When criminals, terrorists and people with anti-national agenda enter into contracts, of course they do not disclose their real purpose. An innocent supplier of services or goods to such groups or individuals often get caught up in events that they did not foresee. What if you are a supplier of chemicals, and it turns out a lab you have been supplying chemicals to actually uses the material you sell to them to make explosives? Can lawyers do something to protect you?

It is not unusual to hear that a landlord, key supplier of services or goods or licensor of technology is pulled up or investigated against, or worse, prosecuted for being connected to a client, buyer or tenant who has been involved in illegal or anti-national activities. There is a simple measure that can be taken to provide some protection in case such an unforeseeable situation arises – by adding a simple clause in the agreement that sets out the terms and conditions between the parties. It is also such a condition that no one will like to negotiate upon for removal.

Whenever one enters into an agreement of supply of goods, raw material or any services, or agreements for renting out or leasing property, it is a prudent practice to include a clause in the agreement stating that if the buyer/licensee uses the property/goods/services supplied under the contract for any anti-national or anti-social purposes, the contract will be terminated.

For instance, the clause could be drafted like this:

“Anti-national or Anti-social use and misuse:

Any misuse or use of goods provided/services provided/property/licensed matter made available for use under this contract for anti-national or anti-social use will render this contract compulsorily liable to be terminated as soon as such misuse of use come to the knowledge of supplier/seller/licensor/service provider.   If such misuse or use comes to the knowledge of the Seller/Service Provider, it/he/she may terminate the contract immediately with a notice to that effect invoking this clause. If such use or misuse continues without the knowledge of the Seller/Supplier/Service provider for more than 15 days, the contract will be terminated as soon as such use or misuse becomes public knowledge or comes to the knowledge of the Seller/Supplier/Licensor/Service provider thereafter and no notice need to be provided for this purpose.”

This kind of a clause protects legitimate business interests of parties and insulates the licensor/seller/service provider/supplier from liability in case of a misuse by a buyer/licensee/recipient of services/leaseholder.  While I have seen this kind of a clause in a few agreements, its not really a widespread practice yet. However, it could be very important a clause given that service providers, suppliers, landlords, etc. run a risk of becoming an accessory or accomplice or at least facing criminal investigations.

Is this clause really necessary? We can always put in Indemnity and Material Adverse Change or Material Adverse Effect (MAC/MAE) clauses

The traditional way to capture illegalities was by way of the parties giving a warranty that he is not in violation of any law and performance of his obligations under the contract will not result in violation of any applicable law. Additionally, an indemnity clause is inserted as well, whereby the cost of any fine that was imposed on an innocent party which was not in the knowledge of a violation would be borne by the party in breach of the law.

However, as the law on economic offences expands, legislations pertaining to specialized sectors such as banking, insurance, securities, etc. contain several provisions, violation of which may result in imprisonment, even if the innocent party was in unintentionally in breach of the law. Second, the reputational impact of such actions, even on innocent parties can be tremendous, and it makes business sense for parties to terminate all dealings with alleged offenders.

The proposed clause may be inefficient for cases where the penalty is only monetary, but it is a must where there are severe criminal consequences that may be faced by parties, and it can contribute substantially to show that there was no intention to engage in illegal activities..

The second type of legal clause resembling the above, and which is commonly found in contracts is the Material Adverse Change or the Material Adverse Effect clause (MAC or MAE). It results in termination of the contract upon a material change in the business or financial condition of a party. There are two reasons for why the MAC clause is very different from the one suggested above – first, the MAC relates to the business or financial condition of the supplier, and until there is a change in such condition it will not kick in. So, a regulatory proceeding or prosecution which does not affect the financial condition or the business will not allow a counterparty to invoke the MAC clause, but it can severely endanger the reputation of the counterparty to a contract.

Second, in case of regulatory proceedings / prosecution arising from violation of a law, the MAC is likely to kick in only after the commencement of the regulatory proceeding, that is, after the violation has been discovered and acted upon by a prosecuting agency. That may be too late for the counterparties to plead ignorance, to prevent their reputation from being tarnished, and to prevent them from being drawn into legal proceedings as abettors. However, the clause above addresses the situation much before this point and allows a counterparty to detect the violation and keep a clean record much before this stage.