Mitigating Legal Risks Through Contracts

© LawQuest 2009. All Rights are Reserved. 1Saturday, December 19, 2009 at the Godrej Premises, Vikhroli, Mumbai

Mitigating Legal Risks Through Contracts

Poorvi Chothani, Esq.LawQuest, Mumbai, India


What is a Contract?


• A contract is an agreement between two or more individuals, businesses, organizations or government agencies to do, or to refrain from doing, a particular thing in exchange of something in value.

• In law, a contract is a binding legal agreement that is enforceable in a court of law.

• A contract is an exchange of promises for the breach of which the law will provide a remedy.

• As long as the goods or service provided are legal, any oral agreement between two parties can constitute a binding legal contract.


Traditionally We:

• Are “contract averse”• Perceive lawyers as black-coat-sporting litigators• Do not perceive any harm in having contracts drawn up

by a Chartered Accountant or a Company Secretary• Do not perceive any harm in using templates or old

agreements for new deals


What are the Risks Associated With Contracts?


What is Risk?

Definition hazard:

a source of danger;

a possibility of incurring loss or misfortune

Types of Business

Risk

• Financial• Political• Fidelity• Legal

Oxford Dictionary as a chance or probability of danger, loss, injury or other adverse consequence

Legal Parlance peril, hazard or chance of loss

Common Usage a chance of encountering a situation in which one has to suffer loss or injury


Godrej’s Businesses

•Furniture •FMCG•Real Estate Agriculture•Audio Visual Solutions•Electrical and Electronic Products•Locks •Process Equipment •Security solutions•Machine Tools

• Vending Tools • Chemicals• Construction• IT and Software Solutions• Service Material• Handling Motors• Precision Engineering • Precision systems


Types of Contracts Godrej Employees Need to Deal With

• Marketing Contracts (With Dealers, Agents)

• Distribution Agreements (Consumer Goods, Electrical, Electronics and Engineering Products)

• Agency Agreements (Sole Selling Godrej Agents)

• Procurement Agreements (All Godrej Companies)

• Sale and Purchase Contracts (All Godrej Companies)

• Job Work, Production or Manufacturing Contracts (FMCG) • Warranty Agreements (Consumer Goods, Retail Industry)

• Employment Contracts (All Godrej Companies)


Need to Identify, Predict, Mitigate and Manage Risk

Remember – the law affects all – every entity, whether natural or artificial, is governed by law right from birth to death.

Lack of these might cause:–Business losses–Loss of clients–Penalties–Imprisonment


Risk Exposure

Business Organizations

Regulated Statutes (Laws)

Business Relations

Corporate Policies

Commercial Legal Risks

Contractual Risks

Loss of Business

Minimized Complete and clear risk treatment systems

Managing Expectations


Types of Legal Risks

Organizational Legal Risk

Associated with maintenance of the companies assets and properties

Internal affairs of the Company

Examples Failure to protect intellectual property

Conflict of interest between shareholders and the board of directors

Legal Methodology Risk

Methods adopted and steps taken to protect the company’s assets

Protection against •claims by others •Liability to pay compensation

Example The company does not ask its counterparties for warranties but relies instead on its due diligence process


Contractual and/or Business Risks

Operational Legal Risk Obligations or liabilities that were not foreseen, or are greater than were foreseen

Example The possibility that contractual rights will be void or unenforceable due to:•illegality;•a technical defect (e.g. lack of restriction or registration);•lack of capacity (of either party);

Risk suffered by Companies

Two Types of Loss/ InjuryPecuniary Loss

– Damages– Borne by Company

Corporate Loss– Imprisonment– Borne by Directors


Legal Risks Associated With Contracts

Reasons Example

Contractual provisions unenforceable

Contract for Prostitution

•Unenforceable in India / Middle East Countries

•Enforceable in Australia

Contractual Provisions inadequately drafted

Liabilities of parties not documented

Obligations of the Parties ambiguous

•A agrees to sell 10 mtrs of cloth

•No description of the cloth


Legal Risk Associated With Contracts

Responsibility •Company•Officers In Charge – conduct of the affairs of the company

Offence •Civil i.e. compliance defaults, breach of contract etc. or •Criminal i.e. cheating, breach of trust, fraud etc.


