[TYPE THE COMPANY NAME]

CONTRACTS PROJECT
APPLICATION OF LAW OF CONTRACTS VIS- -VIS CORPORATE ADMINISTRATION IN THE LIGHT OF THE AMBANI BROTHERS CASE.

TABLE OF CONTENTS

____________________________________________

Abstract . Acknowledgement . List of Abbreviations.. List of Cases ... Chapter 1: Principal aims and objectives of the study ...... Chapter 2: Introduction ...... Chapter 3: The Background .... Chapter 4: What the Dispute is About ..... Chapter 5: What is Production Sharing Contract ...... Chapter 6: A Brief History of Petroleum Contracts ..... Chapter 7: Principal Agent Relationships ..... Chapter 8: An Application of the Principal Agent Model . Chapter 9: The Judgment Chapter 10: Doctrine of Identification Chapter 11: States Action for National Interest . Bibliography

3 4 5 6 7 8 9 10 12 17 19 21 23 25 28 30

ABSTRACT

Of all the topics that could have been studied it is the most interesting, intriguing and, a daunting task too, to analyze and study a recent judgment in the present complex legal scenario. The project focuses on recent judgment given by Supreme Court of India in the case of gas dispute between the Ambani Brothers regarding the gas pricing in Krishna-Godavari Basin which shall be determining such disputes in the future and even the extent to which parties can be included in a contract due to pertinent interest in the subject matter. It shows light on the MoU signed between the bros at the time of partition of assets which fixed the prices at $2.34 mmBtu, which the Government later raised to $4.20 mmBtu in 2007. It further discusses in detail the grounds on which the dispute has arisen between the Ambani Brothers and the government. Further in the project, the production sharing contract has been discussed in detail. An elaborated discussion of the contract (PSCs) between the government and the contractor has been done which enlightens the reader of the various aspects of the production sharing contract. The nature of state as the party to PSCs has also been discussed. The project also focuses on the history of petroleum contracts, discussing their emergence, importance, management and distinction from other such contracts. It further emphasis on the principle-agent relationship existing between the government of India and the contractor involved in the case. The applicability of such relationship between parties involved has also been discussed in relation with the Indian contracts Act. Later in the project, the judgment given by the Supreme Court of India proclaiming Production Sharing Contract as an overriding contract has also been mentioned. It also emphasized on the states action to protect the national interest and to act in the greatest good of all. The judgment has a great role to play in giving the government the right and duty to protect the interest of the state in todays globalised world where more and more private individuals compete with the state in matters of not only money or resources but also power.

ACKNOWLEDGEMENT ____________________________________________
I would like to fetch this opportunity to extend some words of gratitude to my esteemed Professor of Law (Contracts), Mr. Ravindra Kumar Singh, who had been a constant source of inspiration for me in the pursuance of not only this project but also my studies. By allotting me this topic of research, Sir provided me with the opportunity to study the application of law of contracts and its importance in the todays globalised era through studying this very important case. Sir has been gracious enough to guide me on the right path which has enabled me to strengthen my efforts. I shall also thank our professor sir to have made the right variety of books available in the library. I shall not forget to acknowledge the help that I got from the college authorities for availing such a good library facility where right books and articles were at my immediate access. My batch mates were always at my side in times of pressure and need. I may also take this opportunity to wish the reader of my project a knowledgeable experience. Last but not the least I would like to thank God as well as my parents for being a continuous source of blessings all through the course of making this project. The project has been made with utmost care & with utmost finesse to see that the information mentioned is to the best of the accuracy and correctness.

LIST OF ABBREVIATIONS

$ - American Dollars & - And All Allahabad Bom. Bombay CIS Commonwealth of Independent States Co. Company FOC Foreign Oil Company HC High Court KG Krishna Godavari Ltd. Limited mmBtu Million British Thermal Units MOU Memorandum Of Understanding NOC National Oil Company Pg. Page PSA Production-Sharing Agreements PSC Production Sharing Contract QB Queens Bench RIL Relience Industries Limited RNRL Relience Natural Resources Limited SC Supreme Court SCC Supreme Court Cases TCF Trillion Cubic Feet Vs. Versus

LIST OF CASES

Assistant Commissioner, Assessment-II, Bangalore & Ors. vs. M/s Velliappa Textiles Ltd. & Ors, AIR 2004 SC 86 J.K. Industries Ltd. & Ors. vs. Chief Inspector of Factories and Boilers & Ors, (1996) 6 SCC 665 Loon Karan v. John n Co., AIR 1967 ALL 308 R. vs. Mc Donnell, (1966) 1 All. E.R. 193 Sahu Madho Das v. Mukand Ram, AIR 1955 SC 441 Salar Jung Sugar Mills Ltd. etc. vs. State of Mysore & Ors., (1972) 1 SCC 23 Snow White Industrial Corp.Madras V. Collector of Central Excise, AIR 1989 SC 1555 State of Tamil Nadu vs. L Abu Kavur Bai, (1984) 1 SCC 515 at 549. Tinsukhia Electric Supply Company Ltd. vs. State of Assam & Ors., (1989) 3 SCC 709 Union of India vs. United India Insurance Co. Ltd., (1997) 8 SCC 683

CHAPTER 1: PRINCIPLE AIM AND OBJECTIVE OF STUDY

This project aims to highlight those areas of contract law and the corporate administration which are covered under the dispute between the Ambani Brothers regarding the distribution of the natural gas. AIMS: To show light upon the contract entered into between the government and the contractor. To discuss nature of contract i.e., Production Sharing Contract. To put forth the applicability of principle-agent relationship. To show the states eligibility in protecting national interest.

