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Importance of Business Contracts & Financial Contracts for Indian SMEs

Apohan Corporate Consultants Pvt. Ltd. > Financial Strategy > Importance of Business Contracts & Financial Contracts for Indian SMEs

Financial contracts

 

 

Importance of existence of financial contracts

We are covering the topic importance of existence of financial contract before the topic of importance of financial contract because has not been realised well by many SME businesses. In case of small and medium enterprises, the need for preparation of a financial contract for long-term strategic relationships and transaction is not paid as much serious attention as should be paid. Apohan has observed in its market survey that many companies have simply not prepared even the most critical financial contracts with their key stakeholders. The understanding between the parties is verbal or is written down on a very cursory manner. It has been observed that the requirement of having to prepare a detailed financial contract is seen as a symbol of distrust in many cases between the partner friends in a SME company. Going is good in the beginning, and there is not much to fight for or to fight about, everything sails smooth. But when the business becomes wealthy and complicated, a lot of new assets, liabilities, rights and obligations, decisions, duties arise which the friends were not aware of before. There is no clear framework between the partner on how to share these positives and negatives. In these circumstances, misunderstandings might get developed and may also ultimately lead to a breakup. When these people approach for dispute resolution, in the absence of a contract, exactly what happened in the history is taken as what was contracted. However, when there is a written down contract, any aberration in performance cannot be the contract itself even if it is ignored by the other party. It is treated as a voluntary waiver and not as a contractual right. So, do prepare a contract!

 


Importance of a financial contract

Many properly organised institutions and organisations dealing with small and medium enterprises will not work without a written down formal contract. The businesses think that the terms and conditions of these contracts are non-negotiable including the clauses on the prices. Their contract are very elaborate as they are prepared by the giant financial institutions who have a wide variety of risks. So the business end up accepting all the standard terms and conditions, completely in the favour of the institutions without a single word of negotiation.
However, when it comes to the relationships between a business (as the legal entity) and the most important stakeholders of the top of the management, or between individuals very close to it or between the other businesses very close to it, elaborate contracts are not prepared even if large value and long-term transactions are being carried out. If we have to capture the essence of a business transaction in just two words, they are: 1. Baat (the context of what has been agreed) 2. Hisaab (for what value). The financial transactions are complex and they have several aspects. The business contracts should capture the obligations of the parties and also should write down what happens if the respective obligations are not honored. If all the foreseeable aspects are captured and also, if the principles of all the the aspects that cannot be foreseen are written down, then parties can work together for many years without any friction. Many Indian Businessmen simply sign the documents written in English (many of the Businessman may not be understanding simple English, and many other businessmen who understand simple English may not be understanding the verbose legal English) without looking at the contents in detail. And that is why they discover the negative aspects or limiting, qualifying, and adverse clauses one by one in the life of the contract. This is why, a contract should be taken very seriously before it is being entered into.

 


Types of financial contracts

If we classify all the contracts, one variety of them is business contracts. If we further classified all the business contracts, one variety of them is financial contracts. Almost every business transaction except for the Memorandum of Understanding (MoU), term-sheet, Letter of Intent, any application, any query, an agreement to sale, an notice inviting tender (NIT), a tender, a teaser, a certificate, an RFP, etc. has of contractual or financial side to it. There is a wide variety of financial contracts based on the number of parties, the legal nature of parties, the purpose of contract, scope of work, value, term of contract, applicable jurisdiction, etc. Below are some important financial contracts:

 

 

Articles of association
Shareholding agreement
Lease contract
Sale purchase contract
Concession contract
EPC contract
Service contract
Work contract
Supply contract
Employment contract
Licence Agreement
Franchise agreement
Royalty contract
Consulting contract
Brokerage contract
International contract
Private contract
Public contract (contract with government, etc)
Verbal contract
Construed contract
Non disclosure agreement
Non-compete agreement
Bank guarantee
Power of attorney
Project management contract
Annual maintenance contract
Service level contract
Death wheel
Bye laws of a club
Gift deed
Trust deed
Share certificate
Currency note
Sale deed
Business transfer agreement
Joint venture agreement
Escrow agreement
Substitution agreement
Investment contract

 

 

This is not an exhaustive and orderly list of the possible varieties of contracts. It is just a random sample of important business contracts. Apohan has expert’s understanding in a wide variety of contracts.

