A commercial contract forms an integral and critical part of any business venture, as such arrangements detail the rights and obligations, commercial terms, discussed and agreed upon between the parties including recourse in case of any dispute. Therefore, it is extremely crucial to ensure that the terms mentioned in the contract are drafted in a manner that protects the interests of the parties to the contract. Moreover, the idea of one form fits all should not be followed while drafting a contract. Any aspect which is not covered or captured appropriately while drafting or negotiating a contract can result in huge losses and/or damages, in case of a dispute or even otherwise.
Now, the term “contract” is defined under Section 2(h) of the Indian Contract Act, 1872 (“Contract Act”) as an agreement enforceable by law. Commercial contracts are primarily governed by the Contract Act and; the Specific Relief Act, 1963 (“SRA”). However, both the legislations have their own binding and governing effect on the provisions of the contracts, as Contract Act stipulates the conditions that are essential to ensure the validity of a contract which include
(i) offer and acceptance
(ii) intent of the parties
(iii) lawful consideration
(iv) parties competent to contract
(v) free consent
Additionally, it also provides the grounds which are necessary to claim damages and indemnity from a defaulting party in case of breach or violation of any provisions or obligations under the contract. On the other hand, the SRA provides remedies to persons whose contractual rights have been violated such as the recovery of possession of the property, specific performance of the contracts, recission of contracts, rectification of instruments etc.
In this article, we will briefly discuss and list out certain types of commercial contracts that are typically executed in India with respect to a business and the legal nuances that are to be kept in mind while drafting and negotiating these commercial contracts in order to avoid any ambiguity or conflict with respect to the analysis/interpretation of the provisions surrounding a commercial contract.
Common Types of Commercial Contracts in India:
The Service Agreement is basically executed between the parties to capture the terms and conditions of the services being provided by one party to another party along with the consideration being paid by the party to the service provider, rights and obligations of the parties.
The Non-Disclosure Agreement (NDA) is basically executed to bind the employees, vendors, suppliers, service providers, consultants, and independent contractors with the purpose of restricting and restraining them from sharing any confidential information in relation to the business, including trade secrets, client details, business plans etc. of a company. The NDA can be either unilateral or mutual based on the requirements of the transaction between the parties.
A Partnership Agreement captures the relationship, duties, powers and obligations of the partners, capital contributed by each partner to the partnership, procedure that will be followed for dissolving the partnership, admission or removal of any partner.
Loan Agreement/ Security Agreement
A Loan Agreement is drafted to capture the terms and conditions of lending including the term of the loan, and repayment terms between a borrower and a lender. Whereas, a Security Agreement is executed when any asset or property is being pledged as collateral for the purpose of securing a loan.
A Licensing Agreement is a contract between 2 (two) parties, i.e. the licensor and the licensee. Under this agreement, the licensor grants the licensee the right to produce and sell goods, apply for a brand name or trademark or use patented technology owned by the licensor.
A Distributor Agreement is basically an agreement between the supplier of goods and the distributor of goods. The supplier can either be the manufacturer of the goods or the distributor reselling another’s goods.
A Franchise Agreement is basically an agreement which sets forth the rights and obligations of the franchisee as well as the franchisor. It is pertinent to note that there is no standard form of the franchise agreement as the terms, conditions and methods of operation of a franchise depends on the type of business being carried out by the franchisor. The payment required to be made by the franchisee to the franchisor under the franchise agreement can either be one-time or periodical as per the terms and conditions agreed between the parties.
Joint Venture Agreement
A Joint Venture Agreement also known as a JV agreement is basically an arrangement between 2 (two) or more entities who have agreed to undertake either new or existing business together. Under the said arrangement, the parties pool their resources by way of contributing the equity and sharing the revenues, expenses and control of the new venture in proportion to the capital that the parties have contributed.
A Shareholder Agreement basically outlines the relationship between the company and its shareholder wherein the rights and obligations of the shareholder is being captured. By way of executing a shareholder agreement, the company ensures that shareholders are being treated fairly and their rights are protected.
Sale and Purchase Agreement
A Sale and Purchase Agreement is executed between the buyer and the seller for the purpose of capturing the terms and conditions of the sale process. The said agreement is important for both, seller and buyer as it captures not only the due diligence periods or conditions that must be met before the sale but also the closing date, purchase price, the amount of earnest money that the buyer must submit as a deposit, and the list of items that are and are not included in the sale.
An Employment Agreement is a legally binding agreement that governs a working relationship between the company/employer and an employee, and it is basically used with respect to new hires, recruits and current employees who are changing job positions. It primarily captures the duration of employment, schedule, salary or wages, job responsibilities, confidentiality, intellectual property rights, grounds for termination, dispute resolution, etc.
Intellectual Property Licensing Agreement
An Intellectual Property Licensing Agreement or IP License Agreement is a legal agreement executed between the licensor who owns the IP rights and the licensee who is authorized to use the rights such as trademarks, trade secrets, copyrights, patents, etc. in exchange for money in terms of royalty or fee or both. There are various factors which need to be taken into consideration while drafting the IP license agreement such as exclusivity, territory, time period, rights to future developments, assignment, sub-license or termination of the license, etc.
FAQs Pertaining to Commercial Contracts
1. Execution and validity of e-contracts in India
There is no prohibition in India pertaining to the execution of e-contracts. However, it is pertinent to note that e-contracts should be in compliance with the necessary pre-requisites provided under the Contract Act. Further, the e-contracts are legally recognised under section 10 of the Information Technology Act, 2000 and their evidentiary value is recognised under section 65A of the Indian Evidence Act, 1872.
