Business

How Does India Plan On Solving its Crippling Contract Enforcement Problem?

Most people who face a breach of contract have no practical remedy to turn to.

The Modi government identified ease of doing business index as a major indicator of its performance and has been trying to increase India’s ranking on this index. India made a big jump to the 100th spot in overall ranking, and made the biggest gains in the entire world with respect to this index, thanks to several reforms that took place in the last two years.

However, India plans to further move its position to within the top 50 countries. How is that going to be possible?

One of the factors that has been causing India to historically lag is the tricky question of enforceability of contracts. This is one index on which India has performed extremely poorly over the years.

How bad exactly is the contract enforcement system in India? A few years back, India was ranked 186th out of 189 countries surveyed on this index. The three countries worse than India were Timor-Leste, Angola and Bangladesh. In other years it has ranked marginally better. In 2018, we ranked 164th in the world. We ranked worse only for getting building permits (181).

There are few things at which we Indians may be the absolutely worst. Contract enforcement is just one of those things. Why is India’s contract enforceability score so terrible?

Primarily, it is India’s absolutely slow judicial system. Civil justice system is especially slow in India. There is a lot of hullabaloo over criminal justice system being slow, and plenty of media attention given to the same. As a result, there is some effort to speed up criminal justice system.

Unfortunately, the civil justice system has been given the step-motherly treatment over the years although it is many times more slower than criminal justice system. Despite the massive growth in economy, which has at least quadrupled in last 20 years if not more, there has been no proportionate increase in the strength of judges or courts.

The situation is so bad that the number of civil disputes being filed has reduced rather than increasing over the last decade, as people with disputes see no point in dragging a matter through expensive court procedure for years and years and getting no resolution. It is possible that some of these people are trying to resolve their matter through the criminal justice system, trying to give a garb of criminality to basically contract enforcement matters as the civil justice system is hopelessly slow and of no practical use for most people.

According to 2016 data published by National Judicial Data Grid, two crore cases were pending in district courts in India, one-third of which were civil cases. At the time, analysts said that at the current rate of clearing, the district civil courts will never finish the backlog of cases.

Will you spend a big court fee, money on lawyers and then wait for years and years to get a judgment? If you don’t want such a fate, filing a civil case is not really a viable option in India. That leaves most people who are facing a breach of contract without any practical remedy.

Of course, the other option is to go through an alternative dispute resolution process. There are some cases that may be solved through mediation. However, lack of a credible legal alternative through which one could enforce a contract emboldens parties to breach contracts, as they know they can get away with it scot free. In such cases mediation is unlikely to help. Arbitration is one possible option, but even arbitrations in India has been plagued by high costs and terrible delays, which keeps arbitration out of the reach of common citizen. Big corporations prefer to take their arbitration to jurisdictions like Dubai and Singapore as in India for these reasons.

Compare this to a country like Singapore or even the US, where one could enforce a contract in a matter of a week or a few months maximum. In jurisdictions like Dubai, Singapore and Hong Kong a large arbitration can be wrapped up in a single day. The threat of enforcement stops people from opportunistically breaching contracts, thus keeping the business ecosystem reliable and trustworthy.

According to the Ease of Doing Business Index Report, enforcing a contract in India can take 1445 days and 30% of the claim value as cost. The report also gives 10.3 points out of 18 to India’s quality of judicial process, which is quite poor. From experience I can say that the report’s estimates appear to be better than the terrible situation Indians come across when they try to enforce contracts.

What’s the economic impact?

The economics of enforcing a contract demands that the cost of enforcing the contract must be lower than the profits one expects to make from execution of the contract. If the cost is too high, it may not make sense for a contract to be enforced at all. Then parties to any contract depend on either benevolence, or good relationship etc. to recover their dues. This increases the number of breaches as parties are not afraid of legal consequences. This can lead to a breakdown in large number of deals, causing a lot of loss to businesses and individuals across the entire economy.

Understandably, in case of larger deals, the enforcement cost may still be lesser than benefit of enforcement. So in those cases, parties with huge stakes will still enforce contracts while smaller businesses and not-so-rich individuals who have smaller deals to protect suffer the most.

Unfortunately, nobody has undertaken the task of quantifying the losses so far. Even the World Bank appears to be calculating their numbers based on big businesses and not the problems faced by SMEs or individuals. In Indian courts, this phenomenon is quite visible as big business houses commandeer more time of the courts by hiring expensive senior counsels, a measure completely out of reach for the average MSME, small businessmen, traders or Individuals who may have a legal claim.

There is no data available in the public domain about the cost of this massive failure to provide justice by enforcing contracts. There is a huge uncertainty cost attached to doing business in India due to uncertain enforceability of contracts, and it makes Indian businesses globally less competitive. It also makes India a difficult place to do business in, therefore silently working as a major force that deters investment, both domestic and foreign. It also prevents companies that would have been otherwise successful from becoming viable, thereby hurting the much talked about startup industry as well as the entire economy.

Uncertain cash flow is a major reason for companies shutting down. Cash flow becomes especially uncertain when contracts are not enforceable. India really cannot hope to become a developed economy in the decades to come without resolving the problem of contract enforcement. While we have no data to establish the quantum of loss, it is probably a few percentages of the GDP if not more, and moreover, a missed opportunity of transforming India in a really business friendly country.

What is the government planning to do about it?

There are two aspects to solving India’s contract enforcement problem. One is reforming India’s sagging civil justice system, which has lost credibility to the extent that the people who are supposed to seek justice through it have begun to avoid it altogether as far as possible. However, reforming the system can be a resource intensive and difficult task.

