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Introduction to drafting contracts

Drafting of Agreements
Understanding the implications of an agreement is critical for any business operations. There are various features and parameters in an agreement which makes it a viable and tenable document to avoid lengthy and cumbersome court battles later on in the event of a breach. This module is designed to equip the takers of this course to make such a decision. This module will impart the skills both for drafting simple agreements as well to interpret the likely legal effect of various provisions mentioned in an agreement drafted by the other party.

Objectives of drafting an agreement
An agreement can be verbal or in written form. However, most of the business understandings are always noted down in black and white in the form of an agreement. This helps in minimizing the possibilities of disagreement on what exactly the parties’ intention was at the time of entering into the business relationship. From this perspective, the objectives of drafting an agreement are:
  • to precisely reflect the “meeting of the minds” in a way that will be understood exactly in the same meaning as was intended to be communicated by all readers and stake-holders
  • To create legally enforceable rights and obligations
  • To act as a roadmap for business relationships
Information required before drafting an agreement
Though each agreement is unique in itself, it is necessary to gather certain information from the proposed parties to the agreement in order to appropriately document the understanding between them. Some of such queries are enumerated below. Answer to these queries would help in meeting the documentation objective.
  • What does the drafter hope to achieve?
  • Who are the parties to the agreement?
  • What is the subject matter and nature of the agreement?
  • From when will the agreement take effect?
  • What does the other party reasonably hope to have included in the agreement?
  • What are the issues and concerns of the parties to the agreement?
Legal issues to be ensured
There are certain contractual legal concepts which need to be kept in mind while drafting or reviewing any agreement. These concepts, although already covered in the Indian Contract Act, 1872, are presented here in a capsule.
  • Offer and acceptance: one of the parties to the agreement makes an offer to do or not to do certain thing and the other party accepts the offer for a valid agreement to exist. There cannot be an agreement without an offer and its acceptance by the other party.
  • Consideration: for a binding and enforceable agreement it is necessary that for the services or goods to be supplied by a party to the agreement, the other party shall compensate the first party.
  • Capacity to contract: the parties to the agreement must have the legal capacity to bind each other to the terms of the agreement. This means a minor, a lunatic or an insolvent cannot enter into an agreement. For a legal entity to be bound by an agreement, it shall be executed by someone who is authorized to execute it.
  • Certainty of subject matter and terms: the subject matter of negotiation and the terms and conditions governing that subject matter should have certainty.
Main provisions of an agreement
Like any other document, an agreement has various parts. Each of these parts must be there in an agreement to impart and ensure surety to the understanding that the parties propose to document through an agreement.
  • Title: this signifies the nature of the agreement between the parties.
  • Date of execution and effective date: the date of execution is one on which parties agree to execute or sign the agreement. The effective date is the day from which the terms and conditions of the agreement are mutually applicable vis-à-vis the parties to the agreement start complying with them . Date of execution and effective date may or may not be the same in an agreement. An agreement which has a different effective date from the date on which it has been executed will specifically indicate the effective date.
  • Parties: Names and address of the parties. This helps in clearly identifying who is binding itself with the provisions of the agreement.
  • Recitals: This provides a background to the agreement i.e. under what circumstances the parties decided to come together to enter into the agreement. Recitals usually start with the term ‘WHEREAS’.
  • Consideration: this clause specifically identifies the goods or services offered and the amount to be paid for the same, the mode of payment and time of making payment.
  • Definitions: Any agreement will be using capitalized words whose meaning need to be clearly defined.
  • Body of the agreement: these clauses capture the details of the goods or services to be provided being the subject matter of the agreement.
  • Boilerplate clauses: irrespective of the nature of the agreement, each agreement should have some standard clauses in order to make the understanding of the parties complete. The content of these clauses may vary from agreement to agreement and require customization depending on what exactly the parties’ expectations are from each other. E.g. Dispute resolution, arbitration, governing law, entire agreement clause, etc.  For example, in a boilerplate arbitration clause, venue of arbitration, number of arbitrators, and procedural rules of arbitration can vary depending on the circumstances of the parties.
  • Schedules: Certain details of the agreement can be put in a schedule and they continue to remain binding on the parties. For example, in a service level agreement (known as an SLA), the various parameters for measurement of the service quality and the standard at which the service must be maintained is specified in a separate schedule.
  • Signatures: The agreement shall be signed by the parties or authorized representative of the parties to the agreement.
Other issues – Besides the provisions stated above, there are certain statutory provisions which need to be complied with while entering into an agreement. These are:
  • Attestation/ Witnesses: Certain agreements must be attested by two witnesses under Indian law. For example, a sale deed which transfers immovable property.
  • Notarization: In India, notarization of an agreement refers to attestation by an officer called a Notary Public.
  • Stamping: All agreements need to be made on a stamp paper. Stamp Duty applicable on different types of agreement varies from state to state.
  • Registration: Although registration of the agreements is not mandatory under the law, it is advisable to register the agreement to give it legal validity and enforceability in a court of law.
  • Foreign agreements – Apostille. An agreement executed in a country other than India needs to be legalized by a process known as apostille where the agreement is attested and verified by the Indian Embassy/consulate in that country.
How do smart businessmen or good commercial lawyers approach drafting?
  • Understand the type and the commercial intent of the transaction – e.g. whether it is a licensing agreement (where some intellectual property is licensed) or simply a marketing agreement, whether an agreement is a joint venture agreement or a private equity investment agreement.
  • Locate a template which resembles the transaction as closely as possible – If you are doing an investment document which has a foreign investor, try and get a precedent (template of another transaction) which had a foreign investor. Don’t use a template which has a domestic investor. If you have a strategic investor who is interested in integrating a start-up with his own company, do not use a template for a financial investor who is simply interested in making a financial return.
  • If possible, speak to the client about various commercial possibilities that could arise
  • Check any changes in law (substantive and procedural) from time to time – e.g. guidelines and procedure for valuation of shares may change, which may alter the way you arrive at the price for subscription to the shares of a company.
5 Critical Issues to watch out for when you draft your own agreement
Drafting should be sufficiently detailed to crystallize the commercial intent and understanding of the parties,  elaborate the roles of the parties with clarity and explain how money will flow.

