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. Rapid 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.
The article is an illustrated rapid resolution example that is useful when lawyers draft contracts for clients who purchase a distressed asset or invest in a distressed or hugely discounted asset. In such cases, the purchase price is much lower than what it would usually be. Drafting using these rules will allow rapid resolution of disputes arising out of allegations of coercion or undue influence in such agreements.
Keywords: Consideration, Coercion, Undue Influence, Purchase Contracts, Investment Contracts, Distressed Assets, Distress Sales
Reference: The Indian Contract Act: Section 25: Illustration (g)
Indian Contract Act: Section 25
Section 25 of the Indian Contract Act, 1872, as a general rule, declares that an agreement without consideration is void. The Section, however, mentions the following three exceptions to the general rule:
- When a promise is made in favor of a near relation on account of natural love and affection, the same is valid even though there was no consideration for the promise. Simply put, this exception describes a Gift Deed.
- When a person without the promisor’s knowledge, or otherwise than at his request, does latter some service, and the promisor undertakes to recompense him for it, then the promise to compensate, though without consideration, becomes binding.
- An agreement to pay a time-barred debt, though, without any consideration, is a valid contract.
Explanation 2 to Section 25 provides that inadequacy of consideration does not make the agreement void. However, the Court may take the inadequacy of the consideration in account to determine the question of whether the consent of the promisor was freely given.
Illustration (g) – Contract Act: Section 25
The seventh illustration of section 25 is as follows:
“A agrees to sell a horse worth Rs. 1,000 for Rs. 10. A denies that his consent to the agreement was freely given. The inadequacy of the consideration is a fact which the Court should take into account in considering whether or not A’s consent was freely given.”
Illustration 1 – A modern-day example
Let us examine a modern-day example of this type of agreement:
“X, who was in severe financial distress, decided to sell his sole proprietorship business worth rupees 20 lakhs. Z offered to purchase the business but stated that he could only pay ten lakhs. The combination of Z’s financial issues and a lack of other buyers led to X agreeing to sell the business to Z for ten lakhs. Afterward, X took Z to Court to void the agreement contending that his consent was obtained using undue influence.
“X, who was in severe financial distress, decided to sell his South Mumbai Apartment worth rupees 200 lakhs. Z offered to purchase the apartment but stated that he could only pay 50 lakhs. The combination of Z’s financial issues and a lack of other buyers led to X agreeing to sell the apartment to Z for 50 lakhs. Afterward, X took Z to Court to void the agreement on contending that his consent was obtained using undue influence.
Interpretation and scenarios
In a situation like the one mentioned in the examples, which essentially is a distress sale, the Court will have to factor in the low price at which Z bought the asset from X when deciding whether or not X’s consent was freely given.
Strategy to make this Contract Rapid Resolution friendly
A dispute arising out of the above example would be friendly to rapid resolution, only if the agreement between X and Z records that the sale price is below the market price and why it is so. Lack of this language in the agreement would require both sides to lead substantial amounts of evidence to prove their respective cases.
However, simple drafting solutions exist 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 removing ambiguity from the agreement and incorporating language to pre-decide certain potentially contentious aspects of the arbitration process.
Two of those solutions are examined here.
The Drafting Solutions
Solution 1- Protects the Buyer
- A contract for a distress sale or investment must record that the transaction is being completed below the market price and the reasons for the same. In our example, the agreement should have stated that X was selling his business at 50% below the market value based on a combination of his financial difficulties, Z’s ability only to pay 50% of the market value, and a lack of any other buyers.
- It may be a better option to also evidence the lack of any buyers by putting an advertisement in the local papers or incorporating a statement to this effect from an intermediary—for example, a well-established neighborhood real estate agency in the case of property.
- The agreement must also state clearly that the seller is entering into the contract of his own free will.
Solution 2 – 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 contractual disputes arising concerning the inadequacy of consideration (as in The Contract Act – Section 25, Illustration g.) can be made very friendly to rapid resolution, provided there is no ambiguity as to the reasons for the inadequacy of the consideration.
Simple Explainer For The Layman
Gaurav Sharma decided to sell his sole proprietorship business due to financial difficulties. The business was valued at 50 lakhs. However, he had much trouble finding a buyer. Eventually, Naveen Deb offered to buy the business for 30 lakhs. Gaurav agreed to the offer because of the lack of buyers and his worsening financial situation.
However, a few months after selling the business, Gaurav took Naveen to Court to void the contract on the ground that his consent to the sale was forced. He cited the fact that the sale price was nearly 50% less than the business’s value as proof that his consent to the sale was coerced.
There were three clauses Naveen’s lawyer ought to have ensured were part of the agreement, which would have either prevented the dispute from arising altogether or even if Gaurav tried to void the agreement citing undue influence, the dispute could be quickly resolved.
Firstly, the agreement ought to have had a clause recording that the reasons for the sale price being close to 50% below the market price.
Second, the agreement should have had a clause whereby Gaurav unequivocally stated that his consent to the sale was freely given. This clause, read with the clause recording the reasons for the distress sale, would make it easy for an arbitrator to arrive at a finding that there was no basis to Gaurav’s claim.
Finally, the contract 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.