1 1872 Chapter The Indian Contract Act 2

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The Indian Contract Act, 1872

UNIT– I : BACKGROUND

Learning objectives

After studying this unit, you would be able to -

♦ Understand the meaning of the terms 'agreement' and 'contract' and note the distinction

between the two.

♦ Note the essential elements of a contract.

♦ Be clear about various types of contract.

♦

Understand the concept of offer and acceptance and rules of communication and

revocation thereof.

Any commercial activity requires ‘understanding’ among people concerned. This

understanding is often reduced into writing to give effect to the intention of the parties. Such

formal versions are known as contracts. These contracts define the rights and obligations of

various parties to facilitate easy performance of the contractual obligations.

The Indian Contract Act, 1872 codifies the legal principles that govern such ‘contracts’. The

Act basically identifies the ingredients of a legally enforceable valid contract in addition to

dealing with certain special type of contractual relationships like indemnity, guarantee,

bailment, pledge, quasi contracts, contingent contracts etc.

1.1 What is a Contract?

While all contracts are agreements, all agreements are not contracts. An agreement which is

legally enforceable alone is a contract. Agreements which are not legally enforceable are not

contracts but remain as void agreements which are not enforceable at all or as voidable

agreements which are enforceable by only one of the parties to the agreement.

The above observation would raise a question in our minds as to what is the exact meaning of

the words ‘agreements’ and ‘contracts’.

An Agreement is a promise or a commitment or set of reciprocal promises or commitments. An

Agreement involves an offer or proposal by one person and acceptance of such offer or proposal

by another person. If the agreement is capable of being enforced by law then it is a contract.

1.2 Business Laws, Ethics and Communication

Now let us take a look at the definitions as per the Act. Section 2(b) while defining a ‘promise’

provides that “when the person to whom the proposal is made signifies his assent thereto, the

proposal is said to be accepted. Proposal when accepted becomes a promise”.

Section 2(e) of the Act defines an agreements as ‘every promise and every set of promises

forming consideration for each other’. Section 2(h) of the Act defines the term contract as “an

agreement enforceable by law”.

The above discussion can be diagramatically represented as follows:

1.2 Essentials of a Valid Contract

Now let us discuss the various essential elements of a valid contract.

In terms of Section 10 of the Act, “all agreements are contracts if they are made by the free

consent of the parties competent to contract, for a lawful consideration and with a lawful object

and are not expressly declared to be void”.

Thus, in order to create a valid contract, the following elements should be present:

1. Intention to create legal obligation through offer and acceptance should be present.

2. Free consent of the parties is necessary.

3. Competency or capacity of parties to enter into contract must be ensured.

4. Lawful consideration & lawful object should be present, and

5. Agreement not expressely declared to be void.

proposal

promise

Consideration

Agreement

Legally enforceable

contract voidable agreement

Legally not enforceable

void agreement

The Indian Contract Act, 1872 1.3

The above important elements may be further analysed as under:

1. Offer and Acceptance: In the first place, there must be an offer and the said offer must

have been accepted. Such offer and acceptance should create legal obligations between

parties. This should result in a moral duty on the person who promises or offers to do

something. Similarly this should also give a right to the promise to claim its fulfillment. Such

duties and rights should be legal and not merely moral.

Case law:

In Balfour v. Balfour, a husband promised to pay maintenance allowance every month to his

wife, so long as they remain separate. When he failed to perform this promise, she brought an

action to enforce it. As it is an agreement of domestic nature, it was held that it does not

contemplate to create any legal obligation.

2. Consent: The second element is the ‘consent’ of the parties. ‘Consent’ means

‘knowledge and approval’ of the parties concerned. This can also be understood as identity of

minds in understanding the term viz consensus ad idem. Further such a consent must be free.

Consent would be considered as free consent if it is not vitiated by coercion, undue influence,

fraud, misrepresentation or mistake. Wherever the consent of any party is not free, the

contract is voidable at the option of that party.

Illustration:- A threatened to shoot B if he (B) does not lend him ` 2000 and B agreed to it.

Here the agreement is entered into under coercion and hence voidable at the option of B.

3. Capacity of the parties: The third element is the capacity of the parties to make a valid

contract. Capacity or incapacity of a person could be decided only after reckoning various

factors. Section 11 of the Indian Contract Act,1872 elaborates on the issue by providing that a

person who-

(a) has not attained the age of majority,

(b) is of unsound mind and

should be considered as not competent to enter into any contract. Therefore law prohibits (a)

Minors (b) persons of unsound mind [excluding the Lucid intervals] and (c) person who are

otherwise disqualified like an alien enemy, insolvents, convicts etc from entering into any

contract.

4. Consideration: The fourth element is presence of a lawful ‘consideration’.

‘Consideration’ would generally mean ‘compensation’ for doing or omitting to do an act or

deed. It is also referred to as ‘quid pro quo’ viz ‘something in return for another thing’. Such a

consideration should be a lawful consideration.

Example:- A agrees to sell his books to B for ` 100, B’s promise to pay ` 100 is the

consideration for A’s promise to sell his books and A’s promise to sell the books is the

consideration for B’s promise to pay ` 100.

1.4 Business Laws, Ethics and Communication

5. Not expressly declared to be void: The last element to clinch a contract is that the

agreement entered into for this purpose must not be which the law declares to be either illegal

or void. An illegal agreement is an agreement expressly or impliedly prohibited by law. A void

agreement is one without any legal effects.

For Example: Threat to commit murder or making/publishing defamatory statements or

entering into agreements which are opposed to public policy are illegal in nature. Similarly any

agreement in restraint of trade, marriage, legal proceedings etc are classic examples of void

agreements.

Key Points

♦ An agreement enforceable by law is a contract. It creates legal obligations between the

parties.

♦ Every promise and every set of promises forming consideration for each other is an

agreement.

♦ An agreement comes into existence when one party accepts a proposal put forward by

other. In other words, agreement is a promise which results from acceptance of a

proposal. Thus agreement, a promise/set of promises is an accepted proposal.

1.3 Types of Contract

Now let us discuss various types of contracts

1. Void Contract: Section 2 (j) states as follows: “A contract which ceases to be

Types of Contracts on the basis of

Validity

Valid contract

Void contract

Voidable contract

Illegal agreement

Unenforceable

Formation

Express contract

Implied contract

Ouasi contract

Performance

Executed contract

Executory contract

Unilateral contract

Bilateral contract

The Indian Contract Act, 1872 1.5

enforceable by law becomes void when it ceases to be enforceable”. Thus a void contract is

one which cannot be enforced by a court of law.

Example : Mr. X agrees to write a book with a publisher. After few days, X dies in an

accident. Here the contract becomes void due to the impossibility of performance of the

contract .

It may be added by way of clarification here that when a contract is void, it is not a contract at

all but for the purpose of identifying it , it has to be called a [void] contract.

2. Voidable Contract: Section 2(i) defines that an agreement which is enforceable by law

at the option of one or more parties but not at the option of the other or others is a voidable

contract.

This infact means where one of the parties to the agreement is in a position or is legally

entitled or authorized to avoid performing his part, then the agreement is treated and becomes

voidable. Such a right might arise from the fact that the contract may have been brought about

by one of the parties by coercion, undue influence, fraud or misrepresentation and hence the

other party has a right to treat it as a voidable contract.

At this juncture it would be desirable to know the distinction between a void contract and a

voidable contract. The distinctions lie in three aspects namely definition, nature and rights.

These are elaborated hereunder:

(a) Definition: A void contract cannot be enforced at all. A voidable contract is an agreement

which is enforceable only at the option of one of the parties but not at the option of the other.