Components which are unique to the body of each agreement

Detailed description of obligations – In a marketing agreement, it may be wise to specify which media will be used for marketing, and in which territory the marketer will market the products.

Detailed Payment Mechanics - The flow of money must be well charted out in the agreement, so that disputes do not arise at the time of payment. For example, if you are thinking of entering into a marketing agreement, possible issues could be –
Does the marketer have the ability to collect money on your behalf and deposit it in your account on a monthly basis, or should he simply ask customers to directly pay money into your account.
How would you recompense the marketer? Does he deduct his share of the commission from every sale on his own and repatriate the balance? Or do you pay him a fee at the end of every periodic cycle?

Mode of payment – The method of making the payment for the goods/services sold/delivered has to be clearly defined. Whether the whole consideration would be paid at the time of delivery or the payment would be broken into tranches? Whether there would be some amount payable as advance at the time of executing the agreement and balance amount payable at a later date? How the payment would be made – by cheque or electronic transfer of funds or simply in cash?

Timelines for performance of obligations and for paymentIt is essential to mention clearly the time and duration for performance of the obligations under the contract and for making the payments to avoid arising of disputes for breach of contract.

Provisions in case of faulty goods/deficient services or non-adherence to service levels In the event goods supplied or services provided turn out to be defective or deficient then the purchaser has recourse under the clause of Warranty which defines the extent to which a defective good or deficient service is covered for repairs or replacement by the supplier/service provider and the duration of time for which the Warranty would remain effective.
Further, the parties can define their liabilities in terms of some maximum amount which would be payable by the supplier/service provider in case the buyer of goods or recipient of services suffers some damage due to defective goods/deficient service under the clause Liability.

Boilerplate provisions for protection of a party’s interest
There are certain provisions which are standardised in most contracts. They may require some element of customization but no major overhaul or substantial modification is required to those terms.

The parties to an agreement want to ensure that they will not be sued by a third party for the actions of the other. To safeguard against this possibility, depending on the specific situation of a case, one party agrees to indemnify the other in case a liability arises due to actions by a third party.
  • An indemnity is a promise to reimburse the other party in respect of a particular type of liability, should it arise.
  • The purpose of an indemnity is to provide a guaranteed remedy to the other party or to provide a specific remedy which might not otherwise be available in law.
Example: In the case of Software License Agreement, a third party can claim that the intellectual property rights in the software or some component of the software lies with it and not with the provider of the software. This third party can sue the user of the software for using his intellectual property without valid permission without any fault being of the user of the software. In such a scenario, it is the responsibility of the software licensor to ensure that the software being licensed is free from all encumbrances and hence he would indemnify the licensee for the damages claimed by the third party.
Confidentiality and non-disclosure
Confidentiality and non-disclosure are important aspects in any agreement so much so that there are separate agreements executed for this namely Non-Disclosure Agreements. There is a lot of information about the company and its business which is not in public domain and the companies would not want to make it to the public domain, yet some amount of such confidential information may have to be disclosed to the other party while entering into a contract with the other party. So, the parties bind themselves to confidentiality and non-disclosure of each other’s confidential information. Breach of this covenant leads to disputes and court battles.

