Legal Aspects of Procurement
Purchasing officers or purchasing managers or purchasing executives are commonly referred to as purchase professionals. These purchase professionals assume the role of buyer/agent and buy goods on behalf of the organization.
A buyer should have a thorough theoretical and practical knowledge of principles, statutes, and rules relating to the purchase transaction. The buyer needs to create a framework or format for the conduct of a purchase transaction and the contract with suppliers.
Table of Content
- 1 Legal Aspects of Procurement
- 2 Law of Agency
- 3 Legal Authority of the Buyer
- 4 Personal Liability of the Buyer
- 5 Contract Law
The buyer also needs to cross-verify whether the purchase agreement is enforceable in court. In addition, the buyer needs to assess what all remedies are available for the buyer organization in case the contract is violated.
The laws and statutes that a buyer must be aware of and which form the framework for organizational purchase transactions are derived from agency law and contract law. They are also based on the tenets of the free market and open competition. Agency law and contract law both originated from common law. Common law is an English law that is derived from customs and judicial precedents. Common law is sometimes referred to as case law. At times, case laws are structured and codified as statutes.
Statutory laws are those that are written and have been enacted by the legislature of a country. The law may define the administrative levels where it will be applicable. For example, we have laws that are applicable pan India; on the other hand, there are laws applicable only to particular states and lastly, there are laws that are applicable at the regional or zonal levels. It must be noted that state laws may formalize, override or modify national laws.
The states may also address issues that have never been dealt with previously. In India, contracts are governed by the Indian Contract Act, 1872. This Act is applicable to pan India. The procurement professional engages in corporate finance when he is procuring goods and creating purchase orders. Therefore, he/she should be fully aware of the legal aspects related to the transaction.
The case of Indian purchase professionals should be well-versed in the provisions of the following laws:
- Indian Contract Act, 1872 (plus the Law of Agency)
- Sale of Goods Act, 1930
- The Insurance Law
- The Insolvency Law
- The Negotiable Instruments Act
- Laws relating to transport
- Laws relating to excise duties, sales tax, import and export duties, foreign exchange regulations
- Laws relating to local taxes, octroi, etc.
We will discuss the Indian Contract Act in the next section.
Each purchase order is considered a legal and binding contract and it should meet the requirements of the applicable laws. In the context of purchasing done by an organization through its employees, you should be aware of three critical concepts, namely the law of agency, the legal authority of the buyer, and the personal liability of the buyer.
Law of Agency
The law of the agency establishes the power and authority of the buyers who purchase goods on behalf of the buyer organization. This type of relation is called an agency (principal-agent) relation. Here the buyer is called the agent of the buyer organization which is the principal.
Companies Act, 2013 states that a company (organization) is an artificial person created by law. However, it is not a real person; therefore, it must act through its authorized agents.
The Agency Law also states that when agents act and conduct themselves in a manner in which they have been authorized to act, the principal is bound by their actions and commitments. On the contrary, if the agents’ actions do not fall into the scope of their authority, the principal is not bound and the agents will themselves be liable for commitments made by them. In such cases, it becomes necessary to define the meaning of authorized.
There are three types of authority which are as follows:
This type of authority is entrusted to the employee (agent) by his employer (principal) in either verbal or written format. It is often a formal definition of what an agent could do. Any action of the agent that lies outside their expressed authority is not binding upon the organization.
It refers to the authority that is implied by law and this authority makes it possible for the agent to carry out his express authority. Such agents may enter into contracts with suppliers, seek quotations, enter into discussions, etc. on behalf of the principal.
It refers to the agent’s power to act on behalf of the principal even if it is not clearly expressed/implied. By observing the conduct of the principal, the third party or the supplier may understand that such power exists.
Here, if an agent does something that lies outside his authority, the principal has the right to approve or ratify it. Such instances of approving or ratifying unauthorized actions give rise to apparent authority.
It is essential that the legal authority of an agent that allows him/her to enter into contracts on behalf of the organization should be clearly defined in the corporate policy. Roles, responsibilities, authority, and accountability must be specified in the agent’s job description.
In fact, the principal must clearly define the roles and authorities for all professionals involved in procurement. These professionals must know about their powers, authority, and level of commitment.
They must also be aware of the expectations that internal customers and stakeholders such as the top management have from the agent. It is necessary to clarify these things in order to create a corporate policy and procedure document on procurement.
This document is essential in order to safeguard the procurement system from abuse. The purchase department is often divided into various levels and the principal defines the value authorization limits for the agents at each level.
The highest level in the procurement department is the procurement head. This approach helps in decreasing the time it takes for small purchases.
An agent usually has the following types of legal authorities:
- Legal authority to offer for sale
- Use of protective legal clauses (to be inserted into the contract) such as acceptance clause, price variation clause, scope variation clause, tolerance clause, rejection clause, delivery terms, terms of service, terms of payments, waivers, and inclusions, divisibility clause, consequential liability clause, termination clause, warrantee clause, performance guarantee clause, liquidated damages, etc.
Personal Liability of the Buyer
There are certain circumstances under which an agent can be held personally liable if he has signed an agreement with a supplier on behalf of the principal. These circumstances include:
- When the agent makes false statements with the intention to deceive or mislead the supplier.
