The eContract Bulletin #2: The first principles of eContracts
Welcome to the second post of The eContract Bulletin. In our last post, we talked about the central role of the signature in ensuring trust and credibility to a contract.
In this post, we were originally going to talk about electronic signatures.
But then we realised we were missing a very important gap. We never spoke about eContracts themselves!
We often receive questions like – What is an eContract? How is it different from a normal contract? How does one create a eContract?
This post answers these questions.
But first, a story.
Manan is still snoring when his phone starts ringing incessantly. Groggy and still half asleep, he sits up slowly.
What time is it? He looks out of the window. 8am?12pm? 5pm? He can’t tell with the November haze in Gurgaon obscuring the Sun all through the day.
His phone reads 11:07am. He’s late for work.
Cursing, he trudges to his workplace – his desk 3 feet away – and switches on his dusty office laptop.
He had an important presentation to give today and he was late for it.
Manan works for a new-age Fintech startup called Finaality. They had recently raised a massive Series A round in excess of $50m on the back of promises of a revolutionary new loan product.
FinaaLity’s Revolutionary New Loan Product was dual purpose. It allowed its customer to BUY shares and also then allowed the same customers to take loans using the shares AS COLLATERAL.
App development had been proceeding at breakneck pace – and FinaaLity was preparing to go live in less than a month. KYC, origination, a working mobile app – all that had been taken care off.
There was just one missing piece in the puzzle. Contractual documentation
For share trading – FinaaLity’s customer’s had to sign demat account opening forms. For loans -they had to get sign loan agreements with FinaaLity.
This was a major problem for FinaaLity.
Signed contracts took time and required an ops team to handle transport, storage and security. FinaaLity didn’t have one.
More importantly – contracts were physical – breaking FinaaLity’s claims of offering a superlative digital journey to their customers.
But Manan thinks he has found a solution. And that’s what his presentation today was about.
“So Manan”, crackled Manan’s colleagues over a choppy Zoom connection. “What’s the solution?”
Manan clears his throat, “eContracts”
“Huh?” exclaim multiple people on the call.
“Its quite simple,” replies Manan and begins his presentation.
Starting with the basics: What are the legal requirements to create a contract in India?
We began the previous post by identifying the centrality of the “contract” to the commercial transaction process. Most formal businesses just won’t enter into commercial relationships without written contracts
For this reason, it is important for us to go briefly revisit our first year of law school and recap what contracts exactly are – under law.
Section 10 of the Indian Contract Act defines what agreements are contracts:
The 5 ingredients of a valid contract are.
- Free consent of parties – all parties are entering into the contract without any coercion or undue influence, fraud, misrepresentation or a mistake
- Parties are competent to contract – all parties are legally entitled to enter into contracts in general
- A lawful consideration is involved – Parties give each other something in exchange for their obligations. What parties give must be lawful.
- A lawful object – The obligations and actions that parties are mandated to do under the contract also need to be lawful
- Not declared to be void – The contract is not declared void by virtue of any law or circumstance
Ingredients 2 to 4
Ingredients 2 to 4 above are easily discernible from the very terms and conditions of the contract.
That is, you can simply look at the copy of the contract and identify whether these legal requirements are met.
So if a Court hears a challenge to a contract’s validity on the grounds that the contract did not meet Ingredients 2, 3, 4 and 5 – it only needs to look at the copy of the contract filed in Court.
Ingredient 1 on the other hand is slightly different.
It is impossible to identify “free consent” merely by looking at the terms of the contract.
Say a Court hears a challenge that impugns the validity of a contract on the ground that a contract did not meet the requirements of Ingredient 1.
In this scenario, the Court must evaluate the mode and manner in which the contract was created – potentially adducing witness testimony and other evidence.
In fact, a court must necessarily find that Ingredient 1 has been met IN ORDER to even evaluate whether the other ingredients are present.
Free consent is, therefore, the key first step after which all other elements flow.
But how exactly does one signify free consent?