OBJECTIVES: To understand the meaning of Production Sharing Contract. To understand the view of the Supreme Court in deciding the overriding effect of PSCs. To put light upon the concept of Principle-agent relationship in PSCs. To put emphasis on the national interest as the main concern of the Supreme Court.

RESEARCH METHODOLOGY: Analytical, Perspective, Critical and Descriptive Research. The research has been based upon the various experts views and description, the superiority of the Production Sharing Contract, the study of the full text of the Supreme Courts judgment, the legal standing of the PSCs as against any other MoUs, the critical analysis of principleagent relationship and its applicability. A much critical and analytical research has opened the scope of perspective and descriptive methodology to be employed.

CHAPTER 2: INTRODUCTION

The use of contracts in economic analysis germinated in institutional economics and later blossomed in the study of labour arrangements 1 . Interest in contracts has re-emerged recently in new institutional economics where transaction costs are emphasized2, in principal agent analysis3 and in the study of asymmetric information 4 . Literature on this topic has expanded to include implicit contracts5, incomplete contracts6, and incentive contracts7. The analysis has also been extended to include studies of land tenure and credit8. Contracts can be used to describe multifaceted agreements between individuals or firms. They may involve explicit as well as implicit stipulations, they may be written or oral, and they may include few or many elements 9 . Formal financial contracts are often written and contain mostly explicit stipulations, while their informal counterparts tend more often to be oral and involve implicit elements. Some contracts can be enforced in courts of law, while others are enforceable only through social sanctions. 10 Contracts are a more robust notion where transactions involve intertemporal stipulations -- receive now and pay later -- and where risk, inflation, uncertainty, and insurance are considerations. Contracts that govern such transactions typically involve more stipulations than do instantaneous cash arrangements. Time and risk are major components of financial contracts.

1 2

Rosen, S. 1985. Implicit Contracts: A Survey. Journal of Economic Literature 23: 1144-1175. Williamson, O.E. 1985. The Economic Institutions of Capitalism. New York: The Free Press. 3 Ross, S. 1973. The Economic Theory of Agency: The Principals Problem. American Economic Review 63: 134139. 4 Akerlof, G. 1970. The Market for Lemons. Quarterly Journal of Economics 84: 488-500. 5 Supra note 1. 6 Hart, O. and Holmstrom, B. 1987. The Theory of Contracts, in T. Bewley, ed., Advances in Economic Theory, Fifth World Congress. Cambridge: Cambridge University Press. 7 Cheung, S.N.S. 1969. The Theory of Share Tenancy: With Special Application to Asian Agriculture and the First Phase of Taiwan Land Reform . Chicago: University of Chicago Press. 8 Braverman, A. and Stiglitz, J.E. 1982. Sharecropping and the Interlinking of Agrarian Markets. American Economic Review 72: 695-715. 9 Mahoney, N. 1977. Contract and Neighbourly Exchange Among the Birwa of Botswana. Journal of African Law 21: 40-65. 10 Adams Dale W., Using Contracts to Analyze Informal Finance, accessed at http://library.wur.nl/way/catalogue/documents/FLR11.pdf

CHAPTER 3: THE BACKGROUND

When two children are fighting on the same piece of chocolate, how would a mother play a mediating role between them? Either she will buy a new chocolate for the other child or just divide that sole piece of chocolate into two equal parts to be distributed between both the children. What did Kokilaben do in case of feuding Ambani brothers?11 When it came to feuding Ambani brothers, Kokilaben had no other option but to move forward with the latter case scenario of dividing equally the fortunes of the humungous empire of the Reliance Group which was built under the leadership of late Dhirubhai Ambani.12 In June 2005, Mukesh and Anil Ambani signed a MoU to reorganize Reliance Industries, in order to take over reins of different assets and businesses of the group under their individual domain.13 The most significant aspect of the MoU was that RIL promised to supply 28 million cubic meters of gas for 17 years at $2.34 mmBtu to Anil Ambanis RNRL 14. However, the MoU came under dispute subsequently in 2007 on government setting up a price of $4.20 mmBtu for gas contracts in the KG Basin fields15. The gas dispute between Mukesh Ambani-led Reliance Industries Ltd (RIL) and Anil Ambani-led Reliance Natural Resources Ltd (RNRL) began about three and a half years ago. 16 Anil Ambani began, what became the biggest battle between industrial giants that the country has ever seen, in 2006 when a case against RIL over Krishna Godavari (KG) basin gas supply. He accused that his elder brother was violating the family agreement signed by the brothers in 2005 in the presence of their mother Kokilaben, when the Reliance group split. Mukesh Ambani, on the other hand, argued the intrinsic role of government and its approval in supply of 28 mmscd gas for 17 years at 2.34 dollars per unit to RNRL.17
11

Viral Dholakia, Reliance & Ambani Brothers Past, Present & Future, (Sep 11, 2010), http://trak.in/tags/business/2010/05/11/reliance-ambani-brothers-past-present-future. 12 Ibid 13 Ibid 14 Ibid 15 Ibid 16 RIL Vs RNRL: Case Timeline, ( Sep 11, 2010), http://news.oneindia.in/feature/2010/ril-vs-rnrl-case-timelineambani-brothers-dispute.html. 17 Ibid

