This piece is part of the series intended for business leaders, providing them working knowledge of various business laws. By its very nature, it is neither comprehensive nor is it supposed to replace the guidance of a law expert. Read more about this series.
Do you feel anxious and agitated when you receive a longish agreement to be approved and signed, after you have negotiated and finalised all essential terms of the contract? Do you have your own in-house or dedicated legal team to scrutinise such agreements? Here is an 11 point checklist you can use before you sign an agreement.
- Name & description of the Parties to the contract: You should check and ensure that the name and address of both the Parties to the contract are correctly recorded. It should record the legal name of the Parties, as opposed to just the popular name – like Dabur or Microsoft. These are brands or trademarks, not the names of actual legal entities. It should also indicate the correct nature of the organization of the other Party. For example, is it a Company, a Partnership Firm, a Trust, an LLP, etc. Once this is established, you will also be better equipped to judge whether the person who will be signing the Agreement on behalf of the other Party is appropriately authorised to do so. Check, and if necessary, ask far the basis for such authorisation.
- Correct stamping of the document: The nature of the transaction and the place of execution of the Agreement determines the stamp duty payable in respect of the Deed of Agreement. Remember two basic principles (a) Stamp Duty is payable on the Instrument , i.e. the document, not on the transaction itself; and (2) Stamp Duty rates are specific to the nature of the underlying transaction and the place of execution (the State in which the transaction is being executed). [Read more about the importance of the place of execution of a contract, here].
- Tax aspects of the transaction: Practically all economic transactions will have a tax angle. Check whether tax liability attracted by the Agreement is not excessive. Broadly, these are the tax angles to think about:
- Stamp duty payable on the transaction document and who should pay it.
- Indirect taxes such as Goods & Services Tax. To ensure that description of the transaction does not wrongly put your transaction in the higher tax group/classification – if you are buyer or receiver of services. Similarly, not in a lower rate classification and invite avoidable litigation with the government – if you are the vendor/service provider. There should be provisions for appropriate mechanisms (such as proper Invoices) to ensure full Input Tax Credit to the buyer before payments are released. Similarly, an appropriate mechanism should also be provided for in respect of other types of taxes, such as who is to reimburse the amount of tax, like property/house taxes, etc. These should only be paid against proof of payment to the relevant authorities.
- Direct taxes: Normally, direct taxes are not mentioned in day to day agreements and it is presumed that the Parties shall bear their respective tax liabilities. However, there are two aspects which are important. The first is the liability of TDS/Withholding Tax. The tax is withheld by the Party who makes the payment, and he is supposed to deposit it with the government. The receiving Party often has to worry whether the other Party has paid it in time to enable the receiver to claim the credit for the tax deducted. If you are the payer, ensure that your authority to deduct is clearly mentioned. Similarly, if you are receiver, ensure there are enough safeguards to ensure that the other Party deposits the tax with the government in time. There is yet another aspect of Income tax liability. It arises when one Party (payer) is not only to make payment to the other Party but also bear the Income-tax liability on such payment. In such cases, the tax liability on such amount has to be grossed up by way of multiple stage grossing up. In this grossing up, a tax liability of a mere 30% rises to an effective rate of 42%. Take care to ensure that the payment structure itself is specified in a way that it does not attract multiple stage grossing up.
- Clear statement of duties and responsibilities: This aspect of the Agreement is generally to be examined by the commercial branch of your organisation instead of the law department. However, ideally such duties should be listed and described in an objective manner, using language which is specific to your trade or business. If any confusion is likely to arise, it is better to clearly define those terms in common man’s language. While the terms of the Agreement should not be repetitive, clarity is more important than brevity. You should not accept clerical and routine responsibilities (like periodical reporting etc.) which are not important to the substance of the contract. All time limits for reporting, delivery, payments should be genuinely possible, keeping in mind the nature of your organisation, your manpower, internal processes etc. Do not agree to unrealistic time frames.
- Billing, payment terms, modes of payment etc.: This aspect of contract documentation is quite important. It has several aspects and need independent discussion:
- Who bills whom?: In joint venture/agency/collaboration type transactions, it is quite natural to strive for an arrangement where you get to show the entire volume of business as your own business; i.e. you want to report the revenues as your own even if you then pass on a bulk of it to the other Party. But remember the adage: top-line is vanity, and bottom-line is sanity. Bigger top-line looks good and impressive, but it comes with its own share of responsibility and complications. First responsibility is that of taxation, accounting, reporting etc. You become liable for all the tax (GST) related issues. Second issue is that you then bill the end user/customer and therefore you become privy to the customer and also target of all possible litigation with him in respect of services/warranties etc. Weigh pros and cons before rushing to grab the top-line.