2. Important Clauses in Commercial Contracts
While drafting a contract, it is pertinent to keep in mind that apart from capturing the business arrangement between the parties, the contract must contain provisions with respect to confidentiality, representations and warranties, force majeure, termination, indemnity and limitation of liability, dispute resolution. The confidentiality clause defines what all information has been received and events/circumstances when such confidential information can be disclosed pursuant to the arrangement under the contract. The representations and warranties clause as the name suggests, lists out each party should provide representation and warranty in relation to their; (a) ability and authority to enter into and execute the contract and further undertake the responsibilities mentioned therein, (b) having the relevant skill and expertise (in case of a service provider) to undertake the obligations mentioned in the contract, amongst others.
Further, the importance of the force majeure clause has escalated due to the situation faced by entrepreneurs as a result of the novel COVID-19 pandemic. The parties to the contract have started including the terms such as ‘epidemic’ and ‘pandemic’ within the definition of a force majeure event in order to avoid any issues arising as a result of the COVID-19 pandemic.
In addition to the foregoing, it is pertinent to note that the termination clause also holds an important value in a commercial contract as it sets out the events and conditions when the contract can be terminated by either party. The indemnity clause plays a vital role in managing the risk associated with commercial contracts as indemnity is an undertaking to make good any monetary or other loss which may be caused due to damage. The key concept behind the indemnity clause is to bring a person back into the position he/she was before the damage happened. Considering that a suitably drafted indemnity clause does not mandate the requirement of proving a loss in order to invoke indemnity, therefore, including a limitation of liability clause helps in capping the extent of claim against the indemnifying party. Finally, the dispute resolution clause defines the process agreed upon between the parties for the resolution of a dispute which may arise in relation to the subject matter of a contract and therefore must be drafted in a manner to avoid further delays in the resolution of a dispute.
3. Factors to be Kept in Mind While Negotiating any Contract
From the foregoing, it is important to take due care while negotiating the terms of a contract as any breach of any of the terms and conditions may result in invocation of the indemnity provided under such commercial contract.
Under any commercial contract, the clauses pertaining to representations and warranties, indemnity and limitation of liability, events constituting breach and dispute resolution are aggressively negotiated. The clauses with respect to representations and warranties seem harmless at first glance but in case of a breach of a representation or a warranty, the non-defaulting party can terminate the contract and invoke indemnity as representations and warranties are typically backed by an indemnity from the party providing them. Thus, the party may be liable for an indemnity claim by the counterparty for breach of any such representation and warranties. It is always advisable to cap indemnity where a party is providing services under a contract, this can be achieved by limiting the extent of liability by way of a limitation of liability clause. The service provider in such an event must ensure that the indemnity is not open-ended and the liability is capped to an agreed threshold, or a minimum threshold is decided below which no claims may be raised by the indemnified party under the indemnity provision. However, in the case of a service recipient, it would be advisable to have the process for payment of indemnity clearly laid out including ensuring that in case of a limitation of liability provision, sufficient exclusions are made where liability is not capped or specific indemnities are obtained in case of any foreseeable claims.
Further, the dispute resolution clause is also important for any commercial contract as it sets out a written understanding between the parties specifying what exact recourse is required to be taken in case of disagreement between the parties and the steps to be followed for resolving such dispute based on the mechanism chosen by the parties for resolving the disputes. Dispute resolution can be a tricky provision to negotiate in case parties are from two different jurisdictions, however, in any event, a two-step process for resolution of a dispute is advisable to avoid unnecessary litigation. Parties may choose for a short timeframe to amicably resolve a dispute amongst themselves and in the event, the parties fail to amicably settle the dispute they may proceed to court. In case of failure to amicably resolve a dispute, if the parties decide that resolution of a dispute must take place through arbitration instead through court, the procedure with respect to the appointment of an arbitrator and the arbitration proceedings must be properly outlined in the contract for utmost clarity.
4. Statutory limitation on indemnity under a commercial contract
The extent of liability in the indemnity clause under any commercial contract depends majorly on the nature and terms of such contract. While there are certain protections and limitations provided under law for claiming liquidated and unliquidated damages, however, there is no such statutory restriction imposed on the quantum of loss that can be claimed under the indemnity clause due to which indemnity clauses in commercial contracts are subject to extensive negotiations. Under the indemnity clause, the indemnifying party focuses on limiting the scope of indemnity to the maximum extent possible whereas, the indemnified party focuses on widening the scope for indemnity. Further, the indemnity clauses can be drafted and structured in a way that they can also cover the liability for any past transactions along with future transactions.
5. Right of one party to terminate a commercial contract if the other party has declared insolvent
It is pertinent to note that there is no statutory restriction on terminating any commercial contract if the other party has been declared insolvent or is in financial distress if the parties have already agreed upon the ground for termination and have accordingly captured them explicitly in the commercial contract. Generally, parties under commercial contracts capture the understanding that the contract can be terminated immediately if the other party is declared insolvent or is in financial distress.
6. Requirement to seek the prior consent of the other party before assigning rights and obligations under a commercial contract
A party under a commercial contract can assign its rights and obligations without obtaining prior written consent from the other party if the right of assignment has expressly permitted under the commercial contract. In the event a commercial contract is silent on the aspect of assignment then it shall be dependent on the intention of the parties.
The commercial contract must be carefully drafted and should be thoroughly checked before signing. The parties should expressly mention what they want to include or exclude from the contract. Any term, right or obligation is written vaguely will only leave ambiguity between the parties. Therefore, it is important that the contract should be drafted with clarity and precision and with appropriate professional help to avoid any dispute or litigation in future.