Professional Documents
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Law of Contracts is the most important branch of Mercantile Law without which it would be difficult to carry
on any trade or business in a smooth manner. Further, in the course of the discussion that follows, one will learn
that the law of contract is applicable not only to business but also to all day to day personal dealings. In fact,
each one of us enters in to a number of contracts from sunrise to sunset. When a person buys a newspaper or
rides a bus or purchases goods or gives his watch for repair or borrows a book from the library or even from a
friend, he is actually entering into a contract.
The provisions of the Indian Contract Act, 1872, hereinafter referred to as The “Act”, define the extremely
important aspects of business transactions relating to contracts. In business dealings, offer for sale are made and
accepted, consideration or the price is agreed upon, conditions of the sale or transaction are specified. Disputes
arise when an offer or acceptance is violated, consideration or price is not paid or the conditions of the
transaction are violated. A contract may be made in writing or by word of mouth or inferred from the conduct of
the parties or circumstances of the case.
According to Section 2(h) of the Act, ‘an agreement enforceable by law is a Contract’. An agreement will be
enforceable by law only if it contains all the essential elements of a contract. A person signifying his
willingness to do or abstain from doing something is said to make a proposal and is called the “Proposer”.
When the person to whom the proposal is made signifies his assent to the proposal, it is called “Acceptance”.
Upon acceptance, the proposal becomes a “promise”, the proposer becomes the ‘promisor’ and the acceptor
becomes ‘promisee’.
“ALL CONTRACTS ARE AGREEMENTS BUT ALL AGREEMENTS ARE NOT CONTRACTS”.
Thus, an agreement will become a contract which will be enforceable in a court of law only if the essential
elements of a contract are present in the said agreement. “An offer and acceptance make an agreement but an
agreement and enforceability make a contract”. The Essential elements of a valid contract are highlighted as
follows:-
1) Offer and Acceptance:- There should be an offer which is properly communicated to the offeree. When
the person to whom the offer is made signifies his assent, the proposal is said to be accepted. When an
organization runs tramway cars along the streets, it is an implied offer by the organization to carry
passengers. When a person boards the tram with an intention to travel it is an acceptance. An offer
should be distinguished from an invitation to offer. A prospectus issued in a public offer of shares is
an invitation to offer and the persons making an application for the shares are said to make the offer,
which may or may not be accepted by the Company by way of allotment of the shares.
The issue of when THE COMMUNICATION of an offer or acceptance or the revocation of an offer or
acceptance is COMPLETE is of importance under the Indian contract Act.
Persons may enter in to contracts (1) when they are face to face, (2) over telephone or telex or (3)
through post office courier service etc. When persons are face to face, one person making the offer and
the other accepting, the contract comes into existence immediately. Similarly, in the case of
conversation over telephone, the contract is formed as soon as the offer is accepted but the offeree must
make sure that his acceptance is received by the offeror, as otherwise there will be no contract as
communication of acceptance is not complete.
Section 4 of the Indian Contract Act explains this issue in the circumstance when the offer, acceptance
and revocation are made through post office/courier :-
The communication of proposal is complete, when it comes to the knowledge of the person to whom it
is made.(ie the offeree)
The communication of acceptance is complete,
-as against the proposer:- When it is put in course of transmission to him, so as to be out of the power
of power of the acceptor.
-as against the acceptor, when it comes to the knowledge of the proposer.(ie till the proposer is unaware
of the acceptance, the acceptor is not liable and can withdraw the acceptance)
Section 5 of the Indian Contract Act deals when a proposal or acceptance can be revoked.
A proposal may be revoked at any time BEFORE the COMMUNICATION OF ACCEPTANCE is
complete against the proposer.
An acceptance may be revoked at any time BEFORE the COMMUNICATION OF ACCEPTANCE
is complete against the acceptor.
