Gujarat National Law University

Contracts Project

Application of Law of Contracts vis- à-vis Corporate Administration in the light of the Ambani Brother’s Case.

Submitted By: Prateek Kumar Semester: III Enrolment ID: 09B084

SUBMITTED TO: MR. RAVINDRA KUMAR SINGH

ASSISTANT PROFESSOR OF LAW

TABLE OF CONTENTS

____________________________________________

Abstract ………………………………………………………………………….

3

Acknowledgement ………………………………………………….……………

4

List of Abbreviations……………………………………………………………..

5

List of Cases ……………………………………………………………………...

6

Chapter 1: Principal aims and objectives of the study ...

…………………………... 7

Chapter 2: Introduction ………………………...………………………………...

8

Chapter 3: The Background ……………………………………………………....

9

Chapter 4: What the Dispute is About ………………………………………….....

10

Chapter 5: What is Production Sharing Contract ………………………………......

12

Chapter 6: A Brief History of Petroleum Contracts ...……………………………..

17

Chapter 7: Principal Agent Relationships ………………..………………………...

19

Chapter 8: An Application of the Principal Agent Model …….……………………

21

Chapter 9: The Judgment …………………………………………………………

23

2

Chapter 10: Doctrine of Identification ……………………………………………

25

Chapter 11: State’s Action for National Interest ………………………………….

28

Bibliography ………………………………………………………………………

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.

3

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 state’s 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 today’s 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 today’s 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

4

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

5

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 – Queen’s 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

6

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

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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 state’s 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 Court’s judgment, the legal standing of the

PSCs as against any other MoUs, the critical analysis of principle-agent

relationship and its applicability. A much critical and analytical research

8

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 arrangements1.

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 information4. 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

elements9. 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 1 Rosen, S. 1985. “Implicit Contracts: A Survey.” Journal of Economic Literature 23: 1144-1175.2 Williamson, O.E. 1985. The Economic Institutions of Capitalism. New York: The Free Press.3 Ross, S. 1973. “The Economic Theory of Agency: The Principal’s Problem.” American Economic Review 63: 134- 139.4 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.” AmericanEconomic 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

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Contracts are a more robust notion where transactions involve inter-

temporal 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.

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

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 Ibid13 Ibid

10

Ambani’s RNRL14. 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.16Anil 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

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

14 Ibid

15 Ibid

16 RIL Vs RNRL: Case Timeline, ( Sep 11, 2010), http://news.oneindia.in/feature/2010/ril-vs-rnrl-case-timeline-ambani-brothers-dispute.html.17 Ibid18 Expert’s views on Gas Pricing dispute between Ambani Brothers, (Sep 12, 2010), http://www.ourkarnataka.com/Articles/starofmysore/gas009.htm.

11

The alleged settlement was for Mukesh Ambani’s 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 Ambani’s

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 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

19 Ibid20Full 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.

22 Supra note 20.

12

PSC has that clause or not. But PSC definitely will have the clause of selling

gas at arm’s length and be market - based.

A price agreed by brothers cannot be considered to be arm’s 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

23 Supra note 18.

13

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,

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.

14

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

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

26 Ibid.27 Supra note 25.28 Ibid.29 Supra note 18.

15

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

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

30 Ibid.31 Ibid.32 Ibid.33 Ibid.

16

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. CHARACTERISTICS OF PSAs:

1. 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

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 PSA’s validity, is obligated to abstain on the given

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.

17

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

 

IV. THE DISTINCTION

37 Ibid.38Ibid.39 Ibid.

18

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

19

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

41 Ibid.42 Ibid.

20

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 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 Ibid.44 Ibid.

21

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

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 Structure”Journal of Financial Economics, October, 1976, V. 3, No. 4, pp. 305-360; See also Supra note 3.

22

often there will be a divergence between the actual decisions made by

agents and the decisions that would maximize the principal’s 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 '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

46Ohad 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.

23

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.

24

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

50 Ibid.51 Sahu Madho Das v. Mukand Ram, AIR 1955 SC 441 pg 45852 Snow White Industrial Corp.Madras V. Collector of Central Excise, AIR 1989 SC 1555; pg no. 454

25

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 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.

53 Desai T.R. and R.K.Desai, The Law Relating to Tenders and Government Contracts, University Book Agency, Allahabad, pg 454. 54 Loon Karan v. John n Co., AIR 1967 ALL 308; pg. 45455 Singh, Avatar, Law of Contract and Specific Relief, (10th 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

56 SC asks Ambani brothers to renegotiate gas deal , ( Sep 13,2010),http://www.moneylife.in/article/8/5242.html.57 Ibid.

27

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 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 de-merger 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

58 Ibid.59 Ibid.60 Ibid.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.

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contract between Mukesh's Reliance Industries (RIL) , and the younger

Anil's Reliance Natural Resources (RNRL).62

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

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.

29

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-à-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 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

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.

30

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 company’s “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 company’s 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

67 Supra note 62.68 Ibid.

31

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 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,

Assessment-II, Bangalore & Ors. vs. M/s Velliappa Textiles Ltd. & Ors,73

and R. vs. Mc Donnell.74

69 Ibid.70 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-part-ii_1380253-10.71 Ibid. 72 (1997) 8 SCC 683 at pg 695, Supra note 69. 73 AIR 2004 SC 86 para 1674 (1966) 1 All. E.R. 193 pg 196 & 202.

32

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….’

CHAPTER 11: STATE’S 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

75 (1996) 6 SCC 665 para 44 & 45.

33

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, 77held

that the expression 'distribute' under Article 39(b) cannot but be given full

play as it fulfills the basic purpose of re-structuring 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 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

76 Supra note 69.77 (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.

34

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.

35

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