This article deals with disputes concerning a manufacturer or service provider’s right to retain the finished goods until payment by the purchaser, in cases where the purchaser supplies the raw material or the goods to be assembled, serviced, or repaired.
The article discusses solutions that can be incorporated in the contracts to prevent such disputes from arising or enable rapid resolution of the disputes if they do occur.
The article also discusses the importance of drafting agreements that support the rapid scaling up of business relationships between the contracting parties.
Keywords: Manufacturing agreements, Repair and service agreements, lien, bailment, payment delays, payment defaults
Reference: Indian Contract Act, 1872, Section 170, Illustration b
Section 170, Indian Contract Act:
Section 170 of the Indian Contract Act deals with a bailee’s right to retain bailed goods until he receives payment when, as part of the bailment conditions, he exercised some labour or skill in respect of the goods.
Section 170 states that, unless the contract states that he does not have the right to do so when a bailee exercises labour or skill on bailed goods, he can retain the goods until the bailor pays him for his services.
Examples of such transactions include manufacturing agreements where the purchaser provides the raw material and repair or restoration contracts. Illustration (b) to the section is an example of a manufacturing agreement.
Section 170, Illustration b:
A gives cloth to B, a tailor, to make into a coat. B promises A to deliver the coat as soon as it is finished, and to give a three months’ credit for the price. B is not entitled to retain the coat until he is paid.
In cases where goods are bailed to a service provider, a dispute would arise if there is ambiguity over whether the service provider can retain the goods until he is paid. Therefore, our example will deal with such a scenario.
Company X is in the business of selling used cars. Company X decided to expand the business by tying up with an auto-mechanic service provider so that it would not have to reject cars with minor to moderate damage, which could still be repaired and sold at a profit. Accordingly, X identified Company Y as a service provider.
The companies signed an agreement under which X would send vehicles to Y to repair. Y would then quote the repair costs and, if the same were acceptable to X, repair the vehicles. Once the repairs were done, X would arrange for the cars to be picked up from Y’s premises, generally a few days after the repairs were completed. The understanding between X and Y was that X would pay Y before picking up the vehicles, but the agreement was silent.
Initially, the lack of a concrete payment and collection process did not affect the working relationship between the parties as X almost always paid either before or when the vehicles picked up. Occasionally X’s payments got delayed, but Y allowed X to collect the vehicles, and X paid soon after.
However, as X’s business grew, and it began accepting more vehicles that required minor repairs, it did not have sufficient liquidity to pay Y before having the vehicles picked up. As a result, X’s payment delays became more frequent, and, eventually, Y refused to hand over several vehicles in its custody until it was paid. Y also sued X for the recovery of the money it was due.
Interpretation and Analysis:
In our example, Y would justify its refusal to hand over the repaired vehicles to X, citing section 170 of the Contract Act.
On the other hand, X would argue that the agreement between the parties prevented Y from having a lien over the repaired vehicles, and would cite Y’s previous conduct of handing over vehicles before receiving payment as evidence of the same.
However, the dispute could have been rapid resolution friendly if the contract incorporated the solutions discussed in this article.
Solution 1 – Removes Ambiguity (Protects Both Parties And Enables Rapid Determination of Liability)
Contracts, where purchasers provide service providers with raw material/goods, must be clear about the various aspects of the payment process such as whether it is to be made in advance after the service is completed but before the finished product is collected, or within a specific time after the finished product is collected. An unambiguous agreement also ensures that the parties’ business relationship can scale rapidly without disputes or disagreements.
In our example, the agreement ought to have specified that Company X was obligated to pay Company Y before collecting the repaired vehicles, failing which, Company Y was entitled to refuse to hand over the vehicles till payment was received.
Solution 2 -Accelerates the Dispute Resolution Process:
The agreement should have a dispute resolution clause giving 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 either the dispute resolution clause itself or the institution or ODR platform promises a process that binds the arbitrator to rapid resolution. ODR Platforms often do this by minimizing oral hearings, not accepting documentation delays, and not allowing adjournments unless in emergencies.
Business and service provider agreements where one party provides the raw material or goods and the other party exercises labour or skill on the goods must incorporate proper processes, including processes for payments and collection of finished products so that the relationship between the parties to scale.
The agreements must also provide for a process for rapid dispute resolutions so that disagreements if they arise, can be resolved without adversely affecting the working relationship between the parties.
Simple Explainer For the Layman:
Vivek Motors is in the business of selling used cars. Vivek Motors decided to expand it’s business by tying up with an auto-mechanic so that it would not have to reject cars with minor to moderate damage, which could still be repaired and sold at a profit. Accordingly, they identified Anand Auto Repair as a service provider.
The companies signed an agreement under which Vivek Motors would send vehicles to Anand Auto Repair to repair. Anand Auto Repair would then quote the repair costs and, if the same were acceptable to Vivek Motors, repair the vehicles. Once the repairs were done, Vivek Motors would arrange for the cars to be picked up from Anand Auto Repair’s premises, generally a few days after the repairs were completed. The understanding between Vivek Motors and Anand Auto Repairs was that the payment for the repairs would be made before picking up the vehicles. However, the agreement was silent on this aspect.
Initially, the lack of a concrete payment and vehicle collection process did not affect the working relationship between the parties as Vivek Motors almost always paid either before or when getting the vehicles picked up. Occasionally Vivek Motor’s payments got delayed, but Anand Auto Repairs allowed Vivek Motors to collect the vehicles and was paid soon after.
However, as Vivek Motors’ business grew, and it began accepting many vehicles that required minor repairs, it did not have sufficient liquidity to pay Anand Auto Repairs before having the vehicles picked up. As a result, Vivek Motors’ payment delays became more frequent, and, eventually, Anand Auto Repairs refused to hand over a number of vehicles in its custody until it was paid. It also sued Vivek Motors for the recovery of the money it was due.
In court, Anand Auto Repairs justified its refusal to hand over the vehicles to Vivek Motors, citing section 170 of the Contract Act, allowing a service provider like Anand Auto Repairs to retain finished goods until it receives payment for the same.
On the other hand, Vivek Motors argued that the agreement between the parties did not allow Anand Auto Repairs to retain the vehicles’ possession until it received payment and cited Anand Auto Repair’s previous conduct of handing over vehicles before receiving payment as evidence of the same.
The dispute could have been resolved quickly and inexpensively through a rapid resolution method like ODR if the agreement between Vivek Motors and Anand Auto Repairs had incorporated proper processes, including processes for payments and collection of finished products.
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.
About the Author:
Dushyant Krishnan is a Mumbai based lawyer and the co-founder of House Court, an online dispute resolution platform.