Therefore ‘enforceability’ or otherwise, divides the two types of contracts.

(b) Nature: By nature, a void contract is valid at the time when it is made but becomes

unenforceable and thus void on account of subsequent developments or events like

supervening impossibility, subsequent illegality etc., Repudiation of a voidable contract also

renders the contract void. Similarly a contingent contract might become void when the

occurrence of the event on which it is contingent becomes impossible.

On the other hand voidable contract would remain valid until it is rescinded by the person who

has the option to treat it as voidable. The right to treat it as voidable does not invalidate the

contract until such right is exercised. All contracts caused by coercion, undue influence, fraud,

misrepresentation are voidable. Generally, a contract caused by mistake is void.

remedy for the parties as the contract cannot be performed in any way. In the case of voidable

contract the aggrieved party has a right to rescind it within a reasonable time. If it is so

rescinded, it becomes void. If it is not rescinded, it is a valid contract.

3. Illegal Contract: Illegal contract are those that are forbidden by law. All illegal contracts

are hence void also. Because of the illegality of their nature they cannot be enforced by any

court of law. In fact even associated contracts cannot be enforced. Contracts which are

opposed to public policy or immoral are illegal. Similarly contracts to commit crime like supari

contracts are illegal contracts.

1.6 Business Laws, Ethics and Communication

The above discussion shows that illegal contracts are at par with void contracts. The Act

specifies several factors which would render an agreement void. One such factor is unlawful

nature of contract or the consideration meant for it. Though illegal agreements and void

agreements appear similar they differ in the following manner:

(a) Scope: All illegal agreements are void. However void agreements might not be illegal at

the time of entering but would have become void because of some other factors. For

example, where the terms of the agreement are uncertain the agreement would not be

illegal but might be treated as void. An illegal contract would encompass a void contract

where as a void contract may not include in its scope illegal contracts.

(b) Nature and character: Illegal agreements are void since the very beginning they are

invariably described as void ab initio. As already emphasized under the scope, a contract

by nature, which is valid, can subsequently change its character and can become void.

transactions namely transactions which are to be complied with before or after or

concurrently along with main contract also become not enforceable. In contrast in the

case of voidable contracts the collateral transactions can be enforced despite the fact

that the main contract may have become voidable, to the extent the collateral

transactions are capable of being performed independently.

(d) Penalty or punishment: All illegal agreements are punishable under different laws say

like Indian Penal Code etc. Whereas parties to void agreements do not face such

penalties or punishments.

Further classification of contracts according to the formation is also possible. Under this sub-

classification the following contracts fall:

4. Express Contracts: A contract would be an express contract if the terms are expressed

by words or in writing. Section 9 of the Act provides that if a proposal or acceptance of any

promise is made in words the promise is said to be express.

5. Implied Contracts: Implied contracts in contrast come into existence by implication.

Most often the implication is by law and or by action. Section 9 of the Act contemplates such

implied contracts when it lays down that in so far as such proposal or acceptance is made

otherwise than in words, the promise is said to be implied. For instance ‘A’ delivers goods by

mistake at the warehouse of ‘B’ instead of that of ‘C’. Here ‘B’ not being entitled to receive the

goods is obliged to return the goods to ‘A’ although there was no such contract to that effect.

6. Tacit Contracts: Tacit contracts are those that are inferred through the conduct of

parties. A classic example of tacit contract would be when cash is withdrawn by a customer of

a bank from the automatic teller machine [ATM]. Another example of of tacit contract is where

a contract is assumed to have been entered when a sale is given effect to at the fall of

hammer in an auction sale.

Further classification of contracts is possible on the basis of their performance. They are:

7. Executed Contract: The consideration in a given contract could be an act or

The Indian Contract Act, 1872 1.7

forbearance. When the act is done or executed or the forbearance is brought on record, then

the contract is an executed contract.

8. Executory Contract: In an executory contract the consideration is reciprocal promise or

obligation. Such consideration is to be performed in future only and therefore these contracts

are described as executory contracts.

9. Unilateral Contract: Unilateral contract is a one sided contract in which only one party

has to perform his duty or obligation.

10. Bilateral Contract: A Bilateral contract is one where the obligation or promise is

outstanding on the part of both the parties.

Now let us take a look at yet another type of classification of contracts from the view point of

English Law.

The English law classifies contracts as (i) Formal contracts and (ii) Simple contracts.

Formal contracts are further classified as (a) Contract of Record and (b) Contract under Seal.

(a) Contract of Record: A contract of record derives its binding force from the authority of

court. The authority of court is invariably through judgment of a court or by way of

recognizance. The judgment of a court is technically not a contract as it is not based on the

agreement between parties. However the judgment is binding on all the persons who are

litigants. The judgment creates certain rights on certain persons and obligation on certain

other persons. A recognizance, on the other hand is a written acknowledgement of a debt due

to the state generally in the context of criminal proceedings.

(b) Contract under Seal: A contract under seal is one which derives its binding force from

its form alone. It is in writing, duly signed and sealed and delivered to parties. It is also

referred to as a deed or a specialty contract.

Simple contracts as against formal contracts are devoid of all the formalities referred above.

Key Points

♦ Void agreement- Agreement not enforceable by law and is without any legal effect.

♦ Void contract- Valid at the time of making but becomes void subsequently due to change

in circumstances.

♦ Voidable contract- Agreement enforceable at the option of the aggrieved party. Until the

party won’t nullify, it remains valid.

♦ Illegal agreement-An agreement prohibited or forbidden by law.

♦ Express contract-Where parties orally or written defines terms and conditions of the

contract.

♦ Implied contract-Contract inferred from act, conduct or from the circumstances of the

case.

1.8 Business Laws, Ethics and Communication

♦ Executed contract- Which has been completely performed by all the parties.

♦ Executory contract- One in which something remains to be done by all the parties.

♦ Bilateral contracts- Where the obligations on the part of both the parties are outstanding

at the time of formation of the contract.

♦ Unilateral contract- Where only one party has to perform his duty or obligation .

1.4 Proposal / Offer

It has been explained in the previous paragraphs that a proposal or a promise backed by legal

consideration is an agreement and such an agreement, if legally enforceable, becomes a contract.

It would therefore be clear that the starting point of this chain is a proposal or a promise. It is

proposed now to discuss as to what is a proposal/offer, what are the types of offer, etc.

The word ‘proposal’ and the word ‘offer’ mean one and the same thing and therefore are used

interchangeably. In terms of Section 2(a) of the Act “a person is said to make a proposal when

he signifies to another his willingness to do or abstain from doing anything with a view to

obtaining the assent of that other to such act or abstinence”. It must be appreciated that ‘doing

an act’ and ‘not doing an act’ both have the same effect in the eyes of the law, though one is a

positive act and the other is a negative act.

Hence there are two important ingredients to an offer. Firstly, it must be expressions of

willingness to do or to abstain from doing an act. Secondly, the willingness must be expressed

with a view to obtain the assent of the other party to whom the offer is made.

This can be illustrated as follows:

(a) Where “A” tells “B” that he desires to marry ‘B’ by the end of 2006, there is no offer made

unless, he also asks “will you marry me?”, conveying his willingness and tries to obtain

the assent of ‘B’ in the same breadth.

(b) Where “A” offers to sell his car to “B” it conveys his willingness to do an act. Through this

offer not only willingness is being conveyed but also an intention to obtain the assent can

be seen.

Classification of offer: Offer can be classified as general offer, special/specific offer, cross

offer, counter offer, standing/open/continuing offer. Now let us examine each one of them.

