The Authors, Ashutosh Tripathi and Tanush Gupta are 3rd year B.A.LL.B.(Hons.) students at Chaudhary Mahadev Prasad Degree college, Prayagraj.
There are certain steps which are executed before a formal contract is formalised, there goes a lot of homework, foundational work and negotiations on the part of the parties. These steps are oftenly called as Pre-Contractual Instruments (PCIs). Before the formal contract by the parties there are certain discussions on the key terms such as the basic framework of the contract, consideration, the condition preceding etc. These discussions can be recorded by the parties in a pre-contractual instrument like MoU, Term sheet, Letter of intent etc. Hence this becomes the basis of negotiating the formal contracts.
PCIs As a Tool for Negotiations
PCIs help the parties to identify any issues which can help the parties from wasting time and money, it also reduces the time for negotiations of terms as they have been discussed at the very initial stage. PCIs provides an outline for the parties for preparing and negotiating the formal contract. A record of the key terms agreed between the parties is also maintained through the pre-contractual instruments. It covers the broad parameters of their proposed contractual relationships, most of the times it serves an agreement to agree. A proper detailed comprehensive document would be executed later, on an agreed period of say 30days, 60 days and so on. It serves as stepping stone for a more detailed discussion, negotiation, due-diligence and many more aspects.
Types of Pre-Contractual Instruments (PCIs)
There are many types of PCIs also these are interchangeably used but generally their usage depends on the customs in certain industries or while dealing with certain type of parties. There are PCIs which are oftenly used like
- Letter of Intent (LoI) - It shows the intention of the parties to undertake an activity or enter into a transaction. LoI helps to agree and specify upfront the key terms of the proposed transaction. It identifies the major commercial issues between the parties.
- Letter of Award (LoA) - It is typically executed in infrastructure or construction, it deals with the development of infrastructures as they usually have a letter of award to the contractors, which is usually followed by the formal contract.
- Term Sheets It is a document that outlines the main terms and conditions of the agreement between the parties in relation to a proposed transaction.
- Memorandum of Understanding (MoU) - A Memorandum of Understanding (MoU) is a formal agreement between two or more parties outlining their mutual
understanding and intentions on a specific topic or project. While an MoU is not legally binding like a contract, it does demonstrate a commitment to the terms outlined, helping to establish a framework for cooperation. It can demonstrate a moral commitment between the parties to renter into a formal contract also it can create certain binding obligations.
GOVERNING LAWS RELATED TO PCIs
Zostel Hospitality Pvt. Ltd. vs Oravel Stays Private Limited & Anr
Zostel Hospitality Pvt Ltd ("Zostel") and one of its investors- shareholders Orios Venture Partners ("Orios") decided to enter into a contract with Oravel Stays Pvt Ltd. essentially, Zostel would transfer its hotel business to Oravel, against which Oravel would transfer to Zostel which included 7% of its shareholding.
The terms of this proposed arrangement were reduced to writing, in the form of a Term Sheet dated 26th November 2015. This preliminary term sheet sets forth the current intent with regard to the acquisition of identified assets of Zostel Hospitality Private Limited by Oravel Stays Private Limited. This Term Sheet is non-binding and is intended solely as a summary of the current terms that are proposed by the parties; Although the parties do not intend to be bound until they enter into Definitive Agreements regarding the subject matter of this Term Sheet.
According to the agreement, ZO ROOMS (Zostel) had efficiently completed its obligation and had transferred the business. But on the other hand, it was alleged that OYO (Oravel) had failed to transfer its 7% to the ZO ROOM’s shareholders and Zostel also Claiming that, owing to defaults on the part of Oravel, Zostel was unable to acquire the assets of Oravel, Zostel initiated arbitration proceedings against Oravel.
After having long months of legal battle, the Supreme Court accepted the arbitration petition by Zostel and appointed former Chief Justice of India, Justice A M Ahmadi as a sole arbitrator.
The Arbitration Tribunal, headed by former CJI Justice A.M Ahmadi, ruled in favour of ZO Rooms (“zostel”). The Tribunal also acknowledged that the transaction was concluded as ZO Rooms transferred the whole business to oravel. The tribunal also added that the breach wasn’t caused by ZO ROOMS (zostel) and its shareholders, ZO Room’s shareholders were entitled to the issuance of a decree of performance, directing the parties to execute a definitive agreement.
Rajasthan Cooperative Dairy Federation Ltd. Vs. Maha Laxmi Mingrate Marketing Service Pvt. Ltd. & Others,
The case suggests that Letter of Intent merely expresses an intention to enter into a contract and where the conditions stipulated in the Letter of Intent are not fulfilled, and the conduct of the party in whose favour LoI has been issued is otherwise not such as would generate confidence, the party issuing Letter of Intent is entitled to withdraw the same and there is no binding legal relationship between the parties at the stage of issuance of Letter of Intent. It was held that the party issuing Letter of Intent is entitled to look at the totality of the circumstances in deciding whether to enter into a binding contract with the party or not.
Liabilities due to Pre-Contractual Instruments (PCIs)
Liabilities due to PCIs refer to the obligations that arise before a formal contract is formalised usually during the negotiations phase. If the instrument doesn’t specify the nature of obligations i.e. binding or not, then courts could infer it from the intention of parties. The inference can be withdrawn from the language of the instrument, circumstances, the conduct of the parties. If a bound by the terms is intended than fictional and quasi contract is interpreted to exist. This means an instrument should specify any binding relationship to be created.
There can be ambiguity and uncertainty as they are not often legally binding which creates ambiguity about the intentions and responsibility of the parties involved. Parties might overestimate the security or commitment of a PCIs, believing it offers more protection or certainty than it actually does. A significant amount of time, money and effort is invested in negotiating the PCIs without any guarantee that the final contract will be concluded.
Conclusion
The pre-contractual instruments offer significant advantages in the pre-contractual phase, it's essential to understand their limitations. The legal enforceability of PCIs can vary, and ambiguity regarding binding obligations can lead to uncertainty. Parties must be cautious not to overestimate the security or commitment offered by a PCI, as considerable time, effort, and resources can be invested without a guaranteed final agreement. Therefore, careful drafting and clear articulation of the parties' intentions regarding binding versus non-binding provisions are paramount to effectively utilizing PCIs and mitigating potential risks. By understanding both the benefits and potential pitfalls of PCIs, parties can strategically navigate the pre-contractual landscape and lay a solid foundation for successful formal agreements.
