Mitigating Legal Risks Through Contracts
Transcript of Mitigating Legal Risks Through Contracts
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Mitigating Legal Risks Through Contracts
Poorvi Chothani, Esq.LawQuest, Mumbai, India
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What is a Contract?
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• 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.
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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
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What are the Risks Associated With Contracts?
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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
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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
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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)
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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
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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
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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
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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
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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
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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.
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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)
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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
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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
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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.
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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.
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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.
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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.
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Formal Review
• Subject Matter• General Information• Qualification• Credibility and contractual capacity
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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
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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
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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
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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
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Any Queries???
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