(a) General offer: It is an offer made to public at large with or without any time limit. In terms

of Section 8 of the Act, anyone performing the conditions of the offer can be considered to

have accepted the offer (Carlill v. Carbolic Smoke Ball). Until the general offer is retracted or

withdrawn, it can be accepted by anyone at any time as it is a continuing offer.

(b) Special/specific offer: Where an offer is made to a particular and specified person, it is a

specific offer. Only that person can accept such specific offer, as it is special and exclusive to

him. [Boulton v. Jones]

The Indian Contract Act, 1872 1.9

signifies his assent, the proposal is said to be accepted. Thus, assent can be only to a

‘proposal’. If there was no proposal, question of its acceptance cannot arise. For example, if A

makes a proposal to B to sell some goods at a specified price and B, without knowing

proposal of A, makes a proposal to purchase the same goods at the price specified in the

proposal of A, it is not an acceptance, as B was not aware of proposal made by A. It is only

cross proposal (cross offer). And when two persons make offer to each other, it can not be

treated as mutual acceptance. There is no binding contract in such a case [Tin v. Hoffmen &

Co. 1873]

(d) Counter offer: Upon receipt of an offer from an offeror, if the offeree instead of accepting

it straightway, imposes conditions which have the effect of modifying or varying the offer, he is

said to have made a counter offer. Counter offers amounts to rejection of original offer.

(e) Standing or continuing or open offer: An offer which is made to public at large and if it is

kept open for public acceptance for a certain period of time, it is known as standing or

continuing or open offer. Tenders that are invited for supply of materials and goods are classic

examples of standing offer.

Rules relating to offer: Following are the rules for a valid and legal offer:

(a) The ‘offer’ must be with intent to create a legal relationship. Hence if it is accepted, it

must result in a valid contract. An invitation to join a friend for dinner is a social activity.

This does not create a legal relationship or right or obligation.

(b) The offer must be certain and definite. It must not be vague. If the terms are vague, it is

not capable of being accepted as the vagueness would not create any contractual

relationship. For example, where ‘A’ offers to sell 100 litres of oil, without indicating what

kind of oil would be sold, it is a vague offer and hence cannot create any contractual

relationship. If however there is a mechanism to end the vagueness, the offer can be

treated as valid. For example, in the above example if ‘A’ does not deal in any oil but only

in gingilee oil and this is known to every one, the offer cannot be treated as vague offer.

This is for the reason that the trade in which ‘A’ is, is a clear indicator providing a

mechanism to understand the terms of offer.

(d) The offer must be distinguished from an invitation to offer.

(e) The offer must be either specific or general.

(f) The offer must be communicated to the person to whom it is made. Otherwise the offeree

cannot accept the offer. He cannot accept the offer because he is not aware of the

existence of the offer. Such a situation does not create any legal obligation or right on

any one.

(g) The offer must be made with a view to obtaining the consent of the offeree.

(h) An offer can be conditional but there should be no term in the offer that non-compliance

1.10 Business Laws, Ethics and Communication

would amount to acceptance. Thus the offeror cannot say that if non-acceptance is not

communicated by a certain time the offer would be treated as accepted.

What is invitation to offer?

An offer and invitation to offer are not one and the same. The difference between the two must

be appreciated. An offer is definite. It is an intention towards a contract. An invitation to offer is

an act precedent to making an offer. It is done with intent to generally to induce and negotiate.

An invitation to offer gives rise to an offer after due negotiation and it cannot be per se

accepted.

In an invitation to offer there is no expression of willingness by the offeror to be bound by his

offer. It is only a proposal of certain terms on which he is willing to negotiate. It is not capable

of being accepted as it is.

When there is advertisement by a person he has a stock of books for sale, it is an invitation to

offer and not an offer. This advertisement is made to receive offers and to further negotiate.

In terms of Section 2[a] of the Act, it is very clear that an offer is the final expression of

willingness by the offeror to be bound by the offer if it is accepted by the other party. Hence

the only thing that is required is the willingness of the offeree to abide by the terms of offer.

The test to decide whether a statement is an ‘offer’ or ‘invitation to offer’ is to see the

‘intention’. If a person who makes the statement has the intention to be bound by it as soon as

the other accepts, he is making an offer. If he however intends to do some other act, he is

making only an invitation to offer. Thus the intention to be bound is the important thing, which

is to be seen.

In Harvey vs. Facie [1893] AC 552 Privy Council succinctly explained the distinction between

an offer and an invitation to offer. In the given case, the plaintiffs through a telegram asked the

defendants two questions namely,

(i) Will you sell us Bumper Hall Pen? and

(ii) Telegraph lowest cash price.

The defendants replied through telegram that the “lowest price for Bumper Hall Pen is ₤900”.

The plaintiffs sent another telegram stating “we agree to buy Bumper Hall Pen at ₤900…”

However the defendants refused to sell the property at the price.

The plaintiffs sued the defendants contending that they had made an offer to sell the property

at ₤900 and therefore they are bound by the offer.

However the Privy Council did not agree with the plaintiffs on the ground that while plaintiffs

had asked two questions, the defendant replied only to the second question by quoting the

price but did not answer the first question but reserved their answer with regard to their

willingness to sell. Thus they made no offer at all. Their Lordships held that the mere

statement of the lowest price at which the vendor would sell contained no implied contract to

sell to the person who had enquired about the price.

The Indian Contract Act, 1872 1.11

The above decision was followed in Mac Pherson vs Appanna [1951] A.S.C. 184 where the

owner of the property had said that he would not accept less than ` 6000/- for it. This

statement did not indicate any offer but indicated only an invitation to offer.

Similarly when goods are sold through auction, the auctioneer does not contract with any one

who attends the sale. The auction is only an advertisement to sell but the items are not put for

sale though persons who have come to the auction may have the intention to purchase.

Following are instances of invitation to offer to buy or sell:

(i) An invitation by a company to the public to subscribe for its shares.

(ii) Display of goods for sale in shop windows.

(iii) Advertising auction sales and

(iv) Quotation of prices sent in reply to a query regarding price.

Key Points

♦ Offer-An expression of willingness of offeror to an offreee to do or to abstain from doing

anything,with a view to obtain the assent of an offeree and to enter him into a contract.

♦ Agreement-An accepted offer/proposal

♦ Promisor- Person making the proposal.

♦ Promisee- Person accepting the proposal

♦ Express Offer-Expressed by written/spoken words

♦ Implied offer-Expressed other than in written /spoken words

♦ Specific offer-Offer made to a specific person

♦ General offer-Offer made to the public at large

♦ Cross offers- Identical offers made in ignorance to each other.

♦ Counter offers- Offer accepted on the terms and conditions other than set out by the

offeror.

♦ Standing offer- Offer open for acceptance over period of time.

♦ Legal rules for valid offer-Definite and certain, made with an intention to create legal

relations and must be communicated.

♦ Invitation to an offer-One party invites other party to make an offer i.e.,an offer to make an

offer.

1.5 Acceptance

The significance of “acceptance of a proposal” so as to form an agreement has been

discussed in previous paragraphs. Let us analyse various issues concerning ‘acceptance’

now,

1.12 Business Laws, Ethics and Communication

Meaning: In terms of Section 2(b) of the Act, “A proposal or offer is said to have been

accepted when the person to whom the proposal is made signifies his assent to the proposal

to do or not to do something”. In short, act of acceptance lies in signifying one’s assent to the

proposal.