An Offer lapses or ceases to remain in operation on the happening of any one of the following events,
namely:-
a) When the offeror gives notice of revocation to the offeree expressly withdrawing the offer before
the same is accepted and the acceptance is complete against the offeror.
b) By lapse of prescribed time limit.
c) When no time has been prescribed, after expiry of a reasonable time.
d) When the acceptor fails to fulfil a condition precedent.
e) By death or insanity of the proposer; if the fact of death or insanity comes to the knowledge of
the acceptor before acceptance.
f) When a proposal once refused it is dead and cannot be revived by a subsequent acceptance.
2) Intention to create legal relationship:- An agreement which does not create any legal
relationship or obligation will not be enforceable by law. When ‘A’ agrees to go to a cinema hall
to view a film, it is not a contract, since there was no intention to create a legal relationship.
However, if ‘A’ agrees to supply raw material to ‘B’ within a particular period, there is an
intention to create legal relationship.
When ‘A’ agrees to sell his house to ‘B’ for Rs.10 lakhs, A’s consideration is the price of Rs. 10 lakhs
and B’s consideration is the house. One can observe from the above definition of consideration that a
consideration can move from the promisee or ANY OTHER PERSON. The Consideration can be PAST,
PRESENT OR FUTURE. Consideration may be a positive act or a promise not to do an act.(abstinence)
It is extremely important to note that INADEQUACY OF CONSIDERATION is a good consideration.
Inadequacy of consideration is BAD only if the agreement does not have FREE CONSENT.
Further, one can infer from the definition of “consideration” that there can be a “stranger to
consideration”. Thus, there can be a stranger to consideration but there cannot be a stranger to contract”.
Section 25 of the Act provides that an agreement without consideration is void unless any one or more
of the following conditions are fulfilled, namely:-
a) The agreement is made in writing and registered (if required under the law for the time being in
force for registration of documents) on account of NATURAL LOVE AND AFFECTION between
the parties STANDING IN NEAR RELATION TO EACH OTHER.
b) A promise to compensate a person who has already voluntarily done something for the promisor.
c) A promise IN WRITING signed by the person to be charged therewith or by his agent to repay a
debt which the creditor could not enforce repayment due to law of limitation.
d) If a person has already gifted certain property to another person, the validity of the gift will
not be affected due to absence of consideration.
It has to be very clearly understood that an agreement to which the consent of the promisor is freely
given is not void merely because THE CONSIDERATION IS INADEQUATE. However, where there is
a dispute as to the existence of free consent or not, the inadequacy of the consideration may be taken in
to account by the court in determining the question whether the consent of the promisor was freely given
or not ie whether it is not vitiated by coercion, undue influence, fraud etc.
4) Capacity of the parties to contract:- Parties to the contract must be competent to make a contract.
ie he must not be a minor, must be of sound mind and is not disqualified from contracting by any
law.(like the law of insolvency etc.,) An agreement made by a guardian of a minor or a person
incapable of entering into contract is valid if it is suitable to the condition in life of the minor or
the life of the persons whom the minor or the person incapable of entering into contract is bound
to support or for their legal necessity. It may not be out of place to state here that under the
Negotiable Instruments Act, 1881,a minor, however, can draw, make or endorse, and deliver
negotiable instruments to bind all parties except himself.
5) Free Consent :- Two or more persons are said to consent when they agree upon the same thing
in the same sense. An agreement is valid only when there is a free consent between or among the
parties to the contract. Free consent is absent when an agreement is entered into due to coercion,
undue influence, fraud, misrepresentation or mistake.
A, threatens to kidnap B’s son if B does not agree to sell his house to him. If B agrees to sell his
house under the threat, the said agreement is without free consent and hence cannot be enforced.
When a patient suffered from a disease or age and his medical practitioner influenced him to pay
an unreasonable sum for his service, it was a case of undue influence.
“Fraud” means all acts committed by a person with a view to deceive another person by false
statement, active concealment, intentional non performance, deception etc. Normally silence is
not fraud UNLESS IN THE CIRCUMSTANCES OF THE CASE IT IS THE DUTY OF THE
PERSON TO SPEAK AND DISCLOSE THE MATERIAL FACTS.