Definition of the confidential information is the key element in a confidentiality clause. A disclosing party will like to make it very wide while the recipient will make it narrow. However, a very wide definition which covers any and every information which is not inherently confidential is not likely to find favour with courts. An alternate approach is to specifically identify by marking or indicating disclosed information as confidential information.

The main remedy for breach of the confidentiality provision is an injunction.  Damages for breach of contract could be available to the disclosing party.

Exclusivity means that during the duration of the contract, the contracting parties would not enter into negotiations or even into an agreement with a third party for similar nature of work/product/services. For example, in an agreement for marketing of diesel gensets, the supplier may ask the dealer to market its products exclusively. It may be qualified by some time duration. It is important in marketing or supply agreement or in an acquisition transaction because it provide economic security for the supplier, as he would not face competition from other supplier for the same product and might make sense if he has invested a substantial amount in customising or have made arrangement for developing a sophisticated logistic chain for the manufacturer.

The contracting parties agree that during the tenure of the agreement and for a certain period of time thereafter, the parties would not solicit the services of other employees, consultants or the suppliers. Non-solicit clause is included when there is a possibility that the other party’s closeness or interaction with the employees or consultants pursuant to the commercial relationship may provide opportunities to him to poach or hire them for his business or to start a competing business
Declaration and Consideration
The body of the agreement will lay the details of the facts agreed to by the parties. This will mention what, when, how and where of the parties agreeing to do and the consideration to be paid for this. The features of these clauses are mentioned below.
  • A declaration is a statement of fact to which parties agree. A party cannot sue on a declaration. There are no remedies associated with this.
  • For example, the purchase price details or governing law provision are declarations.
  • A declaration should be drafted in the present tense because, when read, a contract provision shall always apply to the current situation.
  • The purchase price of the car is Rs. 1,00,000 (Rupees one lakh only).
Representation and Warranties
Representation and warranties confirm certain facts related with the object of and the parties to an agreement. Every agreement will have such facts which are unique to its case and on the basis of confirmation of such facts parties decide to formalize their business relationship. The definition, drafting guidance and the implications of breach of representation and warranty are given below.
  • They deal with past and present facts but not with “future facts.”
  • Generally drafted in active voice unless the focus is on the action rather than the actor. Then use passive voice.
  • They shall be narrow and qualified from the maker’s perspective. On the other hand, the recipient of the representation and warranties would like to have them as broad as possible
  • A representation is a party’s statement of fact as of a moment in time intended to induce reliance by a second party, and based upon that reliance, intended to cause the second party to take an action. A warranty is a promise by the maker of a statement of fact that the statement of fact is true. Since this is a promise, it means any false statement of fact will lead to payment of damages.
  • Every statement that is a representation is also simultaneously a warranty.
  • Representation and warranties are risk allocation mechanism.
  • In order to have a claim for false representation and warranty, the party claiming damages must not have known that the statement was false.
  • In its technical sense, if a representation by a party turns out to be false or to have been wrongly made, the agreement may be terminated and the party who misrepresented can be sued for damages. In commercial agreements, representations and warranties are usually clubbed together. Breach of any representations or warranty may trigger the consequences specified under the agreement. Such breach may allow parties to terminate the agreement. For example, in an investment agreement, breach of a representation or a warranty may allow an investor to terminate his obligations under the agreement (but not the entire agreement) and invoke specific rights under the agreement to exit from the company.
  • The seller represents and warrants that the car has been driven 20000 km.
When parties decide to enter into an agreement, there will be certain actions expected from them in order to implement the agreement or continuing obligations under the agreement. These covenants are promises to do or not to do something.
  • Use ‘shall’ to represent a covenant, except if the sentence has a negative subject
  • Breach of a covenant may offer the possibility of an additional remedy beyond damages i.e. specific performance.
  • The lessor shall maintain the car in good condition.
Conditions Precedent
They are a state of fact on which parties to the contract has no control, but their existence one or the other way is fundamental for the other party to go ahead with the transaction. In many commercial transactions, although the commercial terms are negotiated and the legal documentation is signed, but there are certain steps to be taken before which the obligations of the parties under the agreement do not get triggered.
  • A condition precedent is a state of facts that must exist before a party has an obligation to perform or a right or may exercise discretion.
  • Whenever there is a condition precedent, it must be paired with an obligation (covenant), a right or discretionary authority.
  • The party that has to satisfy a condition would prefer to have it in a way so that it can be satisfied easily. If the other party has to satisfy a condition, consider how difficult it should be in the context of the transaction.
  • Use ‘must’, state that the provision is a condition and consequences of the condition and include an interpretative provision
  • The seller must provide a copy of the occupancy certificate before execution of the sale deed.
  • In a shareholders and share subscription agreement, the obligation of the investor to fund the company could be subject to completion of a due diligence.
Discretionary authority
  • Discretionary authority gives the holder a choice to do or not to do a particular a
  • Use ‘may’ to indicate any discretionary authority related provision
  • Either party may terminate this Agreement by sending written notice to the other party.
Nowadays, especially in international agreements or agreements with the governments, the preferred mode of settling any disputes is arbitration. Arbitration has two aspects, firstly the seat of arbitration and the law that shall govern the arbitration proceedings. For example, the parties may decide that the seat of arbitration would be Singapore but the law governing the arbitration proceeding would be the Indian Arbitration & Conciliation Act. It is imperative that the Arbitration clause is defined and worded carefully to rule out ambiguities and prolonged court battles for the execution of the arbitral award. In agreements where the transaction amount or consideration is small, one should consider adding a clause which will limit the fees of the arbitrator(s) to a reasonable amount to commensurate with the value of the agreement.  Starting with the renowned Bhatia case, there is a line of precedents of the Supreme Court of India and other High Courts delving into enforceability of the arbitral awards awarded by the foreign arbitral tribunals.