Relationship between offer and acceptance: According to Sir William Anson “Acceptance is

to offer what a lighted match is to a train of gun powder”. The effect of this observation is that

what acceptance triggers cannot be recalled or undone. But there is a choice to the person

who had the train to remove it before the match is applied. It in effect means that the offer can

be withdrawn just before it is accepted. Acceptance converts the offer into a promise and then

it is too late to revoke it. This means as soon as the train of gun powder is lighted it would

explode. Gun powder [the train] itself is inert, but it is the lighted match [the acceptance] which

causes the gun powder to explode. The significance of this is an offer by itself cannot create

any legal relationship but it is the acceptance by the offeree which creates a legal relationship.

Once an offer is accepted it becomes a promise and cannot be withdrawn or revoked. An offer

remains an offer so long as it is not accepted, but becomes a contract as soon as it is

accepted.

Rules governing acceptance

(1) Acceptance must be absolute and unqualified: As per section 7 of the Act, acceptance is

valid only when it is absolute and unqualified and is also expressed in some usual and

reasonable manner unless the proposal prescribes the manner in which it must be accepted. If

the proposal prescribes the manner in which it must be accepted, then it must be accepted

accordingly. The above view will be clear from the following example:

‘A’ enquires from ‘B’, “Will you purchase my car for ` 2 lakhs?” If ‘B’ replies “I shall purchase your car

for ` 2 lakhs, if you buy my motorcycle for ` 50000/-, here ‘B’ cannot be considered to have accepted

the proposal. If on the other hand ‘B’ agrees to purchase the car from ‘A’ as per his proposal subject

to availability of valid Registration Certificate / book for the car, then the acceptance is in place though

the offer contained no mention of R.C. book. This is because expecting a valid title for the car is not a

condition. Therefore the acceptance in this case is unconditional.

(2) The acceptance must be communicated: To conclude a contract between the parties, the

acceptance must be communicated in some perceptible form. Any conditional acceptance or

acceptance with varying or too deviant conditions is no acceptance. Such conditional

acceptance is a counter proposal and has to be accepted by the proposer, if the original

proposal has to materialize into a contract. Further when a proposal is accepted, the offeree

must have the knowledge of the offer made to him. If he does not have the knowledge, there

can be no acceptance. The acceptance must relate specifically to the offer made. Then only it

can materialize into a contract. The above points will be clearer from the following examples,

(a) M offered to sell his land to N for £ 280. N replied purporting to accept the offer but

enclosed a cheque for £ 80 only. He promised to pay the balance of £ 200 by monthly

installments of £ 50 each. It was held that N could not enforce his acceptance because it

was not an unqualified one. [Neale vs. Merret [1930] W. N. 189].

The Indian Contract Act, 1872 1.13

(b) A offers to sell his house to B for ` 1000/-. B replied that, “I can pay ` 800 for it. The

offer of ‘A’ is rejected by ‘B’ as the acceptance is not unqualified. B however changes his

mind and is prepared to pay ` 1000/-. This is also treated as counter offer and it is upto

A whether to accept it or not. [Union of India v. Bahulal AIR 1968 Bombay 294].

A mere variation in the language not involving any difference in substance would not make the

acceptance ineffective. [Heyworth vs. Knight [1864] 144 ER 120].

(3) Acceptance must be in the prescribed mode: Where the proposal prescribes the mode of

acceptance, it must be accepted in that manner. Where the proposal does not prescribe the

manner, then it must be accepted in a reasonable manner. If the proposer does not insist on the

proposal being accepted in the manner in which it has to be accepted, after it is accepted in any

other manner not originally prescribed, the proposer is presumed to have consented to the

acceptance. Sometimes the acceptor may agree to a proposal but may insist on a formal

agreement, in which case until a formal agreement is drawn up there is no complete acceptance.

(4) The acceptance must be given within a reasonable time and before the offer lapses.

(5) Mere silence is not acceptance. The acceptor should expressly accept the offer.

Acceptance can be implied also. Acceptance must be given only by that person to whom

it is made, that too only after knowing about the offer made to him.

(6) Acceptance by conduct: As already elaborated above, acceptance has to be signified

either in writing or by word of mouth or by performance of some act. The last of the method,

namely ‘by some act’ has to be understood as acceptance by conduct. In a case like this

where a person performs the act intended by the proposer as the consideration for the

promise offered by him, the performance of the act constitutes acceptance. In other words,

there is an acceptance by conduct.

For example, where a tradesman receives an order from a customer, and the order is

executed accordingly by the trader, there is an “acceptance by conduct” of the offer made by

the customer. The trader’s subsequent act signifies acceptance.

Section 8 of the Act very clearly in this regard lays down that “ the performance of the

condition(s) of a proposal or the acceptance of any consideration of a reciprocal promise

which may be offered with a proposal constitutes an acceptance of the proposal.

Key Points

♦ Acceptance- Assent of offeree to a proposal. On acceptance of proposal, proposer is

called as promisor and offeree as promisee.

♦ Acceptance is irreversible as once it is given and reaches to the proposer it cannot be

recalled,

♦ Rules for valid acceptance- It must be absolute and unqualified, communicated, and

must be in the prescribed mode and given within a reasonable time.

1.14 Business Laws, Ethics and Communication

1.6 Communication of Offer and Acceptance

The importance of ‘offer’ and ‘acceptance’ in giving effect to a valid contract was explained in

the previous paragraphs. One important common requirement for both ‘offer’ and ‘acceptance’

is their effective communication. Effective and proper communication prevents avoidable

revocation and misunderstanding between parties. The communication part of it assumes

importance because parties are separated by and distance. In which case the modes of

communication like, post/courier, telegram, fax, email, telephone etc., become very relevant

because the method of communication would also decide the ‘time’ of ‘offer’ and ‘acceptance’.

The Indian Contract Act,1872 gives a lot of importance to “time” element in deciding when the

offer and acceptance is complete.

Communication of offer: In terms of Section 4 of the Act, “ the communication of offer is

complete when it comes to the knowledge of the person to whom it is made”. Therefore

knowledge of communication is of relevance. Knowledge of the offer would materialize when

the offer is given in writing or made by word of mouth or by some other conduct. This can be

explained by an example. Where ‘A’ makes a proposal to ‘B’ by post to sell his house for ` 5

lakhs and if the letter containing the offer is posted on 10th March and if that letter reaches ‘B’

on 12th March the offer is said to have been communicated on 12th March when B received the

letter. Thus it can be summed up that when a proposal is made by post, its communication will

be complete when the letter containing the proposal reaches the person to whom it is made.

Communication of acceptance: There are two issues for discussion and understanding.

They are: what are the modes of acceptance and when is acceptance complete?

Let us, first consider the modes of acceptance. Section 3 of the Act prescribes in general

terms two modes of communication namely, (a) by any act and (b) by omission, intending

thereby to, to communicate to the other or which has the effect of communicating it to the

other.

Communication by act would include any expression of words whether written or oral. Written

words will include letters, telegrams, faxes, emails and even advertisements. Oral words will

include telephone messages. Again communication would include any conduct intended to

communicate like positive acts or signs so that the other person understands what the person

‘acting ‘ or ‘making signs’ means to say or convey.

Communication can also be by ‘omission’ to do any or something. Such omission is conveyed

by a conduct or by forbearance on the part of one person to convey his willingness or assent.

However silence would not be treated as communication by ‘omission’.

Communication of acceptance is also done by conduct. For instance, delivery of goods at a

price by a seller to a willing buyer will be understood as a communication by conduct to

convey acceptance. Similarly one need not explain why one boards a public bus or drop a coin

in a weighing machine. The first act is a conduct of acceptance and its communication to the

offer by the public transport authority to carry any passenger. The second act is again a

conduct conveying acceptance to use the weighing machine kept by the vending company as

The Indian Contract Act, 1872 1.15

an offer to render that service for a consideration.

