GUJARAT NATIONAL LAW UNIVERSITY

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

SUBMITTED TO: MR. RAVINDRA KUMAR SINGH

ASSISTANT PROFESSOR OF LAW
TABLE OF CONTENTS

____________________________________________

SUBMITTED BY: PRATEEK KUMAR

SEMESTER: III ENROLMENT ID: 09B084
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

2
Chapter 9: The Judgment
23

Chapter 10: Doctrine of Identification

25

Chapter 11: States 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

3
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

4
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

5
 $ - 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

6
 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

7
 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.

8
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 principle-agent
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 emphasized 2, 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.

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 Principals 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. American
Economic Review 72: 695-715.

9
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
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

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
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.

10
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 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

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-timeline-
ambani-brothers-dispute.html.
17 Ibid

11
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
18 Experts views on Gas Pricing dispute between Ambani Brothers, (Sep 12, 2010),
http://www.ourkarnataka.com/Articles/starofmysore/gas009.htm.
19 Ibid
20Full 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.

12
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 PSC 22.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 Supra note 20.

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
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
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

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

26 Ibid.
27 Supra note 25.
28 Ibid.

15
 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

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

29 Supra note 18.

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

16
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. 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

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
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 Ibid.
38Ibid.
39 Ibid.

18
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

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

41 Ibid.

20
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 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

42 Ibid.
43 Ibid.

21
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

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-

44 Ibid.

22
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

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.
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
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
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

50 Ibid.
51 Sahu Madho Das v. Mukand Ram, AIR 1955 SC 441 pg 458

25
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 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
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.
54 Loon Karan v. John n Co., AIR 1967 ALL 308; pg. 454
55 Singh, Avatar, Law of Contract and Specific Relief, (10th Edition), Lucknow: Eastern Book Company, 2008, pg 745.

26
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.

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

27
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 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

57 Ibid.
58 Ibid.
59 Ibid.
60 Ibid.

28
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.

29
 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:

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
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
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

67 Supra note 62.

68 Ibid.

31
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 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,
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.

32
Assessment-II, 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.

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.
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.

33
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, held
77

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

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
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.

35
 BIBLIOGRAPHY

Books :

Singh, Avatar. Law of Contract and Specific Relief, 10th Edition, Eastern
Book Company, Lucknow, 2008.
T.R.Desai and R.K.Desai, The Law Relating to Tenders and Government
Contracts, University Book Agency, Allahabad.

Articles:

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.

36
 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
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-disputemukesh-ambani-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-the-ambani-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-part-ii_1380253-10.

37
 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.
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-vs-rnrl-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.

38
39