CHAPTER 4: WHAT THE DISPUTE IS ABOUT

When the partition took place between the Ambani brothers, Mukesh and Anil, the settlement involved Krishna Godavari (KG) basin D6 block gas reserves. Discovery took place in 2002; reserve estimate is as much as 30 trillion cubic feet (TCF) of gas and 14 TCF has already been proven. Oil reserve proven is 140 million barrels. Peak gas production is 80 million cubic meters per day.18 The alleged settlement was for Mukesh Ambanis RIL (Reliance Industries Ltd) to supply 20 million cubic metres per day for 17 years as per the High Court, at $ 2.34 per million Btu (British thermal unit) to Anil Ambanis RNRL (Reliance Natural Resources Ltd). The High Court might have found that RIL needs to supply gas as per the private settlement between the brothers.19 A Production Sharing Contract (in short "PSC") has been entered into between the Government of India and the Contractor i.e NIKO with whom RIL has formed a Consortium. 20 Since Production Sharing Contract (PSC) is an overriding contract, which controls the sharing of gas reserves between the investor (RIL) and the Government, RIL is bound by the terms of the contract terms. Once RIL gets its share it can decide how to share with RNRL. But the total pie of gas revenues and how it is shared between the Government and RIL have to be as per the PSC.21 As recorded, all exploration expenses required to locate petroleum resources have to be borne by the Contractor. Therefore, the Contractor is bound to incur huge cost and resources for discovery of reserves in the area at their risk. The exploration activities are still in progress, the first gas deal expected in June 2008. As per the PSC, all the expenses relating to the exploration, development and production of cost incurred by the Contractor can only be recovered from the petroleum/gas actually produced and sold by the Contractor. The Contractor has freedom to sell the gas produced from the block subject to the adjustment and the terms of profit sharing between the Government

18

Experts views on Gas Pricing dispute between Ambani Brothers, (Sep 12, 2010), http://www.ourkarnataka.com/Articles/starofmysore/gas009.htm. 19 Ibid 20 Full copy of the judgement on Ambani gas row, (Sep 12, 2010) http://business.rediff.com/report/2010/may/07/full-text-of-the-sc-judgement-in-the-ambani-gas-row. htm. 21 Supra note 18.

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and the RIL as set out in the PSC22.PSC usually does give the right to sell gas to anyone. But it is not clear if this particular PSC has that clause or not. But PSC definitely will have the clause of selling gas at arms length and be market - based. A price agreed by brothers cannot be considered to be arms length. Even if RIL agrees to sell gas at a lower price, the Government is not bound by such a clause since the Government owns all gas reserves, and PSC gives the right to take some portion of those revenues.23

22 23

Supra note 20. Supra note 18.

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CHAPTER 5: WHAT IS PRODUCTION SHARING CONTRACT?

Production-Sharing Agreements (PSAs) are among the most common types of contractual arrangements for petroleum exploration and development. Under a PSA the state as the owner of mineral resources engages a foreign oil company (FOC) as a contractor to provide technical and financial services for exploration and development operations. The state is traditionally represented by the government or one of its agencies such as the national oil company (NOC).24

I.

INTRODUCTION: HISTORICAL BACKGROUND

The first concept for the production sharing was used in Bolivia in the beginning of the 50s. But agreements on production sharing, in their current form are instruments of legal regulation of relations between a state and an investor in the sphere of the extraction of useful minerals (in particular oil) were successfully applied in Indonesia in the 1960s and gradually recognized by leading international oil & gas companies.25 Since those times, PSAs have received wide applications in countries with economies in transition. PSAs as a form of cooperation between an investor and a state in the process of the use of the subsoil now actively is used in more than 40 countries, including Angola, Vietnam, Libya, Egypt, Malaysia, Peru, Syria, the Philippines, Equatorial Guinea and others. In recent years, PSAs have begin to be used in the CIS: e.g. Russia, Azerbaijan and Kazakhstan. In 1995, the Russian State Duma adopted the Federal Law On Agreements about Production Sharing, and at the present time several investors already are conducting their activity in Russia under PSAs, although this law is not yet being widely applied because of the lack of subsequent legislation.26

24

Kirsten Bindemann, Production-Sharing Agreements: An Economic Analysis, Oxford Institute for Energy Studies WPM 25 October 1999, (Sep 13, 2010),http://www.oxfordenergy.org/pdfs/WPM25.pdf. 25 Outlines of the Presentation of Dr. Irina Paliashvi the President of the Russian-Ukrainian Legal Group, at the Seminar on the Legislation on Production Sharing Agreements , September 14, 1998, (Sep, 12, 2010),http://www.rulg.com/documents/The_Concept_of_Production_Sharing.htm. 26 Ibid.

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II.

THE PRODUCTION SHARING AGREEMENT (PSA) CONCEPT

PSA this is a special form of subsoil use relations based on civil-legal contractual principles for relations between a state and an investor with respect to prospecting, exploration and extraction of mineral resources.27 PSA a contract pursuant to which the state (owner of the subsoil) entrusts the investor to conduct prospecting, exploration and extraction of mineral resources within the confines of a defined subsoil area on a compensated basis and for an established time period during which the investor is obligated to conduct the indicated work at its own expense and own risk.28

III.