The other issue in communication of acceptance is about the effect of act or omission or

conduct. These indirect efforts must result in effectively communicating its acceptance or non

acceptance. If it has no such effect, there is no communication regardless of which the

acceptor thinks about the offer within himself. Thus a mere mental unilateral assent in one’s

own mind would not amount to communication. Where a resolution passed by a bank to sell

land to ‘A’ remained uncommunicated to ‘A’, it was held that there was no communication and

hence no contract. [Central Bank Yeotmal vs Vyankatesh (1949) A. Nag. 286].

Let us now come to the issue of when communication of acceptance is complete. In terms of

Section 4 of the Act, it is complete,

(i) As against the proposer, when it is put in course of transmission to him so as to be out of

the power of the acceptor to withdraw the same;

(ii) As against the acceptor, when it comes to the knowledge of the proposer.

Where a proposal is accepted by a letter sent by the post, the communication of acceptance

will be complete as against the proposer when the letter of acceptance is posted and as

against the acceptor when the letter reaches the proposer. For instance in the above example,

if ‘B’ accepts, A’s proposal and sends his acceptance by post on 14th, the communication of

acceptance as against ‘A’ is complete on 14th, when the letter is posted. As against ‘B’

acceptance will be complete, when the letter reaches ‘A’. Here ‘A’ the proposer will be bound

by B’s acceptance, even if the letter of acceptance is delayed in post or lost in transit. The

golden rule is proposer becomes bound by the contract, the moment acceptor has posted the

letter of acceptance. But it is necessary the letter is correctly addressed, sufficiently stamped

and duly posted. In such an event the loss of letter in transit, wrong delivery, non delivery etc.,

will not affect the validity of the contract. However from the view point of acceptor, he will be

bound by his acceptance only when the letter of acceptance has reached the proposer. So it is

crucial in this case that the letter reaches the proposer. If there is no delivery of the letter, the

acceptance could be treated as having been completed from the viewpoint of proposer but not

from the viewpoint of acceptor. Of course this will give rise to an awkward situation of only

one party to the contract being treated as bound by the contract though no one would be sure

as to where the letter of acceptance had gone.

Communication of special conditions: Sometimes there are situations where there are

contracts with special conditions. These special conditions are conveyed tacitly and the

acceptance of these conditions are also conveyed by the offeree again tacitly or without him

even realizing it.

For instance where a passenger undertakes a travel, the conditions of travel are printed at the

back of the tickets, sometimes these special conditions are brought to the notice of the

passenger, sometimes not. In any event, the passenger is treated as having accepted the

special condition the moment he bought his ticket.

When someone travels from one place to another by air, it could be seen that special

1.16 Business Laws, Ethics and Communication

conditions are printed at the back of the air ticket in small letters [in a non computerized train

ticket even these are not printed] Sometimes these conditions are found to have been

displayed at the notice board of the Air lines office, which passengers may not have cared to

read. The question here is whether these conditions can be considered to have been

communicated to the passengers of the Airlines and can the passengers be treated as having

accepted the conditions. The answer to the question is in the affirmative and was so held in

Mukul Datta vs. Indian Airlines [1962] AIR cal. 314 where the plaintiff had travelled from Delhi

to Kolkota by air and the ticket bore conditions in fine print.

Yet another example is where a launderer gives his customer a receipt for clothes received for

washing. The receipt carries special conditions and are to be treated as having been duly

communicated to the customer and therein a tacit acceptance of these conditions is implied by

the customer’s acceptance of the receipt [Lily White vs. R. Muthuswami [1966] A. Mad. 13].

In the cases referred above, the respective documents have been accepted without a protest

and hence amounted to tacit acceptance.

Standard forms of contracts: It is well established that a standard form of contract may be

enforced on another who is subjectively unaware of the contents of the document, provided

the party wanting to enforce the contract has given notice which, in the circumstances of a

case, is sufficiently reasonable. But the acceptor will not incur any contractual obligation, if the

document is so printed and delivered to him in such a state that it does not give reasonable

notice on its face that it contains certain special conditions. In this connection, let us consider

a converse situation. A transport carrier accepted the goods for transport without any

conditions. Subsequently, he issued a circular to the owners of goods limiting his liability for

the goods. In such a case, since the special conditions were not communicated prior to the

date of contract for transport, these were not binding on the owners of goods [Raipur transport

Co. vs. Ghanshyam [1956] A. Nag.145].

1.7 Communication of Performance

We have already discussed that in terms of Section 4 of the Act, communication of a proposal

is complete when it comes to the knowledge of the person to whom it is meant. As regards

acceptance of the proposal, the same would be viewed from two angles. These are (i) from

the viewpoint of proposer and (ii) the other from the viewpoint of acceptor himself. From the

viewpoint of proposer, when the acceptance is put in to a course of transmission, when it

would be out of the power of acceptor. From the viewpoint of acceptor, it would be complete

when it comes to the knowledge of the proposer.

At times the offeree may be required to communicate the performance (or act) by way of

acceptance. In this case it is not enough if the offeree merely performs the act but he should

also communicate his performance unless the offer includes a term that a mere performance

will constitute acceptance. The position was clearly explained in the famous case of Carlill Vs

Carbolic & Smokeball Co. In this case the defendant a sole proprietary concern manufacturing

a medicine which was a carbolic ball whose smoke could be inhaled through the nose to cure

The Indian Contract Act, 1872 1.17

influenza, cold and other connected ailments issued an advertisement for sale of this

medicine. The advertisement also included a reward of $100 to any person who contracted

influenza, after using the medicine (which was described as ‘carbolic smoke ball’). Mrs. Carlill

bought these smoke balls and used them as directed but contracted influenza. It was held that

Mrs Carlill was entitled to a reward of $100 as she had performed the condition for

acceptance. Further as the advertisement did not require any communication of compliance of

the condition, it was not necessary to communicate the same. The court thus in the process

laid down the following three important principles:

(i) an offer, to be capable of acceptance, must contain a definite promise by the offer or that

he would be bound provided the terms specified by him are accepted;

(ii) an offer may be made either to a particular person or to the public at large, and

(iii) if an offer is made in the form of a promise in return for an act, the performance of that act,

even without any communication thereof, is to be treated as an acceptance of the offer.

Key Points

♦ One important common requirement for both ‘offer’ and ‘acceptance’ is their effective

communication. The Indian Contract Act,1872 gives a lot of importance to “time” element

in deciding when the offer and acceptance is complete.

♦ Communication of offer is complete- When it comes to the knowledge of the person to

whom it is made.

♦ Communication of acceptance is complete- (i) Against the proposer-when it is put into the

course of transmission to the proposer.(ii) Against the acceptor—when it comes to the

knowledge of the offeror.

1.8 Revocation of Offer and Acceptance

If there are specific requirements governing the making of an offer and the acceptance of that

offer, we also have specific law governing their revocation.

In term of Section 4, communication of revocation (of the proposal or its acceptance) is

complete.

(i) as against the person who makes it when it is put into a course of transmission to the

person to whom it is made so as to be out of the power of the person who makes it, and

(ii) as against the person to whom it is made, when it comes to his knowledge.

The above law can be illustrated as follows:- If you revoke your proposal made to me by a

telegram, the revocation will be complete, as for as you are concerned when you have

dispatched the telegram. But as far as I am concerned, it will be complete only when I receive

the telegram.

As regards revocation of acceptance, if you go by the above example, I can revoke my acceptance

1.18 Business Laws, Ethics and Communication

(of your offer) by a telegram. This revocation of acceptance by me will be complete when I

dispatch the telegram and against you, it will be complete when it reaches you.