“Misrepresentation” arises when with no intention to deceive, one party asserts some facts
relating to a contract which proves to be untrue.
An agreement which suffers from lack of free consent is VOIDABLE at the option of the
aggrieved party. That means, if the aggrieved party wants to treat the contract as valid, it can do
so and enforce the contract.
An agreement is valid as a contract only when the parties to it do not suffer from a mistake or
erroneous belief in respect of matters related to the agreement. A mistake may be a mistake of
law or mistake of facts. A contract due to a mistake of law is valid. A contract caused by
mistake of one party to the contract as to matter of fact is not voidable and hence VALID.
S.20 of the Contract Act states that an agreement is VOID where both parties are under mistake
as to matter of fact essential to the agreement. However, the explanation to S.20 states that an
erroneous opinion as to the value of the thing which forms the subject matter of the agreement
is not deemed to be a mistake of fact.
6) Legality of object and Consideration:- The object and the consideration of an agreement must be
lawful and if not, it will not be enforced by the court. The following situations make an
agreement unlawful, namely,
a) An act forbidden by law and hence punishable.
b) An act of such nature that if permitted would defeat the provisions of any law. An example:- Mr. A
gave his house on rent and to reduce municipal taxes, a part of the rent was shown as service
charges. When the tenant defaulted in paying service charges, the court held that the agreement was
to defraud the municipality and hence was void. The landlord could not recover the service charge.
c) A fraudulent act.
d) An agreement involving or implying injury to a person or property.
e) An immoral agreement like letting out a house for carrying on immoral activity. In this case the
landlord could not recover the rent as the agreement is void.
f) Agreement opposed to public policy. It means an agreement injurious or against the interest of the
public or the society such as an agreement between the citizens of two countries engaged in war with
each other, unless specially allowed by the Govt.of India.
7) Possibility of performance:- The terms of the agreement must be such as are capable of
performance. An agreement to do an act impossible in itself is void. If the act is impossible of
performance physically or legally, the agreement cannot be enforced by law. It is immaterial
whether at the time of making the contract, the impossibility was known to the parties or not.
The reasoning is simple. We make an agreement with a view to perform it and if the performance
is not possible, what is the fun of making such agreements? For example, A promises to B that
two parallel lines shall meet or that he will ride on horse to the moon. All these acts are such
which are impossible of performance and the agreement is not treated as valid.
8) It is not expressly declared to be void:- Sections 24 to 30 of the Act specify certain types of
agreements which have been expressly declared to be void. They include agreements in
restraint of marriage, agreements in restraint of trade, agreements is restraint of legal
proceedings, agreements where the consideration or object is unlawful in whole or in part,
agreement without consideration etc.
The following agreements(other than what is mentioned above or below separately)are expressly
declared void, namely:-
S.26:- Agreement in restraint of marriage (other than that of a minor) is void.
S.27:- Agreement is restraint of trade is void.
Exception:- agreement not to carry on the business, of which the goodwill is sold.
S.28:- Agreement is restraint of legal proceedings is void.
Exception:- Agreements to refer disputes which may or which has arisen to arbitration.
S.29:- Uncertainty of meaning:- Section 29 of the Act says that an agreement, the meaning of which
is not certain or capable of being made certain is void.
S.30:- Agreement by way of wager, void. No suit shall be brought for recovering anything alleged
to have been won on any wager or entrusted to any person to abide by the result of any game
or other uncertain event on which any wager is made.
What is a wager? It is a promise to give money or money’s worth upon determination or
ascertainment of an uncertain event.
Exception:- A Subscription or contribution of Rs.500/- or more towards or for any price or
sum of money to be rewarded to the winner or winners of horse race.
Whether insurance contracts are wagers?
No. Because a) there is insurable interest and b) only the loss to be compensated.