THE IMPORTANCE

PSC provides for a coordination committee consisting of the representatives from the government and investors to approve all the major decisions. It also provides checks against selling oil and gas below the market prices.29 Once the investment of the investors are recovered and also when their return exceeds some benchmarks, the government gets a larger share of the so called profit oil and gas. It is the PSC which provides the legal framework for exploration, development and production of gas reserves. It is a legal framework used by several countries today for oil and gas exploration.30 If properly administered, PSCs are most suited for profit - sharing when crude oil price can swing widely. When prices go high, as it happened in 2008, it can force the Government to take recourse to windfall profit taxes. PSCs will anticipate such problems.31 While PSC thus gives a stable tax regime for investors, the Government gets a bigger share of the profits when the investment generates "windfall" profits if the PSC terms are structured properly. However, it needs considerable expertise on the part of the Government to implement a PSC. 32

27 28

Supra note 25. Ibid. 29 Supra note 18. 30 Ibid. 31 Ibid.

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A well - negotiated PSC provides protection against the oil companies from gold-plating the investment. It can also prevent excessive operating costs. PSC provides for a coordination committee consisting of representatives from the Government and investors to approve all major decisions.33 PSC can provide checks, as follows, against selling oil and gas below the market prices: the title of hydrocarbons stays with the Government; the State maintains the management control, and the contractor is responsible for the execution of petroleum operations; the contractor is required to submit annual work programmes and budgets for the scrutiny and approval of a State institution, usually the national company; the contract is based on product-sharing, not profit - sharing; the contractor provides all the financing and technology required for the operations and bears the risks; during the contract term, after allowance for up to a specified percentage of annual production for the recovery of costs, the remaining production is split between the contractor and the State; and the equipment purchased and imported by the contractor becomes the property of the State. Service company equipment and leased equipment are exempt.34

IV. 1.

CHARACTERISTICS OF PSAs: The Subject of a PSA

The subject of the given contract is the agreed program of the parties for the extraction of mineral resources which must be fulfilled by the investor in favor of the state. Such program includes the type, costs and period of performance. In other words, the state has hired the investor as a contractor to perform the work envisioned by the program.35 As a result, contractual relations arise between two legally equal parties, each having rights and obligations, the violation of which shall entail their legal liability.36

32 33

Ibid. Ibid. 34 Ibid. 35 Outlines of the Presentation of Dr. Irina Paliashvi the President of the Russian-Ukrainian Legal Group, at the Seminar on the Legislation on Production Sharing Agreements , September 14, 1998, (Sep, 12, 2010), http://www.rulg.com/documents/The_Concept_of_Production_Sharing.htm. 36 Ibid.

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The State hires the investor as a contractor for the conduct of work connected with the extraction of useful minerals. At the same time, it takes onto itself the obligation to transfer to the investor for use the subsoil area specified in the agreement. In the majority of countries in the world (including Ukraine), the subsoil belongs to the state. The state has a monopoly over the use of the subsoil and the removal from it of natural resources. The granting to an investor of exclusive rights denotes that the state during the period of PSAs validity, is obligated to abstain on the given subsoil area from activity included in the volume of the transferred rights and not permit such activity on the part of third persons. Only the investor may conduct activity envisioned by the agreement. But this does not mean that the investor shall obtain unlimited rights. The exclusive rights being transferred to the investor are limited by: (i) the types of activity envisioned by the agreement, (ii) the types of minerals indicated in the agreement, and (iii) the terms indicated in the agreement.37 2. The State as a Party to a PSA

A PSA as a civil-law agreement is concluded between legally equal parties: the state and an investor. All conditions for use of the subsoil and the performance of work is established by the parties by mutual agreement.38 Nonetheless, one has to take into account that the state participating in the agreement preserves its state prerogatives. Therefore in relations for subsoil use arising on the basis of a PSA, the state acts in two roles: on the one hand it fulfills its obligations under the agreement, and on the other hand it preserves its state public-legal functions. These roles may converge or come into conflict with each other. In their delineation, one should be guided by the following principle: within the scope of conditions provided by the agreement, the state and the investor are equal partners, outside such scope - the state makes decisions related to subsoil use on an authoritative, administrative-law basis.39

37 38

Ibid. Ibid. 39 Ibid.

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IV.

THE DISTINCTION

PSAs are distinguished from other types of contracts in two ways. First, the foreign oil company (FOC) carries the entire exploration risk. If no oil is found the company receives no compensation. Second, the government owns both the resource and the installations. In its most basic form a PSA has four main properties. The foreign partner pays a royalty on gross production to the government. After the royalty is deducted, the FOC is entitled to a pre-specified share (e.g. 40 percent) of production for cost recovery. The remainder of the production, so called profit oil, is then shared between government and FOC at a stipulated share (e.g. 65 percent for the government and 35 percent for the FOC). The contractor then has to pay income tax on its share of profit oil. Over time PSAs have changed substantially and today they take many different forms.40

40

Kirsten Bindemann, Production-Sharing Agreements: An Economic Analysis, Oxford Institute for Energy Studies WPM 25 October 1999, (Sep 13, 2010),http://www.oxfordenergy.org/pdfs/WPM25.pdf

