific performance is an order by the court that requires the breaching party to carry out the contract as it was originally written. This type of remedy is rare.  However, it may be ordered in certain circumstances.  For example, specific performance may be imposed when the subject matter is unique, such as a famous painting or a specific piece of property.  Courts are hesitant to order specific performance because it requires the ongoing monitoring by the court of the contract.
  2. Rescission: Rescission of the contract is a remedy that allows the non-breaching party to cancel his or her responsibilities under the contract.  This remedy might be available when the contract was based on fraud or a mistake by one or both of the parties.  It is also available if both parties prefer to cancel the contract and return any money that had been advanced as part of the contract.
  3. Reformation: Reformation allows two parties to modify a contract so that it more accurately reflects what the parties intend.  This remedy requires that the contract to be valid.  It may be available when one of the parties had a mistaken understanding of a material term of the contract.
  4. Legal Remedies: Legal remedies often take the form of monetary damages that are awarded to help make the innocent party whole.  Some examples of legal remedies are discussed below.
  5. Compensatory Damages: Compensatory damages are those that are meant to compensate the non-breaching party for the breach.  These include expectation damages and consequential damages.  Expectation damages are those that give the non-breaching party the monetary funds that he or she would have received had the contract been performed.  These damages are usually based on the contract itself or the fair market value of the subject matter of the contract.
  6. Consequential damages are those damages that reimburse the innocent party for indirect costs that resulted from the breach. They often result from special circumstances that are involved in the contract that may not be ordinarily predictable.  For examples, an innocent party may ask to be reimbursed for the loss of business profits that derived from not having access to the necessary materials to produce a product for a third party.
  7. Liquidated Damages: In some contracts, specific damages are predetermined.  These damages are called liquidated damages.  They are typically part of contracts where it would be difficult to determine the actual damages caused to a party due to a breach, such as a breach of a contract not to compete.
  8. Punitive Damages: Punitive Damages are meant to punish a guilty party in order to prevent that party or others from engaging in similar conduct in the future. However, punitive damages usually require a stronger intent than is necessary for a standard breach of contract claims.  For example, to be awarded punitive damages, a plaintiff may have to show that the breaching party acted in a malicious or fraudulent matter.  Some jurisdictions specifically prohibit plaintiffs from recovering punitive damages on a breach of contract claims.
  9. Restitutio In Integrum: In India, the underlying basis for awarding contractual damages is to put the party suffering from a breach of contract in the same position as if the contract had been performed through payment of damages/compensation for losses.  There has been very little development in relation to the law of damages in India.  The courts have refrained from an extensive discussion about the factors that determine the extent of damages payable in case of a breach of contract.  The courts seek to limit themselves to a simple application of the rule in Hadley v. Baxendale in most circumstances as the rule has been incorporated into section 73 of the Contract Act with little or no modification.

Conclusion

Contract termination is a drastic step and should be done with caution and with proper legal advice. When a contract is terminated, it is often said that it “comes to an end” or “ceases to exist”.  However, these statements are somewhat misleading as the contract not only continues to exist but continues to have an operation in some respects.  What is in fact “terminated” is the future performance of the contract – that is, the primary obligations of the parties that have been partially performed at the time of termination and those that would have fallen due for performance had the contract not been terminated.

Termination takes effect from the time a party exercise the right to terminate the contract, not from the time that party was entitled to terminate.  This is in contrast to “rescission ab initio” (rescission from the beginning) which may be available if there is a defect in the formation of the contract, in which case the contract is annulled from its inception and the parties are substantially restored to the position they held before they entered into the contract.

 

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