9) Necessary legal formalities :- An oral agreement is as good as the written agreement. But, in some cases,
law requires an agreement to be in writing like a promise to repay a debt which is barred by the law of
limitation. As per the Transfer of Property Act and the Indian Registration Act read together, a transfer
of an immovable property with a value of Rs. 100/- or more has to be registered. In such cases, only
when such formalities are fulfilled the agreement can be enforced as a contract in the court of law.
An agreement containing all the essential elements of a contract, becomes a contract enforceable in a court of
law.
Performance of Contract:- A contract creates obligation and carrying out these obligations is performance. The
parties to the contract must perform or offer to perform their promise. An offer to perform the contract is called
“tender” and it must be unconditional. A tender is conditional
where it is not in accordance with the terms of the contract. Thus, where X offers to Y to repay the principal
amount of the loan, this is not a valid tender since the whole of the principal and interest is not offered. When a
contract involves performance by personal skill, the promisor must perform himself. In all other cases, it is
immaterial who performs the contract if the contractual obligations are met to the satisfaction of the other
party. When the performance is promised jointly by more than one person, on the death of one person it
devolves upon others. Any one of the joint promisors may be compelled to perform. Promises bind the
representatives of the promisors in case of death of such promisors BEFORE performance unless contrary
intention appears from the contract.(S.37)
Actual breach of contract occurs when during the performance of the contract, one party fails or refuses to
perform his obligation under the contract.
Liquidated damages and penalty:-Sometimes, the parties to the contract themselves at the time of entering into
a contract agree that a particular sum will be payable by a party in case of breach of the contract by him. Such a
sum may either be by way of liquidated damages or it may be by way of “penalty”. The essence of liquidated
damages is a genuine pre-estimate of damages. In case of “Penalty”, the parties made no attempt to estimate the
loss that might happen to them on breach of the contract but still stipulated a sum to be paid in case of breach
with the object of coercing the offending party to perform the contract. Thus, in case of penalty, the amount
stipulated to be payable in case of breach is out of all proportion with the loss. Under English law, penalty
cannot be claimed. In India, there is no distinction between liquidated damages and penalty. Under Section 74,
where the amount payable in case of breach is fixed in advance in a contract, whether by way of liquidated
damages or penalty, the party may claim only a REASONABLE COMPENSATION for the breach subject to
the amount so fixed.
3) A decree for specific performance:- Where damages are not an adequate remedy, the court may direct the
party in breach to carry out his promise according to the terms of the contract and this is called the specific
performance of the contract. Some of the instances where the court may direct specific performance are a) a
contract for the sale of a particular house or b) some rare article or c) any other thing for which monetary
compensation is not enough because the injured party will not be able to get an exact substitute in the market.
4) Injunction:- Injunction means an order of the court. Where a party does something which HE PROMISED
NOT TO DO, the court may, by issuing an order, prohibit him from doing so.
5) Quantum Meruit:- The phrase “Quantum Meruit”(QM) means “as much as is merited” or “as much as
earned”. When a person has done some work under a contract, and the other party repudiated the
contract or some event happens which makes the further performance of the contract impossible, then
the party who has performed the work can claim remuneration for the work he has already done. This
right of Quantum Meruit does not arise out of the contract as the right to damages does; it is a claim
based on the quasi contractual obligation which the law implies under the circumstances. QM is not
available to the party who breaks the contract even though he might have partly performed it. However,
QM can also be paid when a contract is discovered to be void. The remedy of QM is RESTITUTORY, it
a recompense for the value of the work done by the plaintiff in order to restore him to the position which
he would have been in if the contract had never been entered into. In this respect QM is different from
claim for damages which is a COMPENSATORY REMEDY.
Quasi Contracts:- Quasi Contracts are certain relations resembling those created by contract. Quasi Contract is
a situation in which law imposes upon one person, on grounds of natural justice, an obligation similar to that
which arises from a true contract, although no contract, expressed or implied, has infact been entered into by
them. For example, A supplies B, a lunatic, with necessities suitable to his condition in life. A is entitled to
reimbursement from B’s property.