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CHAPTER 6: A BRIEF HISTORY OF PETROLEUM CONTRACTS

We can distinguish four basic contract types; concessions, production-sharing agreements, service contracts, and joint ventures. Each form can be used to accomplish the same purpose. The differences between the types of contracts are of a conceptual nature mainly with regard to levels of control granted to the foreign contractor, compensation arrangements, and levels of involvement by NOCs.41 In the mid 1960s the Indonesian government introduced production-sharing agreements in response to increasing criticism and hostility towards the existing concession system. Thus, for the moment we only consider the basic features of a PSA. The oil is owned by the state which brings in a foreign company to explore and, in case of commercial discovery, develop the resource. The FOC operates at its sole risk and expense, and receives a specified share of production as reward. Thus, the main difference to concessions is the ownership of the mineral resource. Whereas under concessions all crude oil produced belongs to the FOC, under PSAs it is owned by the host government, and the share of production allocated to the FOC can be regarded as payment or compensation for the risk taken and services rendered.42 PSAs spread from Indonesia to countries such as Egypt, Libya, Algeria and other oil producers in Africa, Asia, the Middle East, and South and Central America. They have become increasingly popular in the Former Soviet Union (FSU) and especially in the Caspian region. While some forms of service agreements bear similarities to PSAs, pure service agreements differ significantly from the latter. As the name of the contract implies the FOC supplies services and know-how. It has, however, no equity position in the venture. Due to the combination of risk and services these contracts are now frequently called risk service agreements. However, the concept became more widely popular in the late 1960s when Iran and Iraq in particular concluded several such agreements. While some service contracts are disguised PSAs, especially with regard to ownership of the resource, the main differences between the two contract forms are the remuneration of the contractor and the control over operations . The government is entitled to a
41 42

Ibid. Ibid.

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share of profits. However, this benefit comes at a cost since development and operating costs are shared between the partners. Although it should be added that it is quite normal for the FOC to assume the entire exploration risk by carrying the government's participation until commercial discovery. Joint ventures take either equity or a contractual form.43 To sum up then, oil exploration and development can only be conducted by virtue of one of several forms of contracts granted either by the government or its NOC. In countries with large or potentially large oil deposits, the resource and its extraction tend to become vital cornerstones of that country's economy. Not surprisingly, governments have increased their involvement in the oil sector. This has resulted in increased state participation, the establishment of NOCs, and greater government shares arising from the financial rewards of oil operations.44

43 44

Ibid. Ibid.

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CHAPTER 7:

PRINCIPAL-AGENT RELATIONSHIPS

__________________________________________________________
The principal-agent problem has done much in recent years to illuminate diverse legal subjects, such as the management-shareholder relationship in corporations, real-estate markets, insurance, employment, and other real-life situations45. In a principal-agent relationship, one party the agent is required to perform some service on the behalf of the other party the principal, who involves the delegation of some discretion and decision-making authority. The problem highlighted by the agency model is that often there will be a divergence between the actual decisions made by agents and the decisions that would maximize the principals benefits. This divergence arises because, when making a decision, agents also seek to maximize their own self-interest. Therefore, whenever the agent's actions are for the sole benefit of the principal (and thus contribute nothing for promoting the agent's self-interest), he/she will engage in a lower level of effort instead of a high level.46 As the name suggests, principal-agent theory deals with the actions of a principal (landlord), who owns an asset, and an agent (tenant), who works with that asset and/or makes decisions which will affect the value of the asset47. The theory focuses on the optimal design of contracts between the two parties whereby it is possible to have more than one agent. Applied to PSAs this means that the state or the NOC is the principal and the foreign contractor is the agent. If the foreign contractor is a consortium this could be regarded as a principal-agent problem with many agents. Modern contract theory48 tells us that contracts are by definition incomplete. If we had only two states of nature, say rain and sunshine, we could foresee that tomorrow we will have either rain or sunshine or a combination of the two. What we do not know is which of the three it will be. A contract based on the possibility of these three events occurring could simply specify that if 'rain' clause x applies, if
45

Harris, M. and A. Raviv, (1978), Some Results on Incentive Contracts with Applications to Education and Employment, Health Insurance, and Law Enforcement, American Economic Review, 68, 20-30; Jensen Michael C. and William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership StructureJournal of Financial Economics, October, 1976, V. 3, No. 4, pp. 305-360; See also Supra note 3. 46 Ohad Soudry, A Principal-Agent Analysis of Accountability in Public Procurement, (Sep 13, 2010), http://www.ippa.ws/IPPC2/BOOK/Chapter_19.pdf. 47 The principal is the landlord in the sharecropping model, while the agent is the tenant, as referred in Kirsten Bindemann, Production-Sharing Agreements: An Economic Analysis, Oxford Institute for Energy Studies WPM 25 October 1999, (Sep 13, 2010),http://www.oxfordenergy.org/pdfs/WPM25.pdf. 48 See Hart, O. (1995), Firms, Contracts and Financial Structure, Oxford University Press. Accessed at http://www.sss.ias.edu/files/papers/econpapereight.pdf; Supra note 40.

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'sunshine' clause y applies and so forth. However, in reality there are infinite events that can occur. Some may be more likely than others, and some will be regarded as being more relevant than others. Assume we are an oil company negotiating a contract in a foreign country. Surely we would be more concerned about say the likelihood of a nationalist terrorist group attacking our oilfield than the likelihood of a plane crashing in the car park. Therefore, the best we can hope for is the formulation of a comprehensive contract. We try to take all possible, relevant future events into consideration and make provisions for those events that we cannot foresee.49

49

Supra note 40.

