Revisiting the case of Dotted Line Contracts in Commercial Transactions: How Equal is the Bargaining Power

Introduction

The Supreme Court (SC) in M/S Indsil Hydro Power and Manganese Limited v. State of Kerala and Ors. (Indsil Hydro Power) discussed the position surrounding the existence of dotted line contracts in commercial transactions. Among other issues, the Court examined whether the terms and conditions of the government policy allowing private agencies and public undertakings to set up hydel schemes for generation of electricity at their own cost were consciously incorporated in the agreements, and whether such terms could be termed to be unconscionable and/or manifestly arbitrary. While doing so, the bench comprising of Justice Uday Umesh Lalit and Justice Vineet Saran upheld the validity of the clauses contained in the terms and conditions by noting that parties had equal bargaining power. In this context, the author analyses the existence of dotted line contracts in commercial transactions and sheds light on the existing lacuna in assessing the same.

Understanding the Concept of Dotted Line Contracts

Dotted line contracts, or ‘take it or leave it’ contracts are contracts in which there would be no occasion for a weaker party to bargain or to assume to have equal bargaining power. In Central Inland Water Transport Corporation Ltd. & Anr. Etc. v. Brojo Nath Ganguly & Anr. (Central Inland Water Transport Corpn.), the SC observed that this concept will apply where the inequality of bargaining power is the result of the great disparity in the economic strength of the contracting parties. Thus, under a dotted line contract, the weaker party has no meaningful choice, but to give his assent to a contract or to sign on the ‘dotted line’ in a prescribed or standard form or to accept a set of rules as part of the contract, despite a clause being unfair, unreasonable and unconscionable.

In countries such as the United States, the United Kingdom and Australia, there are implied covenants of good faith, i.e., ‘fairness’ and ‘reasonableness’ which a contract has to meet, especially where there is inequality of bargaining power between the parties. German Civil Code[1] also provides for a transaction to be void when a person exploits the distressed situation, inexperience, lack of judgmental ability, or weakness of will of another in exchange of advantages that are disproportionate to the performance given in return. French law also retains a similar position.[2] In India, even though there is no implied covenant of good faith, such contracts are generally held to be void under Section 23 of the Indian Contract Act, 1872 (ICA) as they are opposed to public policy. However, there are several instances where courts have upheld the validity of such terms and were reluctant in interfering with contractual terms agreed between the parties. While doing so, the Courts have placed emphasis on the bargaining power of parties to determine the validity of unreasonable clauses.

Does Equal Bargaining Power Override Unfairness and Unreasonableness?

As seen earlier, a dotted line contract contains unfair, unconscionable and unreasonable terms and is entered into between parties having unequal bargaining power. While unfairness and unreasonableness of a term goes against the basic tenets of good faith and fair dealing in contracts, what is unfair and unreasonable is largely subjective. Black’s Law dictionary defines a term as unconscionable, if it is so grossly unfair to one of the parties because of the stronger bargaining powers of the other party. Courts in other jurisdictions have shed light in this regard. In Hume v. United States, it was stated, “a term which no man in his senses, not under delusion, would make, on the one hand, and which no fair and honest man would accept, on the other” would be deemed unconscionable and unfair. Such terms were also held to be void as against public policy. Similarly, in Burger King Corporation v Hungry Jack’s Pty Limited, it was stated that a term that would have rendered the rights conferred on a party by a contract worthless or would seriously undermine it is unreasonable. In Ballard v. Sebring Proprietary company[3], the court observed that a clause that causes significant imbalance in the parties’ rights and obligations, and which is not reasonably necessary to protect the legitimate interests of the party is unfair. In these lines, the Indian case of Central Inland Water Transport Corpn. while describing an unconscionable term observed that an unconscionable term is one which is irreconcilable with what is right or reasonable. Thus it can be concluded that in almost every jurisdiction, a reasonable clause would take into account interests of the parties, as well as the aims and purposes of the contract.

However, such unfairness or unreasonableness ‘alone’ would not render a contractual term void, and the parties’ bargaining power is additionally to be taken into account. For instance, under American law, contracts of adhesion, or ‘take it or leave it’ contracts are not unconscionable per se. The factors that would make them unconscionable are excessive standardization of the agreement and less power to a party to bargain meaningfully. Similarly, the SC in Indsil Hydro Power discussed the bargaining power of the parties in order to determine the fairness of the contract. However, there is a difference in position in the Indian law especially with regard to commercial contracts.

The Relevance of Discussion in Indsil Hydro Power

The SC in Indsil Hydro Power referred to Central Inland Water Transport Corpn. wherein it was observed that the principle of dotted line contracts will not apply where the bargaining power of the contracting parties is equal or almost equal. In order to illustrate equal bargaining power between parties, Central Inland Water Transport Corpn stated that where both parties are businessmen, and where the contract is a ‘commercial transaction,’ the parties are generally said to have equal bargaining power and hence, the question of dotted line contracts does not arise. This view was also upheld in S.K. Jain v. State of Haryana and Anr. (S.K. Jain) and ICOMM Tele Ltd. v. Punjab State water Supply Board (ICOMM Tele Ltd.) wherein the SC noted that the concept of unequal bargaining power has no application in case of commercial contracts. On the other hand, where incorporation of such one-sided clauses in an agreement constitutes an unfair trade practice or was adverse to the consumers, Courts have held it to be unconscionable. For instance, in Pioneer Urban Land & Infrastructure Ltd. v. Govindan Raghavan (Pioneer Urban Land), where flat purchasers had no option but to sign on the dotted line, on a contract framed by the builder, the Court held such an agreement to be ex-facie one-sided, unfair, and unreasonable. Moreover, incorporation of such one-sided clauses in an agreement was said to constitute an unfair trade practice as per Section 2 (r) of the Consumer Protection Act, 1986.

