An illustrated rapid resolution example intended for lawyers. Useful when lawyers draft contracts for clients who are acquiring the assets of a business or acquiring an entire company. And for rapid resolution of disputes arising out of misrepresentation in such agreements.
Keywords: Mergers, Acquisitions, Aquihires, Asset-Sales
Reference: The Contract Act: Section 19: Illustration 1
Indian Contract Act: Section 19
Section 19 of the Indian Contract Act deals with the voidability of an agreement when one of the parties to the agreement obtains the other party’s consent by coercion, fraud, or misrepresentation.
Under this section, the party whose consent was obtained by fraud or misrepresentation has two options:
- Insist on the performance of the contract is performed, and that he is put in the same position, he would be in, had his consent been freely given.
- Void the contract.
There is an exception in cases where a party’s consent is obtained by fraud or misrepresentation, but the party had the means to discover the fraud through ordinary diligence. In such a case, the contract is not voidable and must be performed as if the party’s consent was freely obtained.
Illustration 1 — Contract Act: Section 19
The first illustration of section 19 is as follows:
“A, intending to deceive B, falsely represents that five hundred maunds of indigo are made annually at As factory, and thereby induces B to buy the factory. The contract is voidable at the option of B”
Illustration 1 — A modern-day example
Let us examine a modern-day example of this type of agreement:
“A, intending to deceive B into acquiring his carpet manufacturing company, misrepresents the raw material inventory available in the company. B has to buy new raw material at an additional cost and suffers opportunity cost due to the disruptions caused by running out of inventory, and because of the need to divert money away from marketing to acquire customers and instead use it to purchase additional raw material. “
Interpretation and scenarios
A bare reading of the above example would indicate that the agreement between A and B is voidable at the instance of B. However, in reality, if B were to void the agreement, A most likely would take him to Court or invoke arbitration. Also, voiding the contract would be detrimental to B’s interests as B has already incurred losses and must recover them.
In his defense, A would likely contend any one, or both, of the following:
- He did not misrepresent the raw material available with the company to B
- Even assuming he did misrepresent the amount of raw material available with the company, the exception to Section 19 would cover the case because ordinary diligence and standard industry practices mandate that B conduct due diligence before buying the company.
B, on the other hand, would likely contend that he was deceived despite being diligent. He would also likely sue for compensation for the amount of money he had to spend on acquiring additional raw material and damages for opportunity losses.
Making this Rapid Resolution friendly — Strategy
A dispute arising out of the above example would be friendly to rapid resolution, only if there is well documented, quantified evidence to prove the misrepresentation. Lack of this quantified evidence would require both sides to lead substantial amounts of circumstantial evidence to prove their respective cases.
However, there are simple drafting solutions to ensure that disputes arising out of an agreement like the one in the example above can be made rapid resolution friendly. These solutions involve combining online dispute resolution efficiencies, with pre-decided steps of the arbitration process.
Three of those solutions are examined here.
The Drafting Solutions
Solution 1- protects the buyer (Making it easier to prove misrepresentation)
One way to ensure that any dispute regarding the amount of raw material available with the company is rapid resolution-friendly is to incorporate an inventory of the available raw material as an Annexure to the agreement.
The contract should also specify that if the raw material available were less than what was stated in the agreement, B would be liable to compensate A for the difference and pay damages for opportunity losses suffered by A.
The formula for calculating the opportunity losses should also be specified. It can include the losses caused by delays and losses caused by the need to divert capital to solving this problem.
Proving that the raw material available is less than what was mentioned in the agreement would be reasonably straightforward for B. Further, it would be reasonably easy to quantify the cost of purchasing additional raw material.
Most importantly, an agreement drafted in the manner specified above takes away B’s need to void the contract. He would only need to recover compensation and damages from A, resulting in the agreement being extremely amenable to rapid resolution using an online dispute resolution platform.
Solution 2 — protects the seller (Making it difficult to allege misrepresentation)
The agreement can be made rapid resolution friendly by ensuring that the contract contains a clause whereby B declares that he has verified A’s claims about the inventory available with the company. Such a provision eliminates B’s ability to allege misrepresentation later and ensures that B does his due diligence before signing the contract.
Solution 3 — accelerates dispute resolution for both parties (Pre-decides contentious elements of the Arbitration process)
The agreement gives the claimant the right to ask for the arbitrator’s appointment by a named institution or ODR platform; and for such appointment to be made within 35 days of receipt of the defendant receiving notice.
In these cases, it will better serve the parties if the institution or ODR platform promises a process that binds the arbitrator to rapid resolution. Platforms often do this by minimizing oral hearings, not accepting documentation delays, and not allowing adjournments unless in emergencies.
In conclusion, it is fair to say that misrepresentation in asset or business acquisition scenarios (as in The Contract Act — Section 19, Illustration 1) can be made very friendly to rapid resolution. Such ODR friendly contracts can usually be enforced in a matter of a few months and generally within half a year.
Simple Explainer For The Layman
Ashwin Sanghi was the ambitious promoter of Ashwin Global Exports.
Aiming to support his greatly increased global sale volumes, he made an offer to purchase The Bombay Carpet Manufacturing Company.
The negotiations concluded rapidly and the agreement was signed, due diligence done via professional consultants, payments made and deal concluded..
After a few months, Ashwin found that the inventory of yarn to make carpets was barely 35% of what was represented prior to the sale. It appears that due diligence did not include difficult physical inspection of large warehouses and the written assurances were taken at face value.
Ashwin lost a lot of money as he not only had to purchase the inventory but lost a lot of time and business in the process. He also had to cut into his marketing budgets to instead spend on buying yarn.
There were two things Ashwin’s lawyer could have done while drafting the contract, to ensure that Ashwin was adequately and quickly compensated for the loss.
The first is that inventory lists should have been attached to the agreement and quantifiable methods inserted to calculate the opportunity costs in case the inventories were wrong.
The second was to include an ODR friendly arbitration clause which pre-decides contentious aspects of the dispute resolution process.
If the agreement had been drafted this way, the dispute would have been resolved, the contract enforced and damages awarded to Ashwin within 3 to 6 months.
About the above article and the Author
Rapid Contract Enforcement is an essential requirement for the growth and prosperity of India. It will enable more investment, entrepreneurship, and trust for all stakeholders in business and commerce. However, this is very difficult to do in India because the judicial system in India is overloaded. It could take many years to enforce a contract, making the entire exercise meaningless. The community of lawyers in India does not have access to a practical and scholarly manual that gives them a path to deliver rapid contract enforcement to their clients. Such a manual will also help lawyers to draft contracts that enable timely enforcement. Rapid enforcement requires effective use of the Arbitration Act, the institutional framework and technology enabled dispute resolution infrastructure. This article belongs to a series, where the author analyses each of the Illustrations available in the Contract Act and recommends practical approaches to rapid enforcement. The Author, Dushyant Krishnan, is a Mumbai based lawyer and the co-founder of an Online Dispute Resolution platform in India. He will be publishing a compilation of these articles in Q4 2020 as a practical reference book for rapid resolution of disputes, and rapid contract enforcement in India.