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CHAPTER 8: AN APPLICATION OF THE PRINCIPAL-AGENT MODEL __________________________________________________________

We start with the simple case where there is only one principal and one agent. The principal (landlord) is a state who owns the oil, and the agent (tenant) is a FOC who is willing to provide finance and expertise in order to explore and exploit the resource. The state has to offer contract terms that are attractive enough for the FOC to enter into an agreement. In other words, the reservation utility of the FOC has to be known and, at the very least, matched. At the same time the state has to solve the incentive constraint since it will want to ensure that it receives maximum revenue from the venture. Thus the utility from working hard (fulfilling the contract) should be no less than the utility from shirking (cutting corners). This implies that the profit in the former has to be greater than in the latter case.50

The relationship of principle and agent need not be expressly constituted but can be brought about by implication of law on a particular situation arising or from the necessity of a case. 51 The true relationship of the parties in each case has to be gathered from the nature of the contract, its terms and conditions, and the terminology used by the parties is not decisive of the legal relationship.52 According to the definition in the Section 182 an agent never acts on his own behalf but always on behalf of another. He either represents his principle in any transaction or dealing with a third person, performs any act for the principle. In either case, the act of the agent will be deemed in law to be not his own but of the principle.53 In determining the legal nature of relationship between the alleged principle and the agent the use or omission of the word agent is not conclusive. The court must examine the true nature of the agreement and the subsequent dealings between the parties and then decide whether it establishes

50 51

Ibid. Sahu Madho Das v. Mukand Ram, AIR 1955 SC 441 pg 458 52 Snow White Industrial Corp.Madras V. Collector of Central Excise, AIR 1989 SC 1555; pg no. 454 53 Desai T.R. and R.K.Desai, The Law Relating to Tenders and Government Contracts, University Book Agency, Allahabad, pg 454.

21

relationship of agency under law. 54 The government in Ambani case was the principle and the contractor i.e NIKO, was the agent. The government made certain rules regarding the selling of petroleum products which is considered to be in the national interest of the country. The MoU holds no standing in front of the contract entered into between the government and the contractor as former acting as the principle and latter as the agent. Therefore, the agent is bound to act as per the rules and directions of the principle. Section 211 of the Indian Contract Acts very clearly mentions that: An agent is bound to conduct the business of his principle according to the directions given by the principle, or in the absence of any such directions, according to the custom which prevails in doing business of the same kind at the place where the agent conducts such business. When the agent acts otherwise, if any loss be sustained, he must make it good to his principle, and if any profit accrues, he must account for it.55 Therefore the agent in this case that is NIKO acting through RNRL is bound to follow the prices as lead down by the government. RIL has to agree with that price only as Production Sharing Contract overrides all other contracts entered into by them before.

54 55

Loon Karan v. John n Co., AIR 1967 ALL 308; pg. 454 th Singh, Avatar, Law of Contract and Specific Relief, (10 Edition), Lucknow: Eastern Book Company, 2008, pg 745.

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CHAPTER 9:

THE JUDGMENT

Being aggrieved by the judgment and order of the Division Bench of the High Court of Bombay, Mukesh Ambani led Reliance Natural Resources Ltd. (in short "RNRL") filed a Special Leave Petition questioning the same common order of the Division Bench of the High Court, Reliance Industries Limited (in short "RIL") has filed.56 The Supreme Court asked both Mukesh and Anil Ambani to renegotiate the terms of their gas sale master agreement in six weeks. The three-judge bench headed by Chief Justice KG Balakrishnan, while delivering its verdict on the gas-pricing dispute between the Ambani brothers, said that RIL does not have absolute marketing rights over gas and its prices are subject to approval from the government.57 Soon after the Supreme Court ruling, PMS Prasad, executive director, RIL told PTI that the terms of supply would have to be guided by government's pricing and utilization policy. The price will be what the government has fixed. Supplies will be subject to government allocating the fuel (to RNRL or its affiliate company) and the tenure of supply will have to be in line with the development plan approved for the Krishna-Godavari (KG) D6 fields,".58 Terming the Ambani family memorandum of understanding (MoU) as not legally binding, the Supreme Court said the MoU is between two brothers and their mother and its content is unknown to 30 lakh shareholders of RIL-RNRL. In addition, since the MoU has not been made public, it does not fall in the corporate domain, the apex court said.59 Justice P Sathasivam said, "Ambani family MoU can be a means of arriving at a suitable arrangement but cannot be the sole means for a suitable arrangement.60 Delivering the majority verdict (2:1) of the bench on the four-year gas dispute between RIL and RNRL, Justice Sathasivam said that the production-sharing contract (PSC) overrides all other
56 57

SC asks Ambani brothers to renegotiate gas deal , ( Sep 13,2010),http://www.moneylife.in/article/8/5242.html. Ibid. 58 Ibid. 59 Ibid. 60 Ibid.

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agreements. In the landmark judgment, the Supreme Court has directed that the Production Sharing Contract overrides all contracts including MoU signed by Ambani brothers in 2005 as a part of demerger clause. Further, the apex court said that the government is the legal owner of the gas and is eligible for deciding on the pricing of the gas.61 The court ordered the brothers -- who have a combined fortune of around $43 billion -- to renegotiate within six weeks a private natural gas supply contract between Mukesh's Reliance Industries (RIL) , and the younger Anil's Reliance Natural Resources (RNRL).62

61

Mukesh Wins RNRL RIL war PSC reigns over MoU, (Sep 13, 2010), http://trak.in/tags/business/2010/05/07/mukesh-anil-ambani-ril-rnrl-reliance-verdict. 62 Ambani Brother's Dispute:MUkesh Ambani win Gas Ruling, ( Sep 13, 2010), http://www.allvoices.com/contributed-news/5773510-ambani-brothers-disputemukesh-ambani-win-gas-ruling.