In essence, by bringing out the contrast between the existence of dotted line contracts between parties with unequal bargaining power through the Pioneer Urban Land case, and by highlighting the non-application of unequal bargaining power in commercial transactions through cases such as Central Inland Water Transport Corpn., S.K. Jain, and ICOMM Tele Ltd., the Court reaffirmed the position with regard to the non-applicability of dotted line contracts in commercial transactions. The same however raises concerns.

Time to Reform?

The non-applicability of dotted line contracts in commercial transaction stems from the presumption that all commercial transactions are entered into between parties of equal bargaining power. Courts expect businesses entering into contracts to have undertaken conscious and detailed negotiations, and such parties to be fully aware of the consequences of each term. This stance is similar to the one taken by Lord Diplock in A. Schroeder Music Publishing Co. Ltd. v. Macaulay (formerly Instone), wherein he highlighted the relative strengths and knowledge of business buyers as opposed to consumer buyers. However, it is the author’s assertion that it seldom happens in negotiations that the bargaining powers of the parties are absolutely equal, as rightly pointed out in Alec Lobb (Garages) Ltd v. Total Oil (GB) Ltd.

Moreover, in as early as 1995, the SC in L.I.C. Of India & Anr v. Consumer Education & Research Centre & Ors. etc. discussed the cases of A. Schroeder Music Publishing Co. Ltd. V. Macaulay (Formerly Instone) and Photo Production Ltd. v. Securicor Transport Ltd, which placed regard on the bargaining power of parties’ even in commercial transactions. In Watford Electronics v. Sanderson CFL Ltd, the England and Wales Court of Appeal stated that where experienced businessmen representing substantial companies of equal bargaining power negotiate an agreement, they should be taken to be the best judge on what constitutes fair and reasonable terms. Similarly, the case of Raiffeisen Zentralbank Osterreich AG v. Royal Bank of Scotland held that reasonableness is satisfied where there is a fully negotiated contract between parties of equal bargaining power. Thus, it is evident that other jurisdictions have been long considering the relative bargaining power of parties even in commercial transactions. When seen at this background, the discussion of the SC in Indsil Hydro Power, wherein it stuck to the observation in Central Inland Water Transport Corpn, and presumed that commercial transactions are entered into between parties with equal bargaining power seems regressive. Further, while the statutory protection with regard to consumers is strengthened especially after the recent enactment of Consumer Protection Act, 2019, a void remains with regard to the existence of dotted line contracts in commercial transactions. The time has thus come to redefine the exiting yardstick pertaining to dotted line contracts.

Reconsidering The Yardstick

While parties can include terms in standard forms to protect their legitimate interests, the tests of reasonableness and fairness of the clause should be judged on the facts and circumstances of each case. Additionally, a provision on the lines of Schedule 2(a) of the Unfair Contract Terms Act 1977 which requires regard to the strength of the bargaining positions of the parties relative to each other is required in India. This is especially owing to the fact that Courts mostly restrict the invocation of Section 23 of the ICA to government contracts.

Further, amendments were proposed to the Australian Securities and Investments Commission Act 2010 and the Competition and Consumer Law Act, which extended the unfair contract terms regime that previously covered only consumer contracts, to small business contracts. On the same lines, bargaining power of the parties ought to be evaluated even in the case of commercial transactions in order to protect the interests of small businesses. This becomes even more necessary when businesses enter into contracts using their standard forms, where it is not always possible for contracting parties to have a fair chance to ensure that contractual terms that are favourable to them are included in the final deal. Also, the recommendation of the 103rd Report of the Law Commission of India with regard to inserting a statutory provision has not yet taken effect. Such a step is necessary to benefit small and medium businesses from the presumption of a commercial contract’s fairness in the long run.

A starting point could be the consideration of relative bargaining power of the parties by the Courts in transactions where the issue of unconscionable terms arises, and redefining the exiting yardstick.

(This post has been authored by Pooja V., a third year law student at National Law Institute University, Bhopal )

Cite as: Pooja V., ‘Revisiting the Case of Dotted Line Contracts in Commercial Transactions – How Equal is the Bargaining Power?’ (The Contemporary Law Forum, 11 November 2021) <https://tclf.in/2021/11/12/revisiting-the-case-of-dotted-line-contracts-in-commercial-transactions-how-equal-is-the-bargaining-power> date of access.

References

  1. German Civil Code, § 138(2), https://www.gesetze-im-internet.de/englisch_bgb/englisch_bgb.html#p0417.
  2. French Civil Code, 2015, Art. 1134, 1135, https://www.fd.ulisboa.pt/wp-content/uploads/2014/12/Codigo-Civil-Frances-French-Civil-Code-english-version.pdf.
  3. [2014] VCAT 1636.

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