The types of Quasi Contracts are as follows:-
1) S.68:- Claim for necessaries supplied to person incapable of contracting or on his account:-
If, a person, incapable of entering into a contract or any one whom he is bound to support, is supplied by
another person with necessaries suited to his condition in life, the person who has furnished such supplies is
entitled to be reimbursed from the PROPERTY of such incapable person.
2) S.69:- Reimbursement of person paying money due by another, in payment of which he is interested:-
A person who is interested in the payment of money which another is bound by law to pay, and who therefore
pays it, is entitled to be reimbursed by the other.
3) S.70:- Obligation of person enjoying benefit of non-gratuitious act:-
Where a person lawfully does anything for another person, or delivers anything to him, not intending to do
so gratuitiously(freely), and such other person enjoys the benefit thereof, the latter is bound to make
compensation to the former in respect thereof, or to restore, the thing so done or delivered.
4) S.71:- Right of finder of goods:- A person who finds goods belonging to another, and takes them into his
custody, is subject to the same responsibility as a BAILEE.
5) S.72:- Liability of person to whom money is paid or thing delivered, by mistake or under coercion:- Any
person to whom money has been paid, or anything delivered, by mistake or under coercion, must repay or
return it.
Contract of Indemnity :- A Contract of Indemnity means a contract by which one party promises to save the
other from loss caused to him by the conduct of the promisor himself or by the conduct of any other person.
(Section 124 of the Act) The person who promises to compensate for the loss is called the “indemnifier” and the
person to whom this promise is made or whose loss is to be made good is known as the “Indemnity holder” or
“Indemnified”. For example, A contracts to indemnify B against the consequences of any proceedings which C
may take against B in respect of certain sum of money. This is a contract of Indemnity and A is the Indemnifier
and B is the Indemnified.
Contract of Guarantee:- A contract of guarantee is a contract to perform the promise, or discharge the
liability of a third person in case of his default. The person who gives the guarantee is called the “surety”; the
person in respect of whose default the guarantee is given is called the “Principal debtor”; and the person to
whom the guarantee is given is called the “creditor”. A guarantee may be either oral or written. For example,
Where A requests B to lend Rs.20,000/- to C and guarantees that C will repay the amount within the agreed
time and that on C failing to do so, he will himself pay to B, there is a contract of guarantee.
The liability of a surety is called as secondary or contingent, as, under Section 126, his liability arises only on
default by the principal debtor. Therefore, on due date, the creditor cannot straight approach surety for
repayment, he must first call upon the principal debtor. It is only if the principal debtor defaults, that the
demand can be made on the surety. But as soon as the principal debtor defaults, the liability of the surety arises
and then as per Section 128 of the Act, runs CO-EXTENSIVE with that of the Principal Debtor. The liability of
the surety being co-extensive with that of the principal debtor means that unless otherwise is agreed to, surety
will be liable for all those amounts, the principal debtor is liable for.
What is the position of surety in case of a Minor principal debtor?
In case where the principal debtor is a minor, the guarantor cannot be held liable unless otherwise agreed.
Kinds of Guarantee:- A Contract of Guarantee may either be oral or in writing, though a creditor should
always prefer to put it in writing to avoid any disputes regarding the terms etc. In case of an oral agreement, the
existence of the agreement itself is very difficult to prove. As regards the scope of guarantee, a contract of
guarantee may be either specific or continuing. When a guarantee is given in respect of a single debt or
specific transaction and is to come to an end when the guaranteed debt is paid or promise is duly performed, it is
called a specific guarantee. A specific guarantee once given is irrevocable. Even the death of a surety does not
result in revocation or termination of guarantee. Surety’s legal successors shall continue to remain liable upto
the value of the assets inherited by them. A guarantee which extends to a series of transactions ( like
guaranteeing advances in Cash Credit Account upto Rs.50,00,000/-) is called a continuing guarantee. A
guarantee regarding the conduct of another is a continuing guarantee. Unlike a specific guarantee which is
irrevocable, a continuing guarantee can be revoked regarding future transactions. However, regarding
transactions that have already taken place, continuing guarantee cannot be revoked. The death of a surety
operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee so far as
regards the future transactions.
