How to read an agreement

Reading an Agreement

1. Introduction

 From time immemorial, the commercial world has worked on contracts and agreements. The only difference between then and now, is that earlier a lot of these agreements were oral in nature, whereas nowadays, most businesses, if not all, prefer a binding written agreement. An agreement may be entered into for the smallest of matters to the largest of issues. Agreements in India are governed by the Indian Contract Act and in addition by specific statutes depending upon the nature of the agreements. For instance, an agreement to assign a copyright must bear in mind the provisions of the Copyright Act, 1957. In addition, certain taxing statutes, such as the Stamp Act, contain certain provisions which must be borne in mind while executing the agreement. It is interesting to note that there is no specific format for an agreement. There are various ways in which an agreement can be drafted. The American style of drafting is substantially different from the English style. However, it is important that it contains the vital provisions or else the purpose behind the agreement would be defeated. This Chapter looks at some of the important parts of an agreement.

2. Standard Clauses

2.1.Name Clause

This is the first part and contains the names and addresses of the parties to the agreement. It also specifies whether the agreement includes the heirs, assigns, executors, successors, administrators, etc., of the parties to the agreement. In case there is no provision for an assignment then it would be difficult for any party to do so. This clause also contains the Date of the Agreement when it is executed.

2.2.Recitals

The recitals give a brief background about the agreement. They explain the purpose behind the agreement and the objectives which it seeks to achieve. In case of property conveyancing documents, the recitals also contain a brief title history of the property. The recitals are an integral part of the document and should be carefully drafted so that it becomes easy to construe the agreement.

2.3.Representations and Warranties

This is a very important clause and due care and precaution is required while drafting the same. The parties give out certain representations and warranties in this clause and hence, if they turn out to be false then the other party has a right of action against the party making such false statements. For instance in a flat sale agreement, the flat seller can give a representation that he has not sold or mortgaged the flat to any other party and if there is a claim to the contrary, then he would indemnify the flat purchaser. This clause is also very significant in a Shareholders’ Agreement or a Joint Venture Agreement.

2.4.Prior Permissions and Approvals

Quite often, it may happen that a particular agreement is subject to prior permission from Governmental authorities. In this case, the agreement must clearly mention its conditional nature or else it may be a cause for action. For instance, a share subscription agreement which requires the prior FIPB / RBI permission must clearly state so. In the event the permission is refused then the agreement would terminate.

2.5.Costs and Charges

This Clause mentions who would bear various expenses, professional fees, etc. pertaining to and incidental to the agreement. This may also include the stamp duty cost in case of a transaction pertaining to an immovable property. It is always a good practice to have a clear understanding on this front so as to avoid disputes later on.

2.6.Notice

This clause lays down the address and contact details of the parties in case any notice, demand or other communication is to be delivered to them by any of the parties to the agreement. It provides complete postal address, telephone, fax, etc. Emails as a form of notices are frowned upon by many people and hence, not included.

2.7.Arbitration

In this Clause, the parties agree that all the disputes between them shall be amicably settled. In the event of failure to do so, the same shall be settled by an arbitration, and the provisions of the Arbitration and Conciliation Act, 1996 shall apply. This is a very vital part as in its absence all disputes would go to Court and that would be a long drawn out process.

The clause normally provides the place of arbitration and the language of the proceedings. It also mentions that all arbitral awards given in respect of disputes referred to arbitration in accordance with the provisions of this Clause shall be final and binding on all parties concerned

The importance of drafting this clause carefully in case of international contracts cannot be overstressed.

2.8.Variation

Variation to the agreement shall be binding on any of the parties only if and to the extent, such variation is recorded in a written document executed between the parties.

2.9.Confidentiality

Several agreements, such as joint venture agreements, share purchase agreements, etc., contain a Confidentiality Clause. It provides that the parties would not disclose any information to a third person unless there are circumstances such as statutory requirements, etc. In certain highly sensitive agreements it is also provided that the leakage of information may be taken as a ground for termination of the agreement.