It does have some big advantages, however. Since you will bill/ invoice the customer, you will get the amount in your account and you will not be at the mercy of the other Party to deliver your share in the top-line. Second advantage is that you get to use the funds before you are required to give the share of the other Party. Further, since you will pay to the other Party, you will deduct the TDS, if any, and would therefore be entitled to enjoy the float of TDS amount as well. - The currency in which the Invoice is to be raised (especially where cross-border transactions are involved) should also be clearly mentioned, as it may have complications as to foreign exchange rate fluctuations and the conversion costs thereof. As a side note, ensure that the currency is precisely specified. For instance, a Dollar is not necessarily the US Dollar. Ideally, use the three letter ISO currency code like USD or INR.
- Time frame of payments: The exact time frame within which payments have to be made, or the conditions which should be satisfied, time frame for raising of objection, resolution of such objections etc. should be clearly mentioned. Consequences of delay in payment-like levy of interest, circumstances in which it could be waived are essential components of the relevant clause of the Agreement. It should be examined whether the entire amount of invoice could be held up when there is an objection relating to some smaller aspect of the transaction. It should be clearly mentioned that undisputed payment obligation does not get defeated by any circumstances, including Force Majeure events (see here). In cross border transactions, special care has to be taken in respect of remittances in case of development of hostilities between the countries involved.
- Mode of payment: It is wise to provide that all payments shall be through banking channels, viz. crossed cheques, drafts, banker’s cheque, NEFT, RTGS, IMPS and shall be given credit only on sighting of the credit in the account of the recipient. If there are likely to be any expenses in connection with remittance, it should be specified as to who bears the remittance costs. In case you expect to receive funds frequently, giving the details of bank account in the Agreement itself may be thought through fully. Putting bank details in public domain is not a great idea.
- Who bills whom?: In joint venture/agency/collaboration type transactions, it is quite natural to strive for an arrangement where you get to show the entire volume of business as your own business; i.e. you want to report the revenues as your own even if you then pass on a bulk of it to the other Party. But remember the adage: top-line is vanity, and bottom-line is sanity. Bigger top-line looks good and impressive, but it comes with its own share of responsibility and complications. First responsibility is that of taxation, accounting, reporting etc. You become liable for all the tax (GST) related issues. Second issue is that you then bill the end user/customer and therefore you become privy to the customer and also target of all possible litigation with him in respect of services/warranties etc. Weigh pros and cons before rushing to grab the top-line.
- Representation & Warranties: Most modern drafting styles include specific clauses dealing with Representation and Warranties. Representations are those assertions of facts, as of the date of making the assertion, which are made to induce the other party to enter into the transaction. These can include statements such as the scale of your business, the brand names and licenses/permits you own, etc. On the other hand, Warranties are assurances that you will make good the loss if the representations made by you are found to be false. In some serious circumstances, some representations may lead to cancellation or annulment of the agreements. Generally, though, the consequences are the claims for indemnifying the consequential losses. Therefore, you must ensure that the Agreement does not include any factual assertion on your part of which you are not absolutely sure of. On the other hand, ensure that all the representations made by the other Party, because of which you are signing the Agreement, are appropriately incorporated in the Agreement. Ensure that there is a representation from the other party that it is competent to contract, that it is an entity subsisting in accordance with law and the person who is signing the document has proper authorisation to represent the other Party. Remember, not every employee can automatically sign an Agreement on behalf of his or her employer. Apart from the representation, you should in fact ensure that the signatory of the document authorised to do so.
- Indemnities: Indemnities are agreements to compensate the other party for any losses incurred or suffered on account of any action by the indemnifying party or its agents. Indemnities included are independent of the core purpose and subject matter of the Agreement. Indemnities also include the consequences of third party claims arising on account of things like defaulting Party having defect in their title of goods, services, assets, IP Rights or defaulting party knowingly or unknowingly affecting third party rights etc. You must ensure that you are not held responsible for indemnifying the other party for acts and events which are not in your control. Further, in any case, the extent of indemnification must be limited to actual loss and expenses incurred by the other Party. There must be no sweeping statements making you liable for indirect or consequential losses and expenses. The Agreement should not disallow you from challenging the amount of claim for the indemnity, and there should not be a lump-sum estimated amount of loss to be reimbursed in any circumstance.