The government has promised to address a part of the problem through institution of commercial courts. On March 9, the Cabinet passed an amendment to the Commercial Courts, Commercial Division and Commercial Division of High Courts Act, 2015, making some very important changes to the law. For one, disputes worth at least Rs 1 crore could be referred to these commercial courts. The proposed amendment will bring down the floor to Rs 3 lakhs, thereby opening up the benefit of these specialised courts, which are expected to be faster and better in terms of expertise in commercial matters, thereby directly impacting the time taken to enforce contractual claims worth over Rs 3 lakh. This could be a key aspect of improving India’s rank on the ease of doing business index.

Further, in major cities, commercial courts are being introduced at the level of district judges. This is likely to have a long term positive impact provided that judges in larger numbers are actually appointed in these courts rather than just giving additional duties to existing judges who are already overburdened with cases for optical purposes, as has happened in the past.

Also, this government has attempted to make a structural change to how arbitration, the other major avenue to resolve disputes and enforce contracts, in conducted in India. It has attempted to introduce time limits on how long arbitrators may take to render decisions, and tried to push the market away from ad-hoc arbitration, which happens to be the norm now, towards institutional arbitration. To empower, recognise and at the same time keep arbitral institutions in check, it is also creating a regulator of arbitrators and arbitral institutions, and has named it Arbitration Council of India.

All of these are major structural developments which are much awaited and are likely to have very positive impact on enforceability of contracts in India provided that these proposed amendments see the light of the day and continue to remain priority of the government in an election year.

There is another very important aspect of the contract enforcement problem. India has so far followed the jurisprudence that a contract can be freely breached as long as the party breaching the contract compensates for the losses arising out of such breach. This is one of the most important contract law principles – often called the principle of efficient breach of contract, which was originally developed in UK and adopted in India. The embodiment of this principle is enshrined mainly in the Specific Relief Act of 1963.

The problem with theory of efficient breach is that it assumes that it is easy to quantify the damages or that the transaction related to the compensation happens smoothly. In countries with strong judicial systems this may be true, but in India it is a very different story.

Let’s say I hired a freelancer to write an article on efficient breach of contract for my blog in exchange for Rs 1,000. I paid Rs 500 in advance. However, the freelancer decides to not write the article by the agreed upon deadline and even refuses to return my advance. I now have to go to the court, prove that I suffered a loss, and prove to the court what is the amount of the loss so that the court will give me a decree. Once I have the decree, I have to approach the court again for enforcing the decree. This is a long process that in Indian courts could easily take three-to-five years and possibly lakhs in lawyer fees. Hence, I will have no interest in enforcing this contract. This is where the theory of efficient breach falls flat on its face.

What if the court simply asked the freelancer to write the article he promised instead of asking me to quantify my losses and prove the same? What if the court allowed me to get the article written by another author on urgent basis (due to urgency, lets say he charges me Rs 3,000 instead) and recover the same from the freelancer?

It would certainly reduce the length of the judicial process and make it easier to enforce contracts. This is what the government is now planning on doing. There are two major changes it is introducing. One is that it is throwing out the principle of efficient breach. Till now, the rule was that breaching a contract and paying damage was fine, and court awarded specific performance as an exception in a few deserving cases. The amendments will now make specific performance of contracts the rule, and damages the exception.

The new law will also create a category of public works contracts and an easier regime to enforce these contracts, in an effort to boost the infrastructure sector.

A long term solution

It is much easier to amend a few legal provisions than implementing them on the ground. India has never been very bad at making laws but implementation is quite another thing. A good example of this would be GST reforms which was amazing in theory but turned into a nightmare for many and perhaps the economy due to poor implementation. There are several major hurdles that the government will face in bringing any real change to enforceability of contracts in India at implementation level once these laws are made.

If enforceability problem is to be solved, sufficient number of judges must be recruited and vacancies in courts must be quickly filled. Investment in the judiciary is also in a desperate need of enhancement. While developed countries have over 50 judges per million population, and USA has about 100 judges, we have around 15.

Another major way to increase productivity of judges will be to introduce fully digital systems in the courts. There are courts like Delhi High Court which has adopted high level of digital transformation, while the Supreme Court still functions through manual systems. Lower courts around the country are mostly yet to be introduced to meaningful digitalization. This alone could make a huge difference to the entire system.

A huge challenge is also that it is easy to challenge the validity of a contract itself due to poor and costly registration system in India. It is demand of the time that registering contracts with the sub-registry should become a digital process that can happen seamlessly thanks to digital signatures and other technology such as blockchain so that disputes over genuineness of a contract can become redundant. This will reduce contract enforceability problem and serve the interest of justice in a very big way.

It is also important that individuals and businesses also make an effort to learn more about contracts and contract enforceability. My lawyer friends who visit China for their work are usually shocked by how aware the Chinese are regarding contractual provisions and their implications despite no formal legal training. Compared to that, the average Indian knows precisely little about how to negotiate a contract and what are the implications of various clauses in the agreements they are signing. If contracts are to be more enforceable in India in reality, we need this to change as well. As someone who teach contract drafting and negotiation, I see the big difference even a basic level of knowledge can make.

Simply put, while the sweeping amendments are a good place to start from, and will probably help to raise India’s ranks in the ease of doing business index, but real solutions will take a lot more time and effort.

Ramanuj Mukherjee is one of the founders of LawSikho.com, an online legal education platform, where he teaches contract drafting and negotiation.