Fundamentals and Practical Aspects of Negotiation and Drafting of Commercial Contracts - PowerPoint Presentation

1. Fundamentals and Practical Aspects of Negotiation and Drafting of Commercial Contracts with Special Coverage on Joint Ventures and Shareholders AgreementMadhavan Srivatsan, Corporate Counselmadhavan@madhavansrivatsan.com

2. Negotiation and Drafting of Commercials Contracts (including JV and SHA)

3. Contents:Pre-Negotiation: Preparation and GroundworkCommercialsLetter of Intent/Non-Binding MoU/Term SheetBinding MoUNegotiation: Give some and Take someDrafting of Commercial ContractsDistribution ContractsEmployment Contracts

4. Contents:Joint Venture AgreementShareholders Agreement

5. Pre-Negotiation: Preparation and Groundwork Commercials:Commercials are the foundation of all Commercial Contracts and the legal clause only supplement it;It is very important to understand the intent behind the Commercials and not just the factual information. The intent might be different than the factual data given by the Commercial team;Spend enough time with the business/commercial/sales team and grill them, if required, to take clarity;There is always a rushing deadline by Sales team– Please take enough time to absorb the commercials and the repercussions behind it. You are the “author” of the contract, not the “sales team”.

6. Pre-Negotiation: Preparation and Groundwork Letter of Intent/Non-Binding MoU/Term SheetNeed to understand the difference between LoI, Non-Binding MoU and Term Sheet the “non-binding intent” versus “binding intent”;Assess the requirement to have a LoI/MoU/Term Sheet before a contract;The provisions of these documents are important as provide a roadmap to the detailed contracts;

7. Pre-Negotiation: Preparation and GroundworkLetter of Intent/Non-Binding MoU/Term SheetContents of LoI/MoU/Term Sheet:Name and Title of Parties;Structure of Transaction (i.e. whether sale and purchase of goods, services, joint venture, technology sharing, intellectual property etc);Roles and Responsibilities of Parties (only in brief and until execution of detailed contract);Duration of the MoU and Timelines to complete the detailed contracts;Conditions required to be fulfilled for execution of contracts (such conditions failing which the transaction can be called off);

8. Pre-Negotiation: Preparation and GroundworkLetter of Intent/Non-Binding MoU/Term SheetContents of LoI/MoU/Term Sheet:Consideration/Payment;Exclusivity- This should be binding;Time period for execution of binding Contracts;Sharing of Information and Confidentiality (this is important clause because parties share lot of information in this interim period);Binding Nature (important to specifically mention which clauses are intended to be binding in nature);Jurisdiction and Dispute Resolution;

9. Pre-Negotiation: Preparation and GroundworkBinding MoUNeed for a Binding MoU/Term Sheet: Not enough time to execute a detailed contract but important to bind the parties;Same contents as Non-Binding MoU discussed in previous slides;In addition, all those clauses of contract (as discussed in subsequent slides) which can be finalized;Fix timelines to finalize the clause/points which could not be finalized in this MoU

10. NegotiationThis is pure Art. It can only be learnt with experience and cannot be taught.Start with the MoU/Term Sheet and first cover all the points mentioned therein;Give Some and Take Some;Don’t open your cards initially;Don’t show eagerness to commit unless there are clear instructions;

11. NegotiationLegal persons should not take a call on commercial points without due assistance/intervention from business/finance team;Be very clear in your mind as to what are the “deal breaking points” for yourself;Show “respect” and “courtesy” to the other side. Many deals gets broken or delayed on account of “ego”. If there is some point which is not important for you but is important for the other side, give it up after some time. Don’t just stick to it for the sake of it.Please remember– “No one wants to know, how much knowledge you have. People want to close the deal and sign the contract.”

12. Drafting of Commercial ContractsNeed for a ContractRequired for the purpose of Audit;Requirement to follow Arms Length principle;To record Related Party Transaction for good Corporate Governance;Requirement by Independent Directors on the board;Requirement by an Investor in the Company;Actual Need (as compared to an informal arrangement such as purchase orders, verbal arrangements etc.)

13. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:RecitalsShould give a very clear description of the nature of parties and the purpose of contract;Should ideally not contain the terms of the contract though Recitals may also be binding in nature; Definitions and InterpretationsDefinitions clarify the terms which are used in capitalized term and in the absence of a definition, one may draw a contrary or generic meaning such as “Business”, “Business Days”, “Force Majeure”, “Material Adverse Effect” “Laws”, “Losses”

14. Drafting of a Commercial ContractDo’s and Don’tsDo’sPrepare a structure of the commercials;Contract should follow the commercials and not the other way;Use definitions for generic terms such as “Law”, “Event of Default”, “Loss” etc.;The structure of the Contract should be, as far as possible, as per sequence of events such as introduction of parties, purpose, payment, roles, etc.Don’tsDon’t depend on customary usage;Avoid lengthy sentences;Avoid using sub-headings beyond three levels unless necessary;Avoid too many cross references;Avoid too much of subjectivity such as “ as the parties may agree” or “best efforts”

15. Drafting of a Commercial ContractDo’s and Don’tsDo’s:Use appropriate headings and sub headings;All the relevant clauses should be linked to each other with the prefix “Subject to..” or “ Without prejudice to …”;Make sure there are no contrary provisions and if there is, use the words “notwithstanding” for one of the important clauses;Use annexure if a particular concept cannot be described in legal language such as calculations, technical inputsDon’ts:Avoid legal terms such as “provided that” or “notwithstanding” or “subject to” together in one sentence or clause;Avoid using the same heading for two different concepts to shorten the contract;

16. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:Interpretations They are as important as any other terms and conditions and they define the rules of the interpretation of a contract such as “headings not to be treated as operative part”, “schedules to be part of the contract”, “references to the Parties to include assigns”, etc.Scope of WorkThe Scope of Work should very clearly define the nature of services to be performed or the nature of goods to be supplied;If the Scope of work is detailed and lengthy, it is advisable to have it as part of the Annexure;It is important to mention as to whether the Scope of Work can be amended or not and if amended, what would be the variation of price.

17. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:ConsiderationThis being one of the important constituent of relationship, casual drafting should be avoided;In the event of dispute, the courts tend to follow the wordings in the contract rather than the intention of the parties;The Consideration may be based on the actual sales, may have in-built commission, based on profitability, fixed or variable commission. In the event of a breach of a contract, the consideration is an important constituent in assessing the loss of revenue or claims;Even though Tax structuring may not allow complete clarity, but an attempt should be made to give complete clarity. (Example- EPC Contracts);

18. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:ConsiderationSubjectivity should be avoided. If the Consideration is based on Net Profits, Total Sales, Targets etc, the terms such as “Net Profits”, “Total Sales”, “Targets” should be very clearly defined in the Contract and not left to subjective interpretation;Inclusion or exclusion of Taxes should be very clearly specified;Any scope in variation of the Consideration should be very clearly mentioned along with a detailed mechanism as to how the variation would be effective and binding;

19. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:Billing and InvoiceThis again is one of the important constituent of the Contract which should not be drafted loosely;On certain occasion, the party raising an invoice tend to follow customary practice and not the written contract by allowing certain delays. In such cases, it should be mentioned that, such waiver is optional and discretionary;In the event of a breakdown of relationship and service provider claiming a breach, any minor delay in payments in regular intervals becomes one of allegations in the notice;The billing cycle should be very clearly mentioned, whether it be weekly, monthly, quarterly or as and when certain events takes place;

20. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:Billing and InvoiceThe number of Business Days within which payment is to be made should be mentioned clearly as well as the term “Business Days” should be defined clearly;Performance ReviewBased on the nature of the Contract, a review of performance is necessary whether it be a services contract, employment contract, collaboration contract, technology contract;A mere provision of Performance Review is not enough. There should be a detailed mechanism as to how the review would be conducted and based upon such review, if there is a downfall, the consequences (whether termination, adjustment in consideration, damages etc.) should be clearly mentioned.

21. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:Roles and ResponsibilitiesRoles and responsibilities along with rights of the party, should be clearly defined and should be as exhaustive as possible;Any lack of clarity in the roles and responsibilities leads to friction in the relationship between the parties;Minor obligations such as submitting regular report, providing additional services, providing back up infrastructure, inspection rights, intimating the other party of certain events at times assume a greater responsibility and thus whatever could be contemplated and agreed, should be put in writing and not left on good faith.

22. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:Term of the Contract and RenewalThe duration of the contract should be unambiguous and as far as possible, avoid concept like “expiration at mutual consent”;If the intention is to have a long term relationship, then it is not advisable to have a unilateral termination without any reasons until a certain period, i.e. lock-in period to be provided;The mechanism of renewal should be clearly defined as to whether renewal is “automatic unless terminated” or whether renewal requires an affirmative action on part of the parties.

23. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:Force Majeure“Force Majeure” is a French term which means “greater power” and it relieves the party from performing its obligation if an event occurs which is beyond the control of the Parties;It has certain inclusions such as floods, riots, political strikes etc. on account of which a party is excused from performing its part of the contract if any of such event occurs;However, it is very important to provide in the contract, that a party seeking recourse of Force Majeure was actually prevented from performing its part of the contract on account of such events;

24. Drafting of a Commercial ContractGeneral and Common ClausesGeneric Clauses:Force MajeureOne of the important constituent of Force Majeure is “beyond reasonable control of the party seeking to enforce Force Majeure”. This provision should be caveated with obligation on the party to take all reasonable steps to prevent such situation;Once the agreed Force Majeure period has expired, there should be some “cooling-off” period during which the Parties should discuss and assess the situation;Depending on the nature of the Contract, it is important to make an assessment as to whether the Force Majeure event would make the entire contract incapable of being performed or only a part of the contract and accordingly provisions should be provided for the same;

25. Drafting of a Commercial ContractGeneral and Common ClausesRepresentations and Warranties“Representations and Warranties” (“R&W”) is one of the most important part of the contract and has substantial legal consequences;R&W are the statement of fact about any particular and identified right, claim, asset or liability by the person deemed to be in control of such statement;The other party relies on the R&W given to enter into the contract;The statement of facts should be as of a particular date and not futuristic;Time limitation of the R&W with respect to a product should be very clearly mentioned;

26. Drafting of a Commercial ContractGeneral and Common ClausesRepresentations and WarrantiesR&W should have certain exclusions such as normal wear and tear and any other technical exclusion which may ordinarily bring down the value of product in normal usage;Some of the R&W which are generic in nature and are quite broad such as “infringement over third party’s IP rights”, “compliance with law”, etc. should be qualified with words “to the best knowledge” or “subject to” or “except as disclosed”;If the R&W is given on usage/ merchantability of a particular product, such R&W should also provide conditions under which such R&W will not be applicable like “mishandling”, “ operation/ repair work done contrary to standard procedures” etc.

27. Drafting of a Commercial ContractGeneral and Common ClausesRepresentations and WarrantiesThere should be limited qualification of R&W’s;R&W should not be qualified with “opportunity provided to the buyer to carry out inspection”;R&W should include warranty for the spare and ancillary parts;If any product is replaced during the Warranty period, a fresh warranty should commence on such new product;R&W with respect to purchase of goods should provide that such goods conform to the description in the invoice;There should be clear and clean title of ownership of the product/service intended to be purchased without any qualification particularly in cases of transfer of intellectual property or technology.

28. Drafting of a Commercial ContractGeneral and Common ClausesIndemnities:Under the law of contract, Indemnity contract is one under which one party promises to save the other party from loss caused to him by the conduct of the promisor or any other person.One of the main difference between Indemnity and Damages is, Indemnity is usually claimed for loss arising out of action of a third party, whereas damages are claimed for loss arising out the breach of the contract by the parties to the contract;The main principle behind indemnity is to put the person back into the place he was before the loss occurred;All the members of Indemnified should be clearly mentioned such as “officers”, “directors”, “agents” etc.