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CHAPTER 10: DOCTRINE OF IDENTIFICATION

The judgment given by Bombay High Court said that the family MoU between the two brothers was binding on Reliance Industries because As per the doctrine of identification a company is identified with such of its key personnel through whom it works. Such personnel are the very alter ego of the company and their actions are deemed to be the actions of the company itself Hence the Company RIL is deemed to be aware of and fully bound by the actions of its Managing Director.63

WHAT IS DOCTRINE OF IDENTIFICATION? The doctrine of identification is a derivative from English law and there have been rulings in England where it has been held that if someone purports to be the company or responsible for the company and he does an action, then he identifies with the company then the company cannot renege their liability vis--vis this action.64 The identification principle states that conduct and states of mind of certain senior individuals within a company can be deemed to be those of the company itself. Therefore a prosecution of one of these individuals can, in relation to certain offences, result in the prosecution of the company.65 This doctrine was set out in the case of HL Bolton (Engineering) Co Ltd v TJ Grahams & Sons Ltd66. This stated the following: A company may in many ways be likened to a human body. It has a brain and nerve centre which controls what it does. It also has hands which hold the tools and act in accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing

63

Promoter family agreements: Binding on companies, Source : CNBC-TV18, (Sep 14, 2010), http://thefirm.moneycontrol.com/news_details.php?autono=423396. 64 Ibid. 65 Ibid. 66 [1957] 1 QB 159, Old Common Law Corporate Manslaughter - Identification Doctrine, (Sep 15, 2010), http://www.corporateaccountability.org/manslaughter/law/ident.htm.

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more than the hand to do the work and cannot be said to represent the mind and will. Others are directors and managers who represent the directing mind and will of the company, and control what it does. The state of mind of these managers is the state of mind of the company and is treated by the law as such.

In fact, that 1972 British ruling was cited by the Bombay HC in the Ambani judgment. The British ruling said that: [a corporation] must act through living persons, though not always one or the same person. Then the person who acts is not speaking or acting for the company. He is acting as the company and his mind which directs his acts is the mind of the company.67 A judgment that has been cited and applied by the Indian Supreme Court more than one instance, in a 1994 ruling, an Income Tax commissioner in Bangalore was allowed to hold a textile company criminally liable for misreporting perpetrated by its Managing Director The court held that the companys active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and center of the personality of the corporation. 68 Three years later, while determining the liability for a bus accident in the state of Karnataka, the apex court established the bus companys guilt on the basis of the doctrine of identification. Now most case law supporting the doctrine of identification arises out of criminal liability matters. That is the doctrine makes a company accountable for the wrong doing or criminal actions of its directors or key employees. But, experts say the doctrine of identification may also bind a company to contracts entered into by the person in control.69

The MoU is not technically binding between RIL and RNRL. It is not in dispute that MoU is between three persons and the personality of the company must be construed separate from these persons. The principle emphasized by Mr. Jethmalani i.e. Doctrine of Identification may be applicable only in respect of small undertakings but in the case of RIL and RNRL, the companies
67 68

Supra note 62. Ibid. 69 Ibid.

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have more than three million shareholders, in such a situation, one cannot make the companies' personality the same as that of persons involved.70

As per the Doctrine of Identification, a company is identified with such of its key personnel through whom it works. Mr. Jethmalani further pointed out that his actions are deemed to be action of the company itself; hence, RIL is deemed to be aware of and bound by the actions of the Managing Director.71 The principle "Doctrine of Identification has been discussed in many cases like in Union of India vs. United India Insurance Co. Ltd.,72.Other cases which Mr. Jethmalani presented before the court in regard of establishing the doctrine of identification are Assistant Commissioner, AssessmentII, Bangalore & Ors. vs. M/s Velliappa Textiles Ltd. & Ors,73 and R. vs. Mc Donnell.74 In J.K. Industries Ltd. & Ors. vs. Chief Inspector of Factories and Boilers & Ors75, it has been observed that: Similar type of offences based on the principle of strict liability, which means liability without fault or menses, exist in many statutes relating to economic crimes as well as in laws concerning the industry, food adulteration prevention of pollution etc. in India and abroad.

70

Full text of the Supreme Court Judgment: Part II , ( Sep 15, 2010), http://www.dnaindia.com/india/report_fulltext-of-the-supreme-court-judgement-part-ii_1380253-10. 71 Ibid. 72 (1997) 8 SCC 683 at pg 695, Supra note 69. 73 AIR 2004 SC 86 para 16 74 (1966) 1 All. E.R. 193 pg 196 & 202. 75 (1996) 6 SCC 665 para 44 & 45.

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CHAPTER 11: STATES ACTION FOR NATIONAL INTEREST

It is the policy of the Government that Petroleum Resources which may exist in the territorial waters, the continental shelf and the exclusive economic zone of India be discovered and exploited with utmost expedition in the overall interest of India and in accordance with good International Petroleum Industry Practice. Article 39(b) of the Constitution envisages that the State shall, in particular, direct its policy towards securing the ownership and control of material resources of the community as so distributed as best to sub-serve the common good.76 The Court, in the case of State of Tamil Nadu vs. L Abu Kavur Bai,
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held that the expression

'distribute' under Article 39(b) cannot but be given full play as it fulfills the basic purpose of restructuring the economic order. It embraces the entire material resources of the community. Its goal is so to undertake distribution as best to sub-serve the common good. It re-organizes by such distribution the ownership and control. In Salar Jung Sugar Mills Ltd. etc. vs. State of Mysore & Ors., 78 the Court held as under:

"38............Delimiting areas for transactions or parties or denoting price for transactions are all within the area of individual freedom of contract with limited choice by reason of ensuring the greatest good for the greatest number by achieving proper supply at standard or fair price to eliminate the evils of hoarding and scarcity on the one hand and availability on the other." In Tinsukhia Electric Supply Company Ltd. vs. State of Assam & Ors.79, the Court affirmed the views expressed in the above cases in the context of electricity supply and also affirmed the Government's role in the securing and distributing of the resources of the community that best sub-serves the common good. The Oil Fields (Regulation & Development) Act, 1948 and the Petroleum and Natural Gas Rules, 1959, make provisions, inter alia, for the regulation of petroleum operation and grant of
76 77

Supra note 69. (1984) 1 SCC 515 at 549. See also Ibid. 78 (1972) 1 SCC 23 pg 36. See also Supra note 69. 79 (1989) 3 SCC 709. See also Supra note 69.