Kinds of Legal Risk

• Product Liability (Commercial and Statutory)

• Employee Liability (Contractual and Statutory)

• Management Liability (All encompassing, corporate governance, statutory compliance, etc.)

• Compliance Default (Statutory and Organizational Policies)

• Tax Compliance (Statutory)

• Environmental (Statutory and Organizational Policies)

• IPR Protection (Management, Internal Systems and Enforcement)


Advantages of Contracts

• Contracts help define the scope of services and the deliverables of a product

• They help define expectations and obligations• Well defined expectations and obligations are imperative

to manage client or customer relationships• Written contracts mitigate ambiguities and

misunderstandings• Reduce risks


Product Liability Risk

Association • Final product• Arising from the performance of the product and spare parts or components

Minimized by • Inserting clauses clearing defining liability and limiting it• Limiting liability of the manufacturer and fixing the liability on the sub-contractors wherever appropriate

Example • Manufacturing Companies - Exposed• Minimized by outsourcing the work


Employment Liability Risks

Association •Deduction and/or payments of employee welfare statutory dues like provident fund, ESI contribution, bonus, gratuity, wages etc.•Company held responsible for the act of its employees/directors/managers

Minimized By •Execution of proper Employment contract•Statutory compliances like labour laws•Limiting liability of the Company for the acts of its employees/ directors/ manager.


Management Liability Risk

Satyam Case

•Promoter and Chairman of the Company issued misleading financial information

•Indulged in falsification of accounts, overstatement of profits and debt owed to the Company and understatement of liabilities

• Charged with offences of criminal conspiracy, cheating, impersonation, forgery etc.


Management Liability Risk….Contd

Satyam Case

•Price Waterhouse Coopers independent auditors of the Company verified the accounts and approved it

•The role of Price Waterhouse Coopers - the statutory auditors in “India’s Enron” comes under the spotlight amid allegations that large Indian companies regularly use misleading accounting techniques and bully analysts, accountants and auditors into staying quiet

•Proceedings started against Auditors also

•The Company as a whole and the all the employees of the Company had to suffer as a result of the fraud by the Promoters and the Chairman

•Third Party Fault - Company liable - Price Waterhouse Coopers failed to discharge its duties.


Compliance Default Risk

Association Compliance with laws e.g.

(i) Companies Act

(ii) Income tax Act,

(iii) Labour legislation

(iv) Banking Regulation Act by banking companies

(v) Electricity Act by electricity companies etc.

(vi) Contract Act, 1872

Consequences • Entails Penal Provisions

Exposure to legal actions by regulatory authorities

Minimized by Legal Compliance Systems and Periodic Audits


Tax Compliance Risk

Association •Non-payment of direct or indirect taxes •Short payment thereof•TDS deductions

Consequences •Results in severe penal actions•Attachment of property•Fine / Penalty


Intellectual Property Rights Protection Risk

Registered IPRs Patents, copyrights, Trademarks and Designs registration.

Unregistered IPRs

Know-how and trade secrets

Minimized by •Inserting confidentiality and non-disclosure clauses in the contract •Representation on ownership of IPR


Mitigation of Risk

Definition •Reduction of the loss or injury arising out of legal risk

Ways • Limiting the liability of parties to the contract•Quantifying Damages•Insurance•Specific representations and warranty clauses•Due Diligence•Indemnity


Contract and Risk Management

Impact of Contract

•Role in management •Operations •Business activities of enterprises•Decides the legitimate rights and interests of enterprises

Ways •Contract Review•Contract Drafting


Management and Reduction of Risk

Risk Management

•Estimation of probability of risk•Implementation of risk treatments

Risk Mitigation Is the exercise aimed at reducing loss or injury arising out of legal risk exposure.

Risk Treatment •Risk avoidance•Risk reduction•Risk transfer•Risk retention


Risk TreatmentRisk avoidance •Activities that may invite risk are not performed or

minimized•Example - Not buying a disputed property

Risk reduction • Reduction of the severity of the loss •Example – Due Diligence, Background Check

Risk retention •Acceptance of loss. •Risks that are incapable of being avoided or reduced are retained by default.•Example – Events of Force Majeure

Risk transfer •The loss is transferred to a third party•Example - Insurance•Non assuming of third party claims in Contracts


Key Elements of a Contract

Developing key contractual elements

Negotiate •key elements of the contract

Examine •concepts of consideration

Maintain •clear communication •record of all contracts•tabulate time lines to ensure compliance•tabulate deliverables to ensure compliance

Analyze •conditions and warranty clauses


Key Elements of a Contract…contd.