No discussion on this subject would be complete without mentioning Limitation of liability clause. The moment you come across such a clause, be on alert. The other Party should not get away with limiting its liability for damages to a trivial maximum sum, especially when such a loss or damage arises on account of (1) fraud and gross negligence of the party or its agents; (2) breach of your IPRs and misuse of your tradename/brands; or (3) disclosing your confidential information. - Confidentiality obligation: It is quite common that parties to a contract exchange valuable business secrets between them. More often than not, you may suffer significant losses if the said secret information is either leaked or is used by the other Party for purpose other than those of the Agreement. Wherever the proposed business relationship is very significant or likely to last long, or there is significant intellectual property secrets like patents, processes, formulas, sources of raw materials, etc, it is advisable to execute a separate and detailed Non-disclosure agreement. However, in smaller cases, an efficiently drafted small clause can also serve the purpose. You should ensure that whatever business secrets you are likely to disclose to the other Party are included in the Agreement, either specifically or reasonably in expressions of general nature. These should not be left to any guess work. The next important thing is the period for which the said confidentiality of the information is to be maintained. Generally it should last for some further period after conclusion of the agreed project/transaction or termination of the contract. We will discuss non-disclosure agreements in detail in a separate article.
- Intellectual Property rights: You should ensure that the scheme of the Agreement does not result in your unintended license or permission to the other Party to use your Intellectual Property Rights, whether or not the IPRs are registered. It is very common for the other Party to use your trademarks and logos to derive commercial benefits by holding out business associations with you. Some continue to do so even after the completion of the project/transaction and/or termination of the contract. There should be a distinct clause prohibiting the other party from doing this. In case of violation, you should be entitled not only to claim damages for losses but also for prompt termination of the contract if the breach of this condition is something which cannot be effectively cured.
- Termination conditions and consequences : Termination of contracts is not very rare. Therefore, there are elaborate provisions dealing with situations which would entitle the Parties to the contract to terminate the same. While termination of the contract on account of breach of material conditions of the contract are obviously justified, its consequences should be commensurate with the severity of the breach, and should not be in the nature of severe penalty, especially if the breach is not intentional or fraudulent. It is important that the other Party should not be able to terminate the Agreement for mere business convenience or if they realise that it is burdensome to continue with the Agreement. You should ensure that termination in such situations is (a) after sufficiently long notice which enables you to make alternative arrangements (b) you are not left with the heavy luggage of the past – like unsold inventory, advertisement material, unfinished third party contracts of supplies, stock and goods in process, unrealised trade debtors etc.; and (c) it sufficiently compensates you for all the one time expenses/capital expenses incurred by you to start and continue the Agreement project. The converse is also true, in the sense that you should be able to wriggle out of an onerous Agreement by giving reasonable notice etc. without being liable for penal consequences. In this Covid-19 period, discussion would be incomplete without mentioning the Force majeure clause. While Force Majeure events should be appropriately described and listed, termination of the Agreement should not be automatic. You may provide for a cure period, and there should be a proper written communication of such event(s). In any case, it is desirable that the obligations to pay the agreed/accepted/accrued liability is free from the effect of Force Majeure events clause. (A more detailed discussion on this is here.)
- Dispute Resolution Mechanism – Law and jurisdiction applicable to the proposed Agreement: While more than 95% of all Agreements and transactions get executed successfully without any significant dispute, you cannot be lax about this point. Considering the time of judicial processes, modern agreements specifically provide for consent to refer the matter to arbitration as a matter of first resort. While bigger agreements contain very detailed terms of arbitration, smaller agreements contain the basic clause of referring the matter to arbitration in accordance with the local law relating to arbitration – in India – the Arbitration and Conciliation Act, 1996. Indian law as of now (after recent amendments) is quite detailed and effective and also reasonable. Therefore, any provision which is detailed but which gives arbitrary powers or discretion to one party, should be protested against. Generally, it is in respect of selection of the arbitrator(s) and also the place of arbitration. Avoid all unreasonable terms in this regard. Please note that arbitration, though a faster process, is no longer cheap process and therefore both the above terms become important. Holding of arbitration at any place outside India or under the aegis of any Arbitration forum of any foreign country should be strongly resisted as they are very costly. You should also see that arbitration clause does not cripple you in enforcing recovery of agreed payments/dues and that the arbitration panel is given power of granting interim reliefs also.
Coming to the applicable law and jurisdiction. There are some transactions/disputes which are specifically provided to be dealt with in accordance with the law of specified State, not all of them are so specifically provided for. Therefore, check as to which court(s) will have jurisdiction to deal with potential disputes. In all likelihood, the other Party would specify the court which is most convenient to it, and would not bother to see your convenience. Take care of it. At the same time, remember the basic rule: jurisdiction of court is not a matter of contract but of law. So, even if both the Parties agree, they cannot agree to jurisdiction of a court who does not have anything to do with the subject matter of agreement/dispute. But where courts of more than one city/location can have jurisdiction, Parties may agree to restrict it to one specific court. Ensure that your convenience is also taken care of.