Governing Law
The agreement must always specify the law under which purview the disputes, if any, would be settled. For example, in an international agreement, the parties must agree that laws of which country would be applicable to settle any disputes. Choice of governing law depends primarily on who is the stronger party in the agreement.

Jurisdiction refers to the territorial jurisdiction of the court of law. For example, in a domestic agreement, one party being in Mumbai and the other in New Delhi, the parties may agree on the courts either Mumbai or New Delhi to have jurisdiction in case of a dispute.
Termination can be either organic, that is, the agreement terminates at the end of its stated date or it may terminate at the happening of an event which is defined in the agreement. For example, the parties may decide that in the event payment is not made within 30 days from the date of supply of goods, the agreement would stand terminated without prior notice. Usually, a written notice is required to be given by the party terminating the agreement to the other party

Proper use of shall
  • A party’s name should always precede shall
  • Shall should not be used in the following manner
    • To couple “shall” with the verb “to be”
    • To couple “shall” with the verb “to have”
    • In a clause that establishes a circumstance
Proper use of will
Use of “will” should be based on the following situations in an agreement:
  • If a provision states a party’s opinion, determination, or belief about the future
  • If a provision is a covenant that includes a statement about the future
  • If a provision is a right that includes a statement about the future
  • If a provision grants a party discretionary authority with respect to some future event
  • If a declaration includes a statement about intent
Would versus Could
  • Your client is a party to a lawsuit. In which of the following alternate versions of the usage of could and would this lawsuit have to be disclosed :
    • The company is not a party to any threatened or pending litigation that could have a material adverse effect on its business or financial condition.
    • The company is not a party to any threatened or pending litigation that could reasonably expected to have a material adverse effect on its business or financial condition.
    • The company is not a party to any threatened or pending litigation that would have a material adverse effect on its business or financial condition.
The use of could gives a discretion to the person who has to make the disclosure decision whether the conditions will be met or not. It will be difficult to question the judgment drawn if such discretion is given. However, with the use of would there is no discretion available and the disclosure have to be made.

Features of a well drafted agreement
  • Clear and concise
  • Well organized
  • Logical numbering of paragraphs
  • Readable and understandable
  • Internally consistent with certainty of meaning
  • Simple while expressing the intent of parties
  • Accurately reflect the understanding of the parties
Contract Interpretation
  • The parol evidence rule: Extrinsic evidence as to the intention of the parties may not be introduced to vary or contradict the terms of an integrated contract.
Note on the a boilerplate clause known as the “Entire Agreement” clause – In order to exclude evidence of an understanding outside the contract, commercial agreements contain a clause which states that the complete understanding of the parties has been documented in the terms of that agreement, and that the agreement will supersede all prior oral or written agreements. 
However, a party can still allege that he relied on certain pre-contractual representations before entering into the agreement, which are not documented in the agreement. To prevent such a situation from arising, one may mention that the parties are not relying on any representations other than the ones mentioned in the contract.
To prevent any confusion regarding any amendment that has been made to the agreement, a clause stating that any modifications to the agreement will only be valid if they are made in writing and are signed by all parties concerned
  • The plain meaning rule: A provision that is clear and unambiguous on its face will be so interpreted, without reference to extrinsic evidence of what may have actually been intended.

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