Ensuring the foundations of the contract are secure at the bargaining table

Understand •requirements to ensure the contract protects their business interests

•technical and legal expectations

•special inclusions / exclusions required

Utilize •techniques to obtain the desired outcome when commercial leverage is absent

Analyze •risk of offers and acceptance

•will your client be inadvertently contracted


Key Elements of a Contract…contd.

Effective dispute resolution clauses

Examine Dispute resolution options

Identify Forum •Which will be the city and court where you will bring a dispute?

Identify Applicable Law

•This is important in cross border or international contracts

Determine •Courtroom Litigation v Arbitration•Forum •Applicable Law

Provide For feasible method of identifying the arbitrator

Ensure Enforceability of arbitration award


Key Elements of a Contract… contd.

Dispute Resolution

Litigation Arbitration

Formal

No control over Judges

Informal

Arbitrators appointed by parties

Public Domain Confidentiality

No experience in the subject matter of the dispute

Practical experience of technicalities in question

Judges powers limited determine and enforce the contractual rights of parties

Arbitrators can modify the contractual rights of the parties

May substitute their discretion as rights expressly given by agreement

Very Lengthy Process Less time Consuming

Less costly than arbitration Costly affair


Key Elements of a Contract… Contd.

Drafting effective Indemnity Clauses

Indemnity safeguard against established risk

Identify critical issues

Consider consequential loss and exclusion clauses

Learn utilize clauses to protect against ambiguity

Understand probability of loss may arise as a consequence of breach of contract

Define consequential loss


Contract Enforceability

Examine •legal enforceability - clause•example - Contract of wagering - void in India but enforceable in Australia

Remove •ambiguity

Review •impact of recent case law on contractual indemnities

Understand •scope of recoverable loss or damages


Contract Review

• A rational analysis of Contract includes:i. feasibility of contract

ii. forecast of contract risks

•Prior Drafting Review - A review of the Contract from legal perspective with special attention emphasis on potential contingencies

•Post Drafting Review - Review of the Contract taking into account the Divisions’ requirement and anticipating practical issues

•Operational Review - Pertaining to the financial viability and internal regulations

•Legal Review - Two types: Formal Review and Substantive Review


Contract Review…..Contd

Authorized Signatory Insist on Board Resolution Granting Authority

Ensure Compliance with Current Policies

Domestic/Foreign

FDI – Direct/Indirect

RBI Approvals

Ask for proof of requisite registrations or licenses

Governments and other statutory authority/ies

Example: Labour Laws

Procedural Compliance relating to Securities laws i.e. Stock Exchange/ SEBI requirements


Contract Review…..Contd

Execution of Agreements

Proper stamp duty been paid on the agreements

Immovable property valuing Rs.100 or more

Registration, admitted execution and registered by the registrar.


Formal Review

• Subject Matter• General Information• Qualification• Credibility and contractual capacity


Substantive Review

Scope and Deliverables Rights and Obligations of parties to the Contract

Substantive Review Review every clause of the Agreement/Contract

Capacity to Contract Examine Capacity and Authority of Contracting Party

Example Manufacturing and Supply Agreements

Purchase Orders/Tenders

Capital Structure Private Limited- Rs 1,00,000

Public Limited – Rs 5,00,000

Shareholder Private Limited- 2

Public Limited – 7

Directors Preferably odd number of directors

Decisions taken by majority


Ongoing Risk Mitigation

• Legal Compliance Audit (LCA)periodical audit to verify, check and confirm compliance with statutory laws and contractual obligations

• Example Hotel Business - Food and Adulteration Act


Legal Compliance Systems

Records •identified risks, their severity, and the actions/steps to be taken

Simple document

•spreadsheet, or a database system

Provides •assessment on how likely it is that this risk will occur. •assessment of the impact that the occurrence of this risk would have on the project


Legal Compliance Audits

Help the management:

• To ensure statutory compliance• To ensure compliance with contractual obligations• To take corrective action in case of non-compliance


Any Queries???


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Mitigating Legal Risks Through Contracts