But the important question for consideration is when a proposal can be revoked? And when

can an acceptance be revoked?. These questions are more important than the question when

the revocation (of proposal and acceptance) is complete.

In terms of Section 5 of the Act a proposal can be revoked at any time before the communication of

its acceptance is complete as against the proposer. An acceptance may be revoked at any time

before the communication of acceptance is complete as against the acceptor.

Revocation of proposal otherwise than by communication: When a proposal is made, the

proposer may not wait indefinitely for its acceptance. The offer can be revoked otherwise than

by communication or sometimes by lapse.

Following are the situations worth noting in this regard

(i) When the acceptor fails to fulfill certain conditions precedent to acceptance:- Where the

acceptor fails to fulfill a condition precedent to acceptance the proposal gets revoked. This principle

is laid down in Section 6 of the Act. The offeror for instance may impose certain conditions such as

executing a certain document or depositing certain amount as earnest money. Failure to satisfy

any condition will result in lapse of the proposal. As stated earlier ‘condition precedent’ to

acceptance prevents an obligation from coming into existence until the condition is satisfied.

Suppose where ‘A’ proposes to sell his house to be ‘B’ for ` 5 lakhs provided ‘B’ leases his land to

‘A’. If ‘B’ refuses to lease the land, the offer of ‘A’ is revoked automatically.

(ii) When the proposer dies or goes insane: Death or insanity of the proposer would result in

automatic revocation of the proposal but only if the fact of death or insanity comes to the

knowledge of the acceptor

(iii) When time for acceptance lapses: The time for acceptance can lapse if the acceptance is

not given within the specified time and where no time is specified, then within a reasonable

time. This is for the reason that proposer should not be made to wait indefinitely. It was held

in Ramsgate Victoria Hotel Co Vs Montefiore (1866 L.R.Z. Ex 109), that a person who applied

for shares in June was not bound by an allotment made in November. This decision was also

followed in India Cooperative Navigation and Trading Co Ltd Vs Padamsey Prem Ji. However

these decisions now will have no relevance in the context of allotment of shares since The

Companies Act, 1956 has several provisions specifically covering these issues.

Key Points

Communication of revocation as against the person who makes it, completes- when it is put

into the course of transmission to the person to whom it is made

♦ Communication of revocation as against the person to whom it is made, completes- when

it comes to his knowledge.

♦ Revocation of proposal and acceptance is complete- at any time before the

communication of proposal and acceptance is complete as against the proposer and the

acceptor, but not afterwards.

The Indian Contract Act, 1872 1.19

UNIT-2 : CONSIDERATION

Learning objectives

After studying this unit, you would be able to -

♦ Understand the concept of consideration, its importance for a contract and its double

aspect.

♦ Clearly understand how consideration may move from a third party and how this makes

the contract valid.

♦ Learn about the peculiar circumstances when a contract is valid even without

consideration.

♦ Be aware of the rule 'A stranger to a contract cannot sue' and exceptions thereof.

In the previous unit we learnt that one of the important elements of contract is “consideration”.

In this unit the concept of consideration and the legal requirements for consideration are

discussed.

1.9 What is Consideration?

The expression ‘consideration’ has to be understood as a price paid for an obligation. In Curie

Vs Misa (1875) LR 10 Ex 153 is was held (in U K) that consideration is “some right, interest,

profit or benefit accruing to one party or forbearance, detriment, loss, or responsibility given,

suffered or undertaken by the other”. The judgment thus refers to the position of both the

promisor, and the promisee in an agreement.

Section 2 (d) of the Indian Contract Act, 1872 defines consideration as ‘when at the desire of

the promisor, the promisee or any other person has done or abstained from doing, or does or

abstains from doing or promises to do or abstain from doing something, such an act or

abstinence or promise is called consideration for the promise’.

From the above definition it can be inferred that,

Consideration is doing or not doing something, which the promisor desires to be done or not

done.

(1) Consideration must be at the desire of the promisor.

(2) Consideration may move from one person to any other person

(3) Consideration may be past, present or future and

(4) Consideration should be real though not adequate

In most cases the promisor for doing an act or not doing an act derives some benefit by way of

consideration. Thus consideration is identified as quid pro quo from the promise or

performance of the promisor.

But it is also possible that there may not be any identifiable benefit towards consideration. For

example ‘A’ promises to carry ‘B’s goods free of charge and B allows ‘A’ to carry the same.

Here ‘B’ does not offer any consideration to ‘A’. Is this a valid contract?

1.20 Business Laws, Ethics and Communication

The answer to the question is ‘B’ has suffered a detriment or disadvantage while allowing ‘A’

to carry his goods. Here there is sufficient consideration. This illustration is given essentially

to prove the point that consideration could be not necessarily a gain or advantage to the

promisor but it can even be a loss or detriment to the promisee. That is why ‘consideration’ is

referred to as a concept with ‘double aspect’.

Where Y applies for a loan of ` 10,000/- to X, and if ‘X’ insists on a guarantee by ‘S’ and upon

‘S’ guaranteeing the loan, ‘X’ gives the loan to “Y”. In this case ‘S’ will be the promisor and ‘X’

the promisee. The benefit in this transaction conferred on ‘Y’ by ‘X’ at the guarantee of ‘S’, is

sufficient consideration for X. In other words ‘X’ has suffered a detriment which is the

consideration for the guarantee of ‘S’ to repay the loan which ‘X’ has given to ‘Y’. Detriment

to one is benefit to another.

It can often be seen that consideration is mutual. For instance if ‘A’ promises to sell his house

to ‘B’ for ` 5 lakhs ,here “A” is the promisor and “B” is the promisee. In the same transaction

where ‘B’ agrees to buy the house for ` 5 lakhs, ‘B’ will be the promisor and ‘A’ will be the

promisee. Here ‘A’ must part with the house and ‘B’ must part with ` 5 lakhs. This proves the

point that consideration is mutual and has two sides.

Thus from above it can be concluded that :

Consideration = Promise / Performance that parties exchange with each other.

Form of consideration= Some benefit, right or profit to one party / some detriment,

loss, or forbearance to the other.

Whether gratuitous promise can be enforced?

The word “gratuitous” means ‘free of cost’ or ‘without expecting any return’. It can therefore be

inferred that a gratuitous promise will not result in an agreement in the absence of

consideration. For instance a promise to subscribe to a charitable cause cannot be enforced.

1.10 Legal Requirements Regarding Consideration

(i) Consideration must move at the desire of the promisor: Consideration must move at

the desire of the promisor, either from the promisee or some other third party. But

consideration cannot move at the desire of a third party. Where collector had passed an order

that any one using the market constructed by the Zamindar, for the purpose of selling his

goods should pay commission to the Zamindar, it was held that it was not a proper order as

the desire to receive consideration had not emanated from the Zamindar but from a third party

namely the collector [Durga Prasad Vs Baldev (1880) 3, All 221]

(ii) Consideration can flow either from the promisee or any other person: The

consideration for a contract can move either from the promisee or from any other person. This

point is made clear even by the definition of the word “consideration”, according to which at

the desire of the promisor, the promisee or any other person, doing something is

consideration.

That the consideration can legitimately move from a third party is an accepted principle of law

in India though not in England. Example: ‘A’ by a deed of gift made over certain property to

The Indian Contract Act, 1872 1.21

her daughter(D) with condition that her brother(B) should be paid annuity by D. On the same

day, D executed a document agreeing to pay annuity accordingly but declined to pay after

sometime. B sued D. It was contended on behalf of D, that there was no consideration from

B and hence there was no valid contract. This plea was rejected on the ground that the

consideration did flow from B’s Sister(A) to ‘D’ and such consideration from third party is

sufficient to enforce the promise of D to pay annuity to A’s brother (B) [Chinnaya Vs

Ramaya(1881) 4.mad.137]

Thus a stranger to a contract can sue upon a contract in India and also in England, where as

stranger to a consideration can sue under Indian law though not under English law.