29. Drafting of a Commercial ContractGeneral and Common ClausesIndemnities: Whilst drafting Indemnity provisions, care should be taken to have a clear and concise definition of “Losses”. Exclusions such as consequential and indirect losses and inclusions such as costs, interests etc. should be mentioned;If there are two or more Indemnifiers, then it is very important to have clarity on “joint and several” obligations. The agreed position should be mentioned as to whether it is “joint and several” or “severally and not jointly” because in the absence of clarity, courts may interpret it either ways on other materials on record;Mechanism to claim indemnity should be provided in Principal to Principal contracts such as issuance of claims notice, responsibility to minimize the loss, right of Indemnifier to defend third party claims in court and restriction on the Indemnified from compromising or accepting the third party claim without contesting.

30. Drafting of a Commercial ContractGeneral and Common ClausesTerminationTermination of a contract can be broadly divided under two heads viz. (a) termination without reasons and (b) termination for reasons;Termination rights under either or both the headings mentioned above are totally based upon the negotiation strength of the parties;A less stronger party may not be able to have a termination right without reasons whereas the other party may the same right.In case of termination right without reasons, the other party should ensure that termination is done with sufficient notice period and all the benefits and payments needs to be settled before termination takes effect;

31. Drafting of a Commercial ContractGeneral and Common ClausesTerminationIn an Employment Contract, the termination provision should also have a “payment in lieu of notice” clause on account of which the management may terminate the services with immediate effect by paying the salary for remaining notice period;In case of termination with reasons, it is very important that all the conditions on account of which a contract can be terminated should be mentioned in specific words and not mere cross reference;Again the nature of this right may depend upon the negotiation strength of the parties to the contract;It is very important to mention that the termination is an option at the hands of the party and is without prejudice to the other rights. In the absence of this clarity, a party intending to exit from the contract may wilfully breach the provisions and seek termination from other party.

32. Drafting of a Commercial ContractGeneral and Common ClausesTerminationConsequences post termination should be provided in the absence of which there is a greater chance of dispute between the parties;In case of termination on account of breach by other party, the contract should clearly mention that exact reasons should be provided in the termination notice.

33. Drafting of a Commercial ContractGeneral and Common ClausesImportant Boiler Plate ClausesNotice and Delivery: In the event of a dispute, the Party should send a written notice only to the address provided in the contract failing which there may be a strong possibility that such notice may not be considered. Further, the Parties should have an option to send the notice through the acceptable means of communication;Waiver: Each party should have a right to waive any breach of other party and at the same time, it should be mentioned that such waiver does not absolve the party from performing its part of the contract;Governing Law: In domestic contracts, the governing law has to be Indian. However, in International Contracts, it is of utmost importance to mention the “governing law country”, which means the laws of such country shall be applicable;

34. Drafting of a Commercial ContractGeneral and Common ClausesImportant Boiler Plate ClausesDispute Resolution: It is this clause, which is interpreted strongly and in priority by the courts to adjudicate whether it has the relevant jurisdiction. If the Clause uses the word “exclusive courts at …”, then it would be strongly interpreted to mean only that court has the jurisdiction. Similarly, if the clause contains arbitration provision, then again the civil court may not have the jurisdiction to adjudicate upon the dispute. Confidentiality: Confidentiality clauses restricts all the parties to the contract to divulge any details of the contract to any third party with exception towards in a legal proceedings, required under law etc.

35. Drafting of a Commercial ContractGeneral and Common ClausesImportant Boiler Plate ClausesSurviving Provision: It is very important to provide that certain key provisions such as Indemnity, Representations and Warranties, Notice Clause, Dispute Resolution will survive (i.e. would be valid) even after termination of contract.No Assignment: It is important to mention that neither party shall have a right to assign the contract to any third party without the express written consent of the other party.AnnexuresAnnexures are considered to be integral part of the Contract and are provided for the purpose of clarity;Any particular clause such as detailed Representations and Warranties or any technical language which has a stand-alone effect should become part of the annexure to make the contract precise.Annexures should contain the same term as is used in the Contract and not any other term.

