About the article
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. 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. Quick enforcement requires the 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.
An illustrated rapid resolution example intended for lawyers. Useful when lawyers draft contracts for clients who enter into partnership or merger or acquisition deeds with other parties. Furthermore, for quick resolution of disputes arising out of allegations of misrepresentation.
Keywords: Partnership agreement, Misrepresentation, Oral Misrepresentation
Reference: The Indian Contract Act: Section 19: Illustration (b)
Indian Contract Act: Section 19
Section 19 of the contract act deals with an agreement’s voidability 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 contract’s performance, and that he is put in the same position he would be in, had his consent been freely given.
- Void the contract.
There are two exceptions to this rule:
- 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.
- A contract is not rendered voidable in cases where the fraud or misrepresentation does not affect the consent of the party on whom the fraud was practiced, or misrepresentation was made.
Illustration (b) of section 19 deals with a situation that falls under the second exception.
Illustration (b) – Contract Act: Section 19
The second illustration of section 19 is as follows:
“A, by a misrepresentation, leads B erroneously to believe that five hundred maunds of indigo are made annually at A’s factory. B examines the accounts of the factory, which show that only four hundred maunds of indigo have been made. After this B buys the factory. The contract is not voidable on account of A’s misrepresentation.”
Illustration 1 – A modern-day example
Let us examine a modern-day example of this type of agreement:
“X Ltd. entered into an agreement with Z to secure investment into the company. During the negotiations, the company misrepresented to Z by claiming that the company’s liabilities amount to only rupees 50 lakhs. However, Z’s accountants discovered that the liabilities were closer to rupees 70 lakhs during the due diligence process.
Despite being aware of the misrepresentation, Z still invested in the company as he believed in the business plan. Unfortunately, the company did not do well, and Z took the company, and it’s promoters to court to void the contract.
Interpretation and scenarios
A reading of the above example would indicate that X and Z’s agreement is not voidable at the instance of Z. Even though X Ltd. misrepresented it’s liabilities, the misrepresentation did not affect Z’s consent to invest.
However, in a court case or arbitration, Z is likely to contend that the contract is voidable on account of the misrepresentation.
In it’s defence, apart from likely denying that any misrepresentation occurred at all, X will contend that, even if it did misrepresent it’s liabilities to Z, it did not affect Z’s consent.
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 either disprove the allegation of misrepresentation or prove that the misrepresentation did not affect the consent of the party that suffered from misrepresentation.
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- Making it difficult to prove misrepresentation
This solution aims to ensure that, even if there is an allegation of misrepresentation, the same can be disproved without having to lead much evidence.
In an investment or M&A contract, in order to protect the company that is the subject of the investment or acquisition from allegations of misrepresentation, it is essential to incorporate a clause laying out the representations and warranties made by the company. This clause would contain representations about the company’s assets, liabilities, revenue, and other factors usually considered by a potential investor or purchaser.
Solution 2 -Making It Difficult To Allege Misrepresentation
It is not enough for the contract to include the representations made by the company. The agreement also needs to incorporate a clause whereby the purchaser or investor agrees that it has verified its representations through due diligence and has found them accurate.
This clause, along with the clause listing out the company’s representations, will make it extremely difficult for a purchaser or investor to allege or prove misrepresentation if the company fails. At the same time, it will also ensure that the company does not make any misrepresentations.
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 disputes arising from allegations of misrepresentation in investment or M&A agreements scenarios 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
Flora Tubes Private Ltd. was a mid-sized garment manufacturing company with ambitious growth plans.
To fund it’s growth, Flora Tubes approached Raj, an investor, and offered him a share of equity in return for a five crore investment.
During it’s presentation and negotiations with Raj, Flora Tubes’ promoters represented that the company’s liabilities were only rupees 50 lakhs. However, Raj discovered that the company’s liabilities were closer to 70 lakhs during the due diligence process. Despite discovering the misrepresentation, Raj went ahead and invested in the company as he believed that the company would be successful
Unfortunately, the company did not grow as fast, or as much as Raj had expected, so he attempted to void the agreement with Flora Tubes on the ground that the company had misrepresented it’s liabilities to him.
As the contract did not contain any language to either prove or disprove the misrepresentation, or whether or not Raj was aware of any misrepresentation, the case took years to resolve due to the amount of evidence that had to be lead.
Had the contract contained three clauses, the entire dispute could have been resolved quickly through ODR
First, the agreement should have had a clause listing out all the representations made by Flora Tubes, including representations about the company’s assets, liabilities, revenue, and any other factors usually considered by a potential investor or purchaser. This clause would have made it difficult for Flora Tubes to misrepresent their liabilities in the first place.
Second, the agreement should have had a clause whereby Raj declared that he had verified Flora Tubes’ representations and found them accurate, making it difficult for him to allege misrepresentation later.
Lastly, the agreement should have had an ODR friendly arbitration clause that pre-decides contentious aspects of the dispute resolution process.
About the Authors
Dushyant Krishnan is a Mumbai based lawyer and the co-founder of House Court, an online dispute resolution platform.
Devansh Garg is a third-year law student at the Vivekananda Institute of Professional Studies, and an associate editor of Indian Law Portal, an online legal news publication.