2.10.Force Majeure

“Man proposes and Nature Disposes”. The best of intentions and actions are sometimes undone by acts of God or forces of nature. These include, but are not limited to any Act of God, strike, lockout, labour dispute, epidemic, cyclone, flood, earthquake, drought, fire, explosion, atmospheric disaster, war, riot, revolution, etc. In times like these, it becomes impossible to perform one’s obligations under an agreement. Hence, the Force Majeure Clause provides that no party shall be liable for any default or delay in the performance of his obligations when such default or delay is due to any contingency beyond his reasonable control.

2.11.Schedules

These are the Schedules, if any, which have to be annexed to the agreement. For instance, in a conveyancing document, it would contain the description of the property being conveyed along with a property map. Schedules are also a part and parcel of the agreement and are as important as the main agreement.

2.12.Signature Clause

This is the Clause where the parties to the agreement sign. Each person signs in the presence of a witness. The witness need not know the contents of the agreement. All he has to certify is that the person signing has done so in his presence. There can be one witness for all signatories. The capacity in which a person is signing must be mentioned in case he is doing so for and on behalf of someone else, e.g., the Director of a Company, Partner of a Firm, Guardian of a minor, etc. In addition to signing in the Signature Clause, normally, each page is also initialled as a mark of identification.

3. Novel Clauses

3.1.Transaction Clause

This is the heart of the Agreement as it deals with the Transaction contemplated therein. For instance, in a Share Purchase Agreement, this Clause would lay down that the seller is interested in selling certain number of shares and the buyer is interested in purchasing them It would also lay down any conditions precedent which must be fulfilled by either party for the successful completion of the transaction. This Clause requires the utmost scrutiny and care while drafting.

3.2.Consideration Clause

One of the important tenets of Contract Law is that “No Consideration, No Contract”. A contract without any consideration is void ab initio except in certain cases. This Clause mentions the consideration payable in respect of the obligations of the party and should carefully scrutinised since it creates obligations for either party. Thus, in case of a share purchase agreement, the consideration clause would mention the price per share and the aggregate consideration. It would also mention the mode and the time of discharge of the consideration.

3.3.Escrow Mechanism

Certain agreements provide for an Escrow Mechanism with a reputed person, e.g., a commonly accepted solicitor or a CA. The Escrow Holder would retain in his custody the payment or documents due to the other party until such party fulfills his part of the obligations. For instance, in case of the sale of a property which is the subject matter of a mortgage, the buyer may deposit the consideration in Escrow till such time as the Seller clears the mortgage. As soon as the mortgage is redeemed, the Escrow Holder would hand over the consideration to the Seller. The events under which the Escrow Holder would release the Escrow should be very clearly specified in unambiguous terms. Escrow Mechanisms are increasingly used in agreements and are a common feature in agreements for complex infrastructure / power projects.

4. Director’s Responsibility

4.1.As agreements are the basis on which a company functions, it is imperative that they are properly drafted and safeguard the company’s interests. If the agreements suffer from some infirmity or legal handicap, then the company may have to incur severe losses. Hence, Directors must be extremely careful and cautious in all such matters. The best way to ensure this is to entrust the task to competent professionals wherever possible. The old adage better safe then sorry should always be borne in mind.

5. Auditor’s Duty

5.1.This is one area where the Auditor can make substantial value addition. As an Auditor one comes across several agreements which the auditee would enter into the course of business. The Auditor would refer to many of these agreements during his audit. He may check these agreements and advise the auditee whether those contracts are legally valid or do they suffer from some patent infirmity due to which the entity may suffer heavily. All agreements, have economic implications, which if material, impact the true and fair view.

5.2.Even otherwise than as an Auditor, a Chartered Accountant can render tremendous services in this area. If Chartered Accountants have a basic knowledge of the important provisions of the Act, they would be able to contribute towards pointing out gross errors or inadequacies in contracts entered into by their clients. This in itself would be a big service to the clients.

5.3.By broadening his peripheral knowledge, the Auditor can make intelligent enquiries and thereby add value to his services. He can caution the auditee of likely unpleasant consequences which might arise. It needs to be repeated and noted that the audit is basically under the relevant law applicable to an entity and an auditor is not an expert on all laws relevant to business operations of an entity. All that is required of him is exercise of ‘due care’.