 


Elements of financial contracts

Typical business contract has the following sections
Preamble and recitals (identification and background of parties)
Contract related clauses (validity , tom, condition president)
Operational clauses (who will do what, what happens if they don’t do that)
Payment mechanism related clauses (mode of payment, credit period, invoicing)
Payment value related classes (elements of payment, payability, schedule of payment, values or formulae o parameters, taxes)
Obligations of the parties (how the parties will enable the purpose of the contract, what they will do and not do)
Strategic clauses (Force Majeure, termination, dispute resolution, representations and warranties, etc)
Standard legal clauses (applicable jurisdiction, interpretation, communication, number of copies, modification, etc)

 


Good contracting practices

Business contract should be written down in plain simple English language or local language. They need not be necessary written in English or in complex legal language. They should be properly stamped and duly registered. It should be ensured that they are legally enforceable and are in line with the laws of land. They should be prepared in as many number of copies as the number of parties to it. It is a good practice to get them vetted by a lawyer. The scope of work should be paid proper attention. Inclusion and exclusion of activities should be clearly mentioned. The contract should be balanced and not learning in favour of any one party. There is a possibility of the judges developing an antagonism for the party which is seen to be having very high bargaining power, in case of a unfortunate litigation in one-sides contracts. Alternative dispute resolution mechanism should be preferred and its award should be made mandatorily binding. Local court should be preferred. Attention should be paid to the amounts other than the main payments such as the penalties and damages or compensations. Attention should also be paid to the levels of deductions for the deficit in service level. Attempt should be made that a contract is exhaustive and covers most of the aspects of the transaction. It should be made into an enabling instrument incorporating all the clauses for reasonable corporate cooperation. All the communication going before the contract should be made a part of contract with lower precedence. It should be made easy to amend the contract as the business circumstances are very dynamic. All the risks that arise from a long-term engagement should be analysed and safety provisions should be made in the document. Circumstances giving the power for exit or termination should be clearly mentioned. Proper references should be made to the corporate documents, industrial standards (matters that are not binding by law but voluntarily chosen by the parties) that will actually govern the contract management and execution of the activity. Mentions of who bears what costs and what risks should be made clear in a joint activity. Even in case of the transactions which are not long-term and not of very high value, and where there is no need felt for a contract, all the details should be communicated through emails etc. These emails are virtually as good as legal contracts. There are many other specific provisions for which Apohan can provide a business and experts advice.

 


Role of lawyers in financial contracts

The business lawyers from reputed companies have in-depth understanding of the business and of the legal framework. They can customise the standard templates of contract if the transaction is very typical, prepare an altogether new contract, covering almost all the innovative aspects right from the scratch, for a very novel business arrangement. They can suggest the contract structure or the exact legal relationship to avoid legal issues. Indian companies are relative lucky in comparison with their Western counterparts in that Indian lawyers have very high degree of expertise in their area of professions, much ahead the evolution of the the regulatory framework in the country, and simultaneously their fees are very less compared to the global fees levels. Legal forms as well as legal professionals have a formal and legal relationship with the bar as well as the judicial system in the country. They don’t enjoy (have) the freedom as much the strategic consultants enjoy in formulating beneficial contracts for the businesses. Also lawyers are always wrapped in the the legality and legal implications frame of mind. As against that, typically, strategic consultants are from Engineering and Management background; they have pure business perspective; they treat law only as a guideline and an enabler. Lawyer to have relinquished their practice certificates for practicing business strategic legal advisory are a rare species.

 


Role of strategic consultants in financial contracts

The lawyers cannot prepare a business contract stand alone. They do not to appreciate the strategic aspects of a business as do the strategic consultants. Following are the legal contract services upon carries out:

 

Preparation of the stakeholder contracts such as shareholders’ agreement
Preparation of strategic business contracts
Preparation of business transfer agreements
Transaction advisory for the public sector tenders
Advisory for private equity investment agreements
Advisory for institutional, bank loan agreements
Advisory for product sale agreement
Advisory for raw material procurement agreement
Bid advisory for the public sector tenders
Review of long-term agreements
Review of short-term agreements
Contract framework
Contract negotiation
Contract execution
Contract management
Risk analysis of a contract
Financial analysis of a contract
Legal review of company documentation, policies, etc
Regulatory study of the sector
Applicable laws’ analysis
Business laws
Obtaining permits, licences, permission & approvals
Support to the litigating lawyers
Support for insolvency and bankruptcy code cases
Support in defending a business pacing recovery laws

There is a wide variety of legal work that strategic consultants can carry out for the businesses. A few of them have been listed above.

 


Apohan’s role

The business contracts in which there is significant financial stake as well as the financial contracts which deal with purely financing and investment matters, are very crucial from the perspective of a businessman. Apohan, as a strategic consultant, helps analysing impacts of these contracts on a business, preparation of a risk matrix of a contract, incorporating all the relevant concerns of a business in them, structuring them, negotiated them with the counter parties, getting them vetted from the professional business lawyers.

 


 

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