For those of us involved in regular business transactions as a part of our professions, even a normal exchange of goods or services often makes us wish that we had had a contract in writing with the opposite party. This is usually because most of us believe that several kinds of transactions work well on trust, but when things are ambiguous or go awry, we realize that a written document should have been in place and regret avoiding one to begin with. Thus, while written contracts are usually circumvented in day-to-day business transactions to do away with complications or avoid "bad blood", one usually ends up creating more by choosing not to have them!
This article will give you a brief insight on the importance of having written contracts in business transactions under Indian laws.
Let us first briefly visit the provisions of the primary law in India which govern contracts – their creation, interpretation and enforcement – namely, the Indian Contract Act, 1872. This law defines a contract as "an agreement enforceable by law". Some of the essentials which are required to be fulfilled under this law for an agreement to be a valid contract are:
- An offer by one person;
- An acceptance of the offer by the other persons;
- The capacity of all the parties to contract;
- A lawful consideration;
- A lawful object; and,
- The agreement not being expressly declared void by a law.
Each of the above requirements have been explained in detail under the Indian Contract Act, 1872.
Once the requirements for the existence of a valid contract as enumerated under this law have been fulfilled, the parties are said to have concluded a contract – a legal concept creating a legal relationship and capable of legal enforcement.
As can be seen from the conditions stated above, it is not necessary that the terms of the contract have to be written. Oral contracts are also recognised under this law and are common enough in business transactions. However, oral contracts can be disadvantageous in several ways, the most important ones being:
- The terms of an oral contract are deduced from the conduct of the parties. Many a time, the actual conduct of the parties to a contract may be different from the terms actually agreed upon and hence, the interpretation of the contract may be totally different from what the parties had originally intended;
- Certain provisions such as consequences in case of breach of contract, time for performance and manner of performance may be left open to interpretation by a third party in the absence of a written contract, thus leaving room for incorrect interpretations or unintended consequences.
It is therefore in the best interest of the parties (irrespective of whether such party is an individual or a business establishment) that an oral contract be avoided and that the contract be reduced in writing. Such a contract should address not only the commercial terms agreed between the parties, but also the essential legal provisions from the perspective of the law applicable to a particulr transaction. For example, in executing a sale deed or an agreement to sell or lease deed, it is important that the commercial terms agreed amounts to a valid contract under the above-mentioned law and such terms are also as per the provisions laid down in the Transfer of Property Act, 1882.
Another strong argument in favour of executing written contracts is that it ensures that most of the terms agreed between the parties are clearly stated in the contract. It is important that the terms are kept simple and lucid, are not ambiguous and are detailed to the extent possible. By ensuring the above, the parties to a contract will, to a large extent, be in a position to ensure that the contract (if disputed and if judged by a competent court or an arbitrator) is given an interpretation as close to the terms intended and agreed by the parties as possible.
It also pertinent to note that if the parties do not detail out all the terms and conditions of the transaction in their contract, certain provisions of the Indian Contract Act may become applicable as the "default" terms. For example, if a contract between two parties does not have any terms on the termination of a contract and one of the parties is wishes to terminate the contract, then such a contract can be terminated by the party only by giving a reasonable notice of termination. This "reasonable notice" is not defined under the law and varies from case to case, being dependent on various factors circumstances, thus allowing the other party to dispute the quantum of notice given. Accordingly, to the extent possible, it is advisable that the parties to a contract detail most of the terms and conditions in the written contract itself instead of leaving such terms open to interpretation under the law.
Some of the clauses which are usually recommended be included in a written contract are:
- The goal or objectives that the parties intend to achieve through the transaction;
- The scope of work to be performed by a service provider in case of a services agreement and by parties in case of a cooperation agreement;
- The description of the goods to be sold (in case of a contract for the sale of goods) and terms governing the manner in which such sale is to be executed (such as delivery terms;
- The consideration agreed to be paid and terms of payment;
- The indemnities which each party would give the other as applicable;
- The limit of the liability of each person vis-à-vis the other party or a third party (for whom the project is to be performed, for instance)
- Grounds of termination of the contract;
- Governing law;
- Arbitration, if necessary;
- Depending on the nature of the contract, a contract also has to also be looked into from the perspective of applicable Indian laws, such Foreign Direct Investments, Companies Act, 1956, Foreign Exchange Management Act, 1999, Indian Contract Act, 1872, and applicable tax laws, if necessary.
An important point to note is that each business transaction is always different from the previous ones. A transaction for the sale of goods will entail a different set of obligations than one for the provision of services, and even different kinds of services involve different duties and rights in each case. Using a standard contract for different situations will often result in loopholes, ambiguities and complications. Therefore, for a complete, effective and reliable contract, the contract for each transaction should always be tailored to the unique needs of the parties and the type of relationship contemplated.
It is therefore clear that a written contract will hold the parties to a business transaction in good stead since their intentions and rights are clearly documented, helping to inspire trust in each other, confidence in the transaction as well as building and strengthening their relationship.
Published on 16th, 2013
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.