36. Drafting of a Commercial ContractDistribution ContractsAgreements between an “Owner” and “Distributor” wherein the Distributor undertakes the responsibility of distributing/selling the goods for and on behalf of the OwnerSuch Distributor Agreements can be for physical goods, services or e-platform such as consumer goods, tickets, etc.;In a typical Distribution Agreement, the title and the right to ownership remain with the Owner and do not pass in the hands of the Distributor;

37. Drafting of a Commercial ContractDistribution ContractsPerformance Review/Sales Target- A Distributor Agreement is different from a Warehousing Agreement and accordingly terms should provide for sales target;Manufacturer’s Warranty- The Distributor should have the right to pass on the Manufacturer’s warranty on the product as-it-is to the consumers;Territory- The territory of the Distributor should be clearly defined to avoid any over-lapping with the territory of another distributor;Delivery and Shipment- The obligation to deliver the product till a certain place and mode of transport should be clearly indicated.

38. Drafting of a Commercial ContractDistribution ContractsExclusivity v. Non- Exclusivity- Exclusivity or non-exclusivity on the Distributor to deal with competing products depends on the negotiation but the agreed position should be specified and not ignored.Advertising and Promotion- Obligation should be placed upon the distributor to advertise and promote the products in accordance with the directions of the manufacturer;Product Liability and Insurance- Product Liability should remain with the manufacturer whereas the responsibility of the Insurance is usually passed at the time of delivery to the Distributor.

39. Drafting of a Commercial ContractEmployment ContractsA detailed employment agreement becomes important to retain a key managerial personnel as well as to ensure a system of checks and balances;Tenure of Employment and conditions for renewal;Non Compete- Unless an employee is paid non-compete fees after expiry of the agreement, a non-compete on the employee is difficult to enforce;Key Employee may have a trade mark in his/her name and thus Right of Company over any Intellectual Property developed by Employee during the Course of Employment should be specified;Rights and Responsibilities- In case of a key management personnel, it becomes extremely important to specify the exact nature of duties and rights in absence of which a dispute may arise with the BoardEntitlements such as Sweat Equity Shares, ESOPs etc. should be clearly linked to the well defined targets;

40. Joint Venture AgreementsIncorporated Joint VentureUnincorporated Joint VentureABC LtdKLM LtdXYZ Ltd(JV Co.)ABC LtdKLM Ltd

41. Joint Venture AgreementsIncorporated Joint VentureABC Ltd. And KLM Ltd are the shareholders in the JV Co.This structure is mainly used wherein two entities intend to keep their “own business” and “JV Business separate;Also, they do derive the equity value from the JV Company;Also, this structure is used wherein there is a requirement for a “special purpose vehicle” (i.e. SPV);As the entire business is being managed in a “separate legal entity”, it is necessary to bind such entity;The only binding thing is the shares held by ABC Ltd. And KLM Ltd. in the JV Co. Thus, there will be Shareholders Agreement (can also be called as Joint Venture Agreement)ABC LtdKLM LtdXYZ Ltd(JV Co.)

42. Joint Venture AgreementsUnincorporated Joint VentureThere is no equity interest or ownership in any of the Parties This is mainly done for the purpose of a specific requirement in the business such as “utilization of Trademark” or “Specified Services” or “Exploring certain Territory”This is mainly for collaboration of certain synergies for the purpose of giving extra push and advantage to the existing businessThis is generally time bound and expires once the purpose of joint venture is achievedABC Ltd.KLM Ltd.

43. Joint Venture AgreementsUnincorporated Joint VentureKey Concepts for Drafting JV AgreementPurpose of the Joint Venture/Collaboration is very important for this agreement as there is no common board of directorsConsiderationRights over the joint venture property such as “market/customers”, “R&D Product”, “brand value” etc.Roles and ResponsibilitiesExpiry PeriodTerminationEvent of DefaultABC LtdKLM Ltd

44. Shareholders Agreement (SHA)Pattern(1) to (5) are shareholders in the Target Company with different equity interestNone of them on a “stand alone basis” can control the board of the Target Company. Thus, they require a detailed SHAThere can be any combinations in order to control the Target Company which can give insecurity to the other shareholders(1), (2) and (3) can join to form hands to control the Target Company(2) and (3) can join to form a “single block majority” but still cannot control the company(4) can join with any of other except (1) to get a right to block special resolutions(2), (3) and (5) can join hands to completely take over the Target Company as they would collectively hold more than 75%ABC (Target Company)1(10%)2 (24%)3 (26%)4 (6%)5(34%)