- When the agent performs certain actions that are damaging to the reputation of the principal even though the agent may think vice versa.
- When the agent performs certain actions that are illegal in the eyes of the law, even if supported by the principal.
- When the agent performs an action that is damaging to the supplier or any other stakeholder.
- When the agent performs a damaging action that is outside the scope of his/her authority even if it was done with the intention to benefit the principal.
It must be remembered that at times, the principal may be held guilty if the agent acted within the apparent authority, but outside the scope of actual authority. However, in such cases, the agent would be answerable to the principal and the supplier both.
There are instances when suppliers have filed legal suits against the agents under circumstances, such as the following:
- Principal becomes insolvent
- The Principal wants to avoid legal obligations to purchase the supplies
- The Principal gets engaged in a suit with the supplier and the suppliers decide to collect the contract value of the agent.
The term ‘contract’ has been defined under Section 2(h) of the Indian Contract Act, of 1872. It defines a contract as an agreement enforceable by law. Therefore, all contracts are agreements, but all agreements are not contracts.
To become enforceable by law, a contract must contain all the essential elements of a valid contract which has been defined in Section 10 of the Indian Contract Act, of 1872.
Section 10 of the Act states that all agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void.
Nothing herein contained shall affect any law in force in India, and not hereby expressly repealed, by which any contract is required to be made in writing or in the presence of witnesses, or any law relating to the registration of documents.
Essential Elements of a Contract
Therefore, the essential elements of a contract as defined under section 10 of the Indian Contract Act, 1872 are:
- Agreement (Offer & Acceptance): It means that an offer or proposal is made by one party which is consequently accepted by another party resulting in an agreement through the meeting of the minds (consensus ad-idem).
- Legal purpose: The contract must be made with an intention to create legal relations or intent to have legal consequences in cases of breach.
- Lawful consideration: The agreement must be made for lawful consideration. It means that an agreement, the consideration or the object of which is not lawful, cannot be enforced by the law.
- Capacity to contract: The parties to contract are legally capable of contracting.
- Consent to contract: There must be genuine consent between the parties to enter into the contract.
- Lawful object: The agreement must be supported by a lawful object.
- Certainty: The terms of the contract must be certain.
- Possibility of performance: It must be possible to perform the contract.
- Not expressly declared void: The agreement must not be expressly void as per the provisions of the Act. For example, agreements in restraint of trade or marriage or legal proceedings and wagering agreements are considered void.
- Legal formalities such as writing and registration: A contract may be oral or in written form. However, the agreement must be written and registered in certain cases.
Please note that according to Section 23 of the Act, the consideration or object of an agreement is lawful, unless:
- it is forbidden by law; or
- is of such nature that, if permitted, it would defeat the provisions of any law; or
- is fraudulent; or
- involves or implies injury to the person or property of another; or
- the Court regards it as immoral or opposed to public policy
Section 14 defines free consent as Consent that is said to be free when it is not caused by (1) coercion, as defined in Section 15, or (2) undue influence, as defined in Section 16, or (3) fraud, as defined in Section 17, or (4) misrepresentation, as defined in Section 18, or (5) mistake, subject to the provisions of Sections 20, 21, and 22.
Consent is said to be so caused when it would not have been given but for the existence of such coercion, undue influence, fraud, misrepresentation, or mistake.
Section 11 states that: every person is competent to contract who is of the age of majority according to the law to which he is subject, and who is sound mind and is not disqualified from contracting by any law to which he is subject.
A purchase order or PO is considered a binding contract between a supplier and the buyer. This is a general practice followed across the world. In the case of India,
the Ministry of Finance in 2013 clarified that a purchase order that contains all the essential ingredients of a valid contract may be treated as a contract under the Indian Contract Act, of 1872. For more information, you may refer to Circular No. 31/2013- custom dated August 6, 2013.
Cancellation of Orders and Breach of Contract
After a contract has been made, the buyer and the supplier must adhere to the terms of the agreement. Most of the time, one party approaches to cancel the contract. However, cancellation is a serious matter and is a concern for the supplier due to the monetary aspects associated with it.
At times, a seller may want to terminate the contract because he/she does not want to comply with the terms of the agreement and may refuse to manufacture goods or may want to deliver goods at a date later than the one fixed in the contract.
In such cases, when a supplier wants to change the terms of the contract or wants to terminate it, the buyers may take the appropriate legal remedy against the supplier depending on the conditions related to the transaction.
If a supplier fails to make delivery to the buyer at the agreed time, the buyer has the right to reject delivery at a later date without incurring any liability.
On the contrary, if the buyer wants to change the terms of the contract, the supplier has the right to reject such contracts or in extreme cases, he may accept such changes without incurring any liability caused due to delay in the delivery of the stated goods. At times, the buyers also claim damages from the supplier and file court cases in this respect.
In such cases, the court upholds that the damages are calculated as the difference between the original contract price and the market value of the merchandise at the time when the buyer came to know about the breach of contract plus any incidental and consequential damages.
Practically, a supplier who has a strong holding and reputation in the market will not suffer even if there is a breach of contract from his end such as failure to provide goods at the decided date and at an agreed price.
This is because there are very low chances that the buyer would be able to acquire goods from another supplier at a reasonable price and within a short period of time.