(iii) Executed and Executory consideration: Where consideration consists of performance,

it is called “executed” consideration. Where it consists only of a promise, it is executory. For

example where A pays ` 5000/- to ‘B’ requesting ‘B’ to deliver certain quantity of rice, to which

B agrees, then here consideration for B is executed by ‘A’ as he has already paid ` 5000/-

whereas ‘B’s promise is executory as he is yet to deliver the rice.

Insurance contracts are of the same type. When A pays a premium of ` 5000/- seeking

insurance cover for the year, from the insurance company which the company promises in the

event of fire, the consideration paid by A to the insurance company is executed but the

promise of insurance company is executory or yet to be executed. A forbearance by the

promisor should however be considered as an executed consideration provided the

forbearance is sufficient at the time of contract.

(iv) Past consideration: The next issue is whether past consideration can be treated as

consideration at all. This is because consideration is given and accepted along with a promise

concurrently. However the Act recognizes past consideration as consideration when it uses

the expression in Section 2(d) ‘has done or abstained from doing”. But in the event of

services being rendered in the past at the request or desire of the promisor the subsequent

promise is regarded as an admission that the past consideration was not gratuitous. The

plaintiff rendered services to the defendant at his desire during his minority. He also

continued to render the same services after the dependant attained majority. It was held to be

good consideration for a subsequent express promise by the defendant to pay an annuity to

the plaintiff but it was admitted that if the services had not been rendered at the desire of the

defendant it would be hit by section 25 of the Act. [Sindia Vs Abraham (1985)Z. Bom 755]

(v) Adequacy of Consideration: Consideration need not necessarily be of the same value

as of the promise for which it is exchanged. But it must be something which can be inadequate

as well. Inadequate consideration would not invalidate an agreement but such inadequate

consideration could be taken into account by the court in deciding whether the consent of the

promisor was freely given.

In Chijjitumal Vs. Rampal Singh AIR, 1968, the Supreme Court reiterated that consideration

need not be material and may be even absent. In the said case, the father had died leaving

his house to two sons. They had agreed to partition the house which did not admit the division

in exactly equal parts and one of the sons had agreed not to construct a door at a certain

place in his portion of the house. In a dispute, the agreement was challenged on the ground

1.22 Business Laws, Ethics and Communication

that it was without adequate consideration. The Supreme Court came to the conclusion that

the motive for the said agreement at the time when it was made, was to avoid any dispute in

future, and held that it was sufficient consideration.

The above view is in tune with explanation 2 to section 25 of the Act, which provides that an

agreement to which the consent of the promisor is freely given is not void merely because the

consideration is inadequate. Where there is valuable consideration, Court will not interfere and

inquire into the adequacy of it but leave the matter to the parties to make their own bargain.

But inadequate consideration might raise suspicion about the free will of the promisor.

Promisor could be treated as victim of some imposition but this would not render the

agreement void.

(vi) Performance of what one is legally bound to perform: The performance of an act by a

person what he is legally bound to perform, the same cannot be consideration for a contract.

Hence, a promise to pay money to a witness is void, for it is without consideration. Hence

such a contract is void for want of consideration. Similarly, an agreement by a client to pay to

his counsel, a certain sum over and above the fee, in the event of success of the case would

be void, since it is without consideration.

But where a person promises to do more than he is legally bound to do, such a promise

provided it is not opposed to public policy, is a good consideration. For instance during a civil

strike, a question arose as to how best to protect a coal mine. The police authorities thought

that surveillance by a mobile force would be adequate but the colliery manager desired a

stationary police guard. Ultimately it was agreed that the police authorities would provide a

stationary guard and the manager would pay $2,200 for the service. It was held that the

promise to pay the amount was not without consideration. The police, no doubt, were bound

to afford protection, but they had discretion as to the form it should take. The undertaking to

provide more protection than what they deemed to be necessary was a consideration for the

promise of reward. [Classbrook Brothers vs. Glamorgan Country Council (19250) A.C.270]

(vii) Consideration must not be unlawful, immoral, or opposed to public policy.

1.11 Suit by a Third Party to an Agreement

There is a big difference between a third party to consideration and third party to a contract;

while the first can sue, the second cannot sue. Thus a stranger / third Party to an

Agreement lead to the doctrine of privity of contract. The doctrine says that only parties

to a contract can enforce the contract. The parties stranger to a contract cannot sue

and be sued. Example, a contract by the purchaser of a mortgaged property to pay off the

mortgage cannot be enforced by the mortgagee who was not a party to the contract between

vendor and vendee.

However there are exceptions to the above principle. These are:

1. In the case of a trust, the beneficiary can sue enforcing his right though he was not a

party to the contract between the trustee and the settler. In Khawja Mohammed Khan Vs

Hussain Begum 371.A. 152, where, the father of the bridegroom promised to pay through

a contract with the father of the bride, an allowance to the bride, if she married his son,

The Indian Contract Act, 1872 1.23

the bride sued her father-in-law after marriage for the allowance which he did not pay as

per the contract. It was held by the Privy Council that though the bride was not a party to

the contract between her father and father in law, she could enforce her claim in equity.

2. In the case of family settlement, if the terms of settlement are reduced in writing,

members of the family who were not a party to the settlement can (also) enforce their

claim.(Shuppu Vs Subramanian 33 Mad.238)

3. In the case of certain marriage contracts a female member can enforce a provision for

marriage expense based on a petition made by the Hindu undivided family (Sunder Raja

Vs Lakshmi 38. Mad 788).

4. Where there is an assignment of a contract, the assignee can enforce the contract for

various benefits that would accrue to him on account of the assignment.[Krishanlal

Sadhu Vs Primila Bala Dasi (1928) Cal.1315]

5. In case of part performance of a contractual obligations or where there is

acknowledgment of liability on account of estoppel, a third party can sue for benefits.

Where for example ‘A’ gives ` 25000/- to ‘B’ to be given to ‘C’ and ‘B’ informs ‘C’ that B

is holding it on behalf of C, but subsequently refuses to pay ‘C’ then ‘C’ can sue and

enforce his claim.

6. Where a piece of land which is sold to buyer with certain covenants relating to land and

the buyer is kept on notice of the covenants with certain duties, there the successors to

the seller can enforce these covenants.

1.12 Validity of an Agreement without Consideration

We have all along learnt that an agreement without consideration is void. Not only that, even

inadequate consideration would render the enforceability of the contract quite difficult as the

free consent of the parties would become suspect. The Act however contains certain

exceptions to this important rule. These are:

(i) On account of natural love and affection: A written and a registered agreement made

between parties out of natural love and affection does not require consideration. Such an

agreement is enforceable even without consideration. It is important that parties should be of

near relation like husband and wife to get this exemption (Rajlukhee Devee Vs Bhootnath).

(ii) Compensation paid for past voluntary services: A promise to compensate wholly or

in part for past voluntary services rendered by someone to promisor does not require

consideration for being enforced. However the past services must have been rendered

voluntarily to the promisor. Further the promisor must have been in existence at that time and

he must have intended to compensate.

(iii) Promise to pay debts barred by limitation: Where there is a promise in writing to pay

a debt, which was barred by limitation, is valid without consideration.

1.24 Business Laws, Ethics and Communication

(iv) Creation of Agency: In term of section 185 of the Act, no consideration is necessary to

create an agency

(v) In case of completed gifts, no consideration is necessary. This is clear from the

Explanation (1) to section 25 of the Act which provides that “nothing in this Section shall affect

the validity as between donor and donee of any gift actually made.