Signifying consent to contract
Section 3 of the Indian Contract Act lays down the core process for consenting to a contract:
As per Section 3 consent to a contract can be given by (1) any act or omission that is (2) intended to convey acceptance and which has the (2) effect of conveying it
If all parties convey acceptance in the above manner – then a contract is “created” or “executed”
A key takeaway – the Indian Contract Act does not prescribe any specific mode or manner for conveying acceptance – and gives parties an extremely wide latitude to offer consent.
A signature, therefore, is not mandatory for conveying consent to a contract. However, as we learnt last week, a signature can be the most prudent way of doing so.
This is not surprising.
Just have a look (again) at the end goals of the signing process:
- Identifies the parties involved
- Conveys the definite acceptance of the contract by the parties themselves
- Links the applicability of the terms and conditions of the contract with the parties
Both – the signing process and the contract consent process have virtually identical end goals!
How is this relevant to eContracts?
At this point, you may be tired and puzzled.
Why have we spent so much time on what a contract is and how it is created?
This is the eContract Bulletin – not the Contracts Bulletin! Where are the eContract laws!?
They’re not there.
You heard that right.
There are no special laws for eContracts.
The Indian Contract Act applies to eContracts as much as it does for physical contracts.
eContracts are identical to physical contracts in legal character.
They only differ when it comes to FORM
eContracts are creatures of operation – not of law
Most contracts in human history till this point have been solely physical – mostly based in paper.
But paper is an operational problem – as FinaaLity realised in Manan’s story above.
eContracts are nothing but an operational solution to the operational problems posed by paper based contracts.
For a contract to be an eContract only two conditions need to be met:
- The contract must be drafted, stored and exchanged digitally
- The contract must be digitally executed
If any of the above two aspects are physical – then its not a eContract – its just your everyday physical contract!
Digital drafting, storage and exchange
This is the easy part. Even physical contracts today are drafted and stored digitally for the most part.
Here is where things get interesting.
As we covered in our first post, a contract that is merely drafted and stored digitally is useless. A contract is useful only when it is anchored into a legally binding form that can be trusted and is enforceable.
In our first post – we identified the “signature” as being the tool that anchors the contract in such a way.
In this post, we learnt that the “signature” is the most common way to execute a contract but is NOT the only way to do so.
This is the same case with electronic execution of eContracts.
Ultimately, the end goal of a signing process – as we have repeated time and again and will continue to repeat till the end of the series is:
- Identify the parties involved
- Convey the definite acceptance of the contract by the parties themselves
- Link the applicability of the terms and conditions of the contract with the parties
In the physical world – the signature is the most practical way to achieve this.
In the digital world – our options increase. There are multiple ways to execute a contract digitally. But not all ways are equal.
Each method must be evaluated on the touchstone of how well it meets the end goals of the signing process.
The different ways to execute a eContract
The basis for digital modes of execution lies in the Information Technology Act, 2000.
The IT Act provides two tiers of electronic execution in India:
TIER 1: Electronic signatures
TIER 2: Other Modes of Electronic Authentication
TIER 1: Electronic signatures
The validity of electronic signatures flows from Section 5 of the Information Technology Act, 2000:
Section 5 grants “electronic signatures” the equivalence to wet-ink signatures.
That is – an “electronic signature” is legally identical to a wet-ink physical signature – even if its form and design may be different.
The necessary implication of Section 5 – where any law requires that anything needs to be authenticated via a “signature” – only an electronic signature can achieve this purpose.
In other words, supposing the law prescribes that any type of document must mandatorily contain a signature of a party (note: the actual words “signature” or any adjunct version of that word must be used).
If you wanted to execute such a document physically – you would require a signature.
But if you wanted to execute such a document digitally then, as per Section 5, you would require an electronic signature.
In Manan’s story above – FinaaLity’s Demat Account Opening Form is one such document. SEBI mandates the customer’s signature on these.
Therefore, if FinaaLity wanted to go completely digital with Demat Account Opening Forms – then it could only get them signed via electronic signature.
A few other examples of such types of contractual documents:
- Copyright assignment – Section 19 of the Copyright Act mandates signatures on these documents
- e-Insurance Policies – IRDA mandates digital signatures for these.