Bailment:- Section 148 of the Act defines Bailment as the delivery of goods by one person to another for some
purpose, upon a contract that when the purpose is accomplished, the goods will be returned to or otherwise
disposed off according to the directions given by the person delivering them.
When you lend your book to a friend for reading or deliver your clothes to a dry cleaner or give your TV or
wrist watch for repairs, you are making a bailment. The person delivering the goods is called “bailor” and the
person to whom the goods are delivered is called the bailee.
The essentials of a valid bailment are a) Agreement b) Delivery of goods c) purpose and d) return of the goods
which is delivered. It is important to note that consideration is not necessary for a transaction to be treated as
bailment.
The following transactions may be analyzed to understand the contract of bailment, namely:-
a) When the goods are transferred by the owner to another, in consideration of a price, it is a sale.
b) Where money is deposited by a customer with a bank in a current, savings or fixed deposit account,
and, therefore, there is no obligation to return the identical money but an equivalent of it, it is no
bailment.
c) If valuables or even coins or notes in a box are deposited for safe custody there is a contract of
bailment, for these are to be returned as they are, and not their monetary value.
d) Where valuables are kept by a customer in a locker with a bank for safe custody, but the operative
key of the locker remains with the depositor, the arrangement cannot be called a bailment. In fact this
arrangement is essentially a lease and the depositor(the locker holder)is the lessee and the bank is the
lessor.
Bailee’s Particular lien:- Section 170 of the Act states that “Where the bailee has, in accordance with the
purpose of the bailment, rendered any service involving the exercise of labour or skill in respect of the goods
bailed, he has, in the absence of a contract to the contrary, a right to retain such goods until he receives due
remuneration for the service he has rendered in respect of them.
Bank’s General lien:- Section 171 of the Act empower certain categories of bailees like bankers, factors,
wharfingers attorneys of High Court and policy brokers to exercise a general lien. Exercising a general lien
means these bailees can retain all goods of the bailor (unless there is a contract to the contrary) so long as any
thing is due to them.
Pledge:-Section 172 of the Act defines a pledge as the bailment of goods as security for payment of a debt or
performance of a promise. The bailor in this case is called the “pawnor”. The bailee is called the “pawnee”. For
example, if you borrow Rs. 500/- from X and keep your wrist watch with him as a security for repayment, it is a
pledge. A pledge is also called “pawn”. The person taking the loan is called the pledgor or the Pawnor and the
person with whom goods are pledged is called the pledgee or the pawnee. It is very important to note that the
ownership of the pledged goods does not pass to the pledge. The “general property” remains with the pledgor
but a “special property” in it passes to the pledge. The special property is a right to the possession of the articles
along with the power of sale on default.
S.201 provides for Termination of Agency. An Agency is terminated by the Principal revoking his
authority or by the Agent renouncing the business of Agency; or by the business of the Agency being
completed; or by either the principal or agent dying or becoming unsound mind; or by the Principal being
adjudicated an insolvent under the provisions of any Act for the time being in force for the relief of insolvent
debtors.(please note that the termination of Agency is only on the insolvency of the Principal and the insolvency
of the Agent does not terminate the Agency.
S.230 of the Contract Act stipulates that an Agent cannot personally enforce, nor be bound by,
contractson behalf of his Principal nor is he personally bound by them, unless there is a contract to that effect.
An agent shall be personally bound by or can personally enforce the contracts entered into by him on
behalf of the principal where:-
(1) the contract is made by an agent for the sale or purchase of goods for a merchant RESIDENT
ABROAD.
(2) the Agent does not disclose the name of his Principal.
(3) the Principal, though disclosed, CANNOT BE SUED, like a minor or lunatic etc.,
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