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license and leases for exploration, development and production of petroleum in India. The Territorial Waters, Continental Shelf, Exclusive Economic Zone and Maritime Zones Act, 1976 provides for the grant or a license of Letter of Authority by the Government to explore and exploit the resources of the Continental Shelf and Exclusive Economic Zone and any Petroleum operation.
80

Production Sharing Contracts are very beneficial to governments of countries that lack the expertise and/or capital to develop their resources and wish to attract foreign companies to do so. They are very profitable agreements for the oil companies involved, but often involve considerable risk. Therefore the government has to intervene in between the contracts and set particular prices for petroleum and gas resources for the national interest and the greater good of the society.

80

Supra note 69.

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Rosen, S. 1985. Implicit Contracts: A Survey. Journal of Economic Literature 23: 1144-1175. Williamson, O.E. 1985. The Economic Institutions of Capitalism. New York: The Free Press. Ross, S. 1973. The Economic Theory of Agency: The Principals Problem. American Economic Review 63: 134- 139. Akerlof, G. 1970. The Market for Lemons. Quarterly Journal of Economics 84: 488-500. Hart, O. and Holmstrom, B. 1987. The Theory of Contracts, in T. Bewley, ed., Advances in Economic Theory, Fifth World Congress. Cambridge: Cambridge University Press. Cheung, S.N.S. 1969. The Theory of Share Tenancy: With Special Application to Asian Agriculture and the First Phase of Taiwan Land Reform. Chicago: University of Chicago Press. Braverman, A. and Stiglitz, J.E. 1982. Sharecropping and the Interlinking of Agrarian Markets. American Economic Review 72: 695-715. Mahoney, N. 1977. Contract and Neighbourly Exchange Among the Birwa of Botswana. Journal of African Law 21: 40-65. Adams Dale W., Using Contracts to Analyze Informal Finance, accessed at http://library.wur.nl/way/catalogue/documents/FLR11.pdf

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Hart, O. (1995), Firms, Contracts and Financial Structure, Oxford University Press. Accessed at http://www.sss.ias.edu/files/papers/econpapereight.pdf

Websites/E-books/ Reports:

Ambani Brother's Dispute: Mukesh Ambani win Gas Ruling, ( Sep 13, 2010), http://www.allvoices.com/contributed-news/5773510-ambani-brothers-disputemukeshambani-win-gas-ruling.

Experts views on Gas Pricing dispute between Ambani Brothers, (Sep 12, 2010), http://www.ourkarnataka.com/Articles/starofmysore/gas009.htm. Full copy of the judgement on Ambani gas row, (Sep 12, 2010) http://business.rediff.com/report/2010/may/07/full-text-of-the-sc-judgement-in-theambani-gas-row. htm.

Full text of the Supreme Court judgment : Part II, (Sep 15, 2010). http://www.dnaindia.com/india/report_full-text-of-the-supreme-court-judgement-partii_1380253-10.

Kirsten Bindemann, Production-Sharing Agreements: An Economic Analysis, Oxford Institute for Energy Studies WPM 25 October 1999, (Sep 13, 2010), http://www.oxfordenergy.org/pdfs/WPM25.pdf.

Mukesh Wins RNRL RIL war PSC reigns over MoU, (Sep 13, 2010). http://trak.in/tags/business/2010/05/07/mukesh-anil-ambani-ril-rnrl-reliance-verdict. Ohad Soudry, A Principal-Agent Analysis of Accountability in Public Procurement, (Sep 13, 2010), http://www.ippa.ws/IPPC2/BOOK/Chapter_19.pdf. Old common law Corporate Manslaughter - identification doctrine,(Sep 15, 2010), http://www.corporateaccountability.org/manslaughter/law/ident.htm. Outlines of the Presentation of Dr. Irina Paliashvi the President of the Russian-Ukrainian Legal Group, at the Seminar on the Legislation on Production Sharing Agreements, September14,1998,(Sep,12,2010). http://www.rulg.com/documents/The_Concept_of_Production_Sharing.htm.

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Promoter family agreements: Binding on companies, Source : CNBC-TV18, (Sep 14, 2010), http://thefirm.moneycontrol.com/news_details.php?autono=423396. RIL Vs RNRL: Case Timeline, (Sep 11, 2010), http://news.oneindia.in/feature/2010/ril-vsrnrl-case-timeline-ambani-brothers-dispute.html. SC asks Ambani brothers to renegotiate gas deal, (Sep13, 2010) http://www.moneylife.in/article/8/5242.html. Viral Dholakia, Reliance & Ambani Brothers Past, Present & Future, (Sep 11, 2010), http://trak.in/tags/business/2010/05/11/reliance-ambani-brothers-past-present-future.

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