- KYC Documentation for various industries – which also mandatorily require signatures by regulation
What exactly are electronic signatures
In many global jurisdictions, electronic signature can be any digital representation of a sign e.g a stylus based representation.
Electronic signatures in India on the other hand have very specific requirements under law.
As per Section 2(ta) of the IT Act, an electronic signature can only be one of two specific things:
- An electronic technique specified in the Second Schedule of the IT Act (elaborated more in Section 3A of the IT Act)
- A digital signature (elaborated more in Section 3 of the IT Act)
Both types of electronic signatures have certain stringent and inviolable technical requirements under law – unlike say a stylus based representation.
We’ll be covering electronic signatures our next 2-3 posts.
TIER 2: Other Electronic Authentication Methods
The validity of the second tier of electronic execution flows from Section 10A of the IT Act:
Remember how Section 3 of the Contract Act gave wide latitude for expressing free consent and acceptance?
Section 10A is the logical corollary to Section 3. It extends the applicability of Section 3 to digital modes of authentication.
And the latitude for what constitutes a valid mode is very, very wide.
Cannot be denied enforceability
The second part of the Section states that a contract cannot be denied enforceability solely on the ground that it has been electronically executed.
Does this indicate that there are some cases where using “other electronic authentication” methods would render a contract invalid?
Yes – but only in two cases. And none of them are surprising.
Case 1: We covered the first case above when we looked at Section 5.
If the law mandates a signature on a contract – then the eContract version of the same requires an electronic signature. No other electronic authentication can be used.
So if you sign your FinaaLity Demat Account Opening Form using a stylus based representation of your physical signature instead of an electronic signature – the Form would be INVALID
Case 2: We covered this in our analysis of Section 10 of the Contract Act.
Section 10 of the Contract Act, as we discussed, lays down 5 ingredients for a valid contract to be created.
If a contract meets those 5 ingredients, then the mode of electronic authentication will not have a bearing on the validity of the contract.
If any of those 5 ingredients are vitiated – then the contract authenticated by an electronic authentication method becomes invalid.
But then again, absence of those 5 ingredients vitiates ANY CONTRACT – whether electronic or physical!
Pertinently, foreign laws like the US eSign Act use very similar language as Section 10A to give validity to their own modes of eSign!
A wide latitude for electronic authentication
The above facts highlight an important takeaway.
Unless the law mandates a signature, any electronic authentication that meets the requirements of Section 3 of the Indian Contract Act can create a binding contract.
So in FinaaLity’s case above, while it’s digital Demat Account Opening Forms require electronic signatures – it can get its Loan Agreements executed via any mode of electronic authentication that meets the requirements of Section 3.
Case Law Alert!
Here’s where you get your money’s worth (ok this bulletin is free, but still) – Case Law!
The best illustration of the wide latitude provided to electronic authentication of eContracts can be found in – Trimex International FZE, Dubai v. Vedanta Aluminum Limited, (2010) 3 SCC 1
In Trimex, the Supreme Court upheld the validity of a contract entered into via an exchange of emails with the binding observation:
“Once the contract is concluded orally or in writing, the mere fact that aformal contract has to be prepared and initialed by the parties would not affect either the acceptance of the contract so entered into or implementation thereof, even if the formal contract has never been initialed.” (Paragraph 9)
An important final note: Validity does not equal enforceability
We’ll conclude with an important caveat.
The above analysis covered the validity of various modes of electronic execution for eContracts. It did not cover the enforceability and efficacy of these modes.
Therefore, while electronic signatures are not necessary for most eContracts – they may be more enforceable and more efficacious than say, a click-wrap or an exchange of emails.
Even within other electronic authentication modes – some methods are more effective than others.
We will cover the efficaciousness and enforceability of various types of electronic execution methods for eContracts in subsequent posts – especially when we talk about The Laws of Electronic Evidence.
Next week – we’ll dig right into the law behind electronic signatures.
We will examine digital signatures under Section 3 of the IT Act – and answer the popular question – What’s the difference between an Electronic Signature and a Digital Signature?”.
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Cover Image: Gerd Altmann, Pixabay