Dilemma in contractual disputes resolution

Arun Maira | Updated on January 11, 2018 Published on July 14, 2017

Tight spot: The principle of sanctity of contracts poses a problem for big business as well as farm loan waivers.- PTI   -  PTI

Should contracts be enforced regardless of consequences or should public institutions consider the greater public good?

The Supreme Court of India’s verdict requiring two private power companies to comply with the contracts they had signed has stirred a large public debate. The companies say that circumstances beyond their control — changes in Indonesian laws — have made the price of their coal input too expensive for them to sell power to their Indian customers at the prices they had contracted. The companies pleaded for force majeure relief. Their opponents had feared that if their plea was accepted, it would be another instance of unforeseen losses of private companies being borne by society whereas the companies would have retained unforeseen gains if there were any. Their plea was that there must be sanctity of contracts to avoid such ‘moral hazards’. However, the other side’s concern is that further investments will not be forthcoming unless a more practical view is taken even if it undoes a legal contract.

The moral hazards dilemma

India has made an ambitious push with PPPs (public-private projects) to build infrastructure for power, roads, airports, and ports. Many of these projects have become unviable because the requisites of their long-term contracts did not allow for unforeseen difficulties. These stranded projects have created a huge overhang of NPAs (non-performing assets) with Indian banks. Moral hazard is complicating the resolution of these NPAs, where, also, the principle of sanctity of contracts is colliding with the sustainability of economic growth. A more poignant issue where the sanctity of contracts is colliding with the sustainability of businesses is waivers of farm loans by many state governments. With farmers unable to pay off their contracted loans , what is at stake here is the sustainability of farmers’ lives. In this case, some of the same economists who plead for policy-makers and courts to be practical in the case of bank loans to large infrastructure companies, invoke moral hazard to argue against writing off the loans of small farmers.

Reality must be faced, whether one is from the left or right of the political spectrum. The future cannot be predicted too far. In the case of businesses, technological changes and geo-political uncertainties – especially when businesses become connected to global supply chains, as the Indian power projects were – make it very difficult to foresee all contingencies beforehand and factor them into contracts. Farmers have a very hard time too, predicting the weather and prices for their produce. In such cases, what should be honoured for justice to be done? The legal contracts that were signed – which in the case of the infrastructure projects – were clearly without coercion or, should considerations of the welfare of the farmers and investors, and the sustainability of their businesses and lives, over-ride legal contracts? What would make a better governed society? Enforcement of contracts, regardless of their consequences, as Shylock had insisted in Shakespeare’s Merchant of Venice? Or, that public institutions should consider the welfare of all affected?

Citizens’ trust in the ability of their state’s institutions to deliver justice is a condition of good societies. In great societies, trust in institutions goes much deeper than expecting that legal contracts will be enforced regardless of their consequences. It comes from the confidence that, if something undesired happens, all points of view will be considered fairly and justice will be done.

The competence question

India’s Supreme Court has been criticised by some people for its decisions in matters that it does not, according to them, have the competence for, such as the implementation of pollution standards for automobiles and the implications of power contracts. In these instances, the Supreme Court had not given any new decision. In the automobile industry case, it upheld a decision taken by the executive branch. In the power producers’ case, it upheld the sanctity of contracts voluntarily entered into by the parties. Given the complexity of these issues, some economists have proposed adding an economist to India’s Supreme Court.

But experts in no discipline, not even economists, can see all aspects of complex systems. Modern experts in social sciences, including economics, are becoming increasingly specialised. They know more than others do about a part of the whole, as do specialists in modern medicine. Therefore, one cannot expect to find any expert with a solution that will do justice to the welfare of the whole system. Besides, economists (and other experts) also have their ideological preferences. Those on the right of the political spectrum evoke the concept of moral hazard to deny farmers relief, while those on the left evoke it against forgiveness to large investors.

A comprehensive view

Many points of view, like the many blind men around the elephant, must be brought together to make sense of complexity. Moreover, in dynamically changing situations, conditions on the ground must be considered to understand reality. Therefore, good and just solutions can only come from a good process of participation of affected stakeholders.

A competent executive and unbiased courts are only two legs of the stool. The third leg is required for societal stability. The third leg is a systematic process of democratic deliberations to supplement the formal institutions.

Prof. Mark Moore of the Kennedy School of Government writes in Creating Public Value: Strategic Management in Government: “We might think of this activity (of public deliberations) as helping to define rather than create public value. But this activity also creates value since it satisfies the desire of citizens for a well-ordered society in which fair, efficient, and accountable public institutions exist.”

In other words, the quality of the process of resolving economic and social issues and making public policy is a public good of great value in itself. It increases citizens’ trust in the institutions that govern their lives. Moreover, participative and well conducted multi-stakeholder processes increase social solidarity, which makes good societies.

This is an investment more in need today than anything else. In great societies, trust in institutions goes much deeper than expecting that legal contracts will be enforced regardless of their consequences. It comes from the confidence that, if the unexpected should happen, all points of view will be considered fairly and justice will be done. Not doing so is a risk to the India story.

The writer is a former member of the Planning Commission (Through The Billion Press)

Published on July 14, 2017

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