45. Shareholders Agreement (SHA)- Key ClausesPatternEquity Holding Pattern: Record the equity interest of each party correctly and if they are holding “convertible instruments”, please record the same on a “fully diluted basis”Funding Support: Commitment by each or some of the Shareholders to provide funds in case of further requirementsBusiness of Target Company: The actual business of the Target Company. Here the definition of “Business” becomes very important because it will be linked to “non-compete”Minority Protection Rights: In case of any further funding, all shareholders to be first given a priority. In absence of this clause, shareholder no. (1), (2) and (4) can be overlookedABC (Target Company)1(10%)2 (24%)3 (26%)4 (6%)5(34%)

46. Shareholders Agreement (SHA)- Key ClausesPatternAnti-Dilution Rights: In the event, there is further round of investment at a lower valuation than the valuation given to the existing shareholders, the existing shareholders would be given an adjustment in equityQuorum Rights in Board and Shareholder Meeting: Some of the shareholder(s) may want a contractual right from all the other shareholders that without their presence no meeting can be held. There can be various in-built combinations in this “right”. Veto Rights/Affirmative Rights: Some of the minority shareholders may ask for a contractual right to state that without their consent, no resolution can be passed. Generally, if such right is granted, the parties always prefer to agree on a list of such specific matters. ABC (Target Company)1(10%)2 (24%)3 (26%)4 (6%)5(34%)

47. Shareholders Agreement (SHA)- Key ClausesPatternShare Transfer Restrictions Rights:Tag Along Right: If (1) has this right over (2), then whenever (2) sells the shares, (1) can also sell his shares to same buyer at same price and seek an exit;ROFR: (Right of First Refusal): If (1) has this right over (2), then whenever (2) decides to sell to any 3rd party, he has to give a right to (1) to buy these shares on the same terms on which they are being sold to the 3rd party;ROFO: (Right of First Offer): If (1) has this right over (2), then before taking any 3rd party offer to sell the shares, (2) has to first offer it to (1) and if (2) does not like the price, he can then sell it to 3rd party at a price higher than given by (2).ABC (Target Company)1(10%)2 (24%)3 (26%)4 (6%)5(34%)

48. Shareholders Agreement (SHA)- Key ClausesPatternShare Transfer Restrictions Rights:Drag Along Right (This right is little draconian in nature and is also used in Event of Default cases)- If (1) has this right over (2), then whenever (1) decides to sell his shares to a 3rd party, (1) can force (2) to also sell his shares to such 3rd party on the same terms and conditions.Exit Rights: Exit rights means that a right has been provided to any one or more shareholders (typically a financial Investor who has invested for certain fixed returns) to exit from the Company with the assistance of other shareholders/promoters if such Investor is not able to exit on his own. This can be in the form of (a) IPO, (b) 3rd party sale, (c) buy back by existing shareholders (d) Sale of assets and liquidation, (d) drag along rights ABC (Target Company)1(10%)2 (24%)3 (26%)4 (6%)5(34%)

49. Shareholders Agreement (SHA)- Key ClausesPatternLiquidation Preference: Some of the shareholders may want a contractual right that in the event of any liquidation of the company, once all the statutory dues are cleared, then they should first get the balance money in priority. There can be various combinations and such rights are in the nature of “waterfall mechanism”.Deadlock: There can be a situation wherein the Shareholders are not able to agree on a common resolution and either or all wants to part ways. In such case, either of the shareholder who want to part ways can either choose to buy shares of others or choose to sell his shares to others.Standard Provisions such as (a) event of default, (b) termination etc. ABC (Target Company)1(10%)2 (24%)3 (26%)4 (6%)5(34%)

50. Thank You Madhavan Srivatsan, Corporate Counsel madhavan@madhavansrivatsan.com +91 9810447406, Regal Building, 69, Connaught Place