Key Points

♦ Consideration- The promise/performance that parties exchange with each other.

♦ Rules of valid consideration: Move at the desire of promisor by promisee and any other

person.It is must for every contract though not necessarily be adequate but must be real

and not illusory and should be of some value in terms of money.

Contract without consideration is void subject to certain exceptions- agreement on

account of natural love and affection, promise to compensate for voluntary services and

promise to pay a time –barred debt, gift actually made, and in agency.

The Indian Contract Act, 1872 1.25

UNIT – 3 : OTHER ESSENTIAL ELEMENTS OF A CONTRACT

Learning objectives

After studying this unit, you would be able to -

♦ Note the various ingredients of incapacity to contract.

♦ Be clear about the legal consequence of contracting with a minor.

♦ Be familiar with the concept of 'consensus ad idem' i.e. parties agreeing upon the same

thing in the same sense.

♦ Try to grasp the characteristics of different elements vitiating free consent and

particularly to distinguish amongst fraud, misrepresentation and mistake.

♦ Understand the circumstances when object and consideration become unlawful.

♦ Be aware of the agreements opposed to public policy.

In the previous units we discussed all aspects of offer, acceptance, revocation, and

consideration. In this unit we will discuss other elements, which would constitute a contract.

We have earlier seen that in terms of section 10 of the Indian Contract Act,1872 a legally

enforceable agreement should be made with the free consent of the parties who are

competent to contract for a lawful consideration with a lawful object. Further the agreement

should not have been expressly declared as void by law. These elements would be examined

hereunder.

1.13 Free Consent

In terms of section 13 of the Act, two or more persons are said to have consented when they

agree upon the same thing in the same manner. This is referred to as identity of minds or

“consensus-ad-idem”. Absence of identity of minds would arise when there is an error on the

part of the parties regarding (a) nature of transaction or (b) person dealt with or (c) subject

matter of agreement .In such cases there would be no consent. However cases of

fundamental errors have to be distinguished from cases of mutual mistakes.

Example: Where the persons refer to a ship of a name in the contract but each of them had a

different ship in mind though of same name, there is no identity of minds and hence there is

no consent. That there is no contract in the absence of consent was considered in the case of

Cundy Vs Lindsay. In this case one Blenkarn in placing order for goods with Cundy closely

imitated the address and signature of another well-known firm known as Blenkiron & Co.

Cundy sent the goods to Blenkarn but thinking that the order was from Blenkiron & Co.

Blenkarn in turn sold the goods to Lindsay. Cundy discovered his mistake, brought a suit

against Lindsay for recovery of goods. It was held by the House of Lords that Cundy was

under mistake as he thought he was dealing with Blenkiron & Co, while he was in fact dealing

with Blenkarn. Hence there was no contract at all. The agreement was declared as void in the

1.26 Business Laws, Ethics and Communication

absence of identity of minds or proper consent. The suit was decreed against Lindsay.

The consent referred above must be “free consent” as well. Consent is free when it is not

caused by coercion, undue influence, fraud, misrepresentation or mistake (Section 14). When

the consent is caused by mistake, the agreement is void, but when caused by other factors it

is voidable.

Now let us discuss each of these factors, which should not influence consent.

(a) Coercion(Section 15): “Coercion” is the committing, or threatening to commit any act

forbidden by the Indian Penal Code 1860, or the unlawful detaining, or threatening to detain

any property, to the prejudice of any person whatever, with the intention of causing any person

to enter into an agreement.

For example, X says to Y ‘I shall not return the documents of title relating to your wife’s

property, unless you agree to sell your house to me for ` 5000’. ‘Y’ says, “All right, I shall sell

my house to you for ` 5000; do not detain my wife’s documents of title”, X has employed

coercion; he cannot therefore enforce the contract. But Y can enforce the contract if he finds

the contract to his benefit. An agreement induced by coercion is voidable and not void. That

means it can be enforced by the party coerced, but not by the party using coercion.

It is immaterial whether the Indian Penal Code,1860 is or is not in force at the place where the

coercion is employed.

Where husband obtained a release deed from his wife and son under a threat of committing

suicide, the transaction was set aside on the ground of coercion, suicide being forbidden by

the Indian Penal Code. (Amiraju Vs. Seshamma (1974) 41 Mad, 33)

A person to whom money has been paid or anything delivered under coercion, must repay or

return it.

(b) Undue influence (Section 16): A contract is said to be induced by “undue influence”

where the relations subsisting between the parties are such that one of the parties is in a

position to dominate the will of the other and uses that position to obtain an unfair advantage

of the other. A person is deemed to be in a position to dominate the will of the other, when he

holds authority, real or apparent over the other, or when he stands in a fiduciary relation to

other.

The essential ingredients of undue influence are:

One of the parties dominates the will of the other and

(i) he has real or apparent authority over the other;

(ii) he is in a position to dominate the will of the other and

(iii) the dominating party takes advantage of the relation.

The Indian Contract Act, 1872 1.27

Following are the instances where one person can be treated as in a position to dominate the

will of the other.

(i) A solicitor can dominate the will of the client.

(ii) A doctor can dominate the will of his patient having protracted illness, and

(iii) A trustee can dominate the will of the beneficiary.

The burden of proof (in situations like the above) that there is no undue influence in an

agreement would be on the person who is in a position to dominate the will of the other. For

instance the ‘father’ should prove that he had not unduly influenced his son in the case of any

given agreement. The stronger party must act in good faith and see that the weaker party

gets independent advice.

The following two decisions would enable us to understand the law.

(a) Allahabad High Court set aside a gift of the whole of the property by an elderly Hindu to

his spiritual advisor.

(b) Similarly, Privy Council set aside a deed of gift executed by an old illiterate Muslim lady

in favour of the manager of her estate.

Money lending operations and undue influence: It is often seen that on account of ‘undue

influence’ borrowers end up paying very high rate of interest to the lenders. This is because

lenders are in a position to dominate the will of the borrowers. Such high rate of interest will be

treated as unconscionable where parties are not on same footing.

Difference between Coercion and Undue Influence: Having discussed in detail the

concepts of coercion and undue influence, let us understand the difference between the two:-

(i) Nature of action: Coercion involves physical force and sometimes only threat. Undue

influence involves only moral pressure.

(ii) Involvement of criminal action: Coercion involves committing or threatening to commit

any act prohibited or forbidden by law, or detention or threatening to detain a person or

property. In undue influence there is no such illegal act involved.

(iii) Relation ship between parties: In coercion there need not be any relationship between

parties; whereas in undue influence, there must be some kind of relationship between parties,

which enables to exercise undue influence over the other.

(iv) Exercise by whom: Coercion need not proceed from the promisor. It also need not be

directed against the promisee. Undue influence is always exercised by one on the other, both

of whom are parties to a contract.

(v) Enforceability: Where there is coercion, the contract is voidable. Where there is undue

influence the contract is voidable or court may set aside or enforce it in a modified form.

(vi) Position of benefits received: In case of coercion, where the contract is rescinded by

the aggrieved party any benefit received has to be restored back. In the case of undue

1.28 Business Laws, Ethics and Communication

influence, the court has discretion to pass orders for return of any such benefit or not to give

any such directions.

party to a contract or with his connivance or by his agent with intent to deceive another party

thereto or his agent or to induce him to enter into the contract.

(i) the suggestion, as to a fact, of that which is not true by one who does not believe it be

true;

(ii) the active concealment of a fact by one, having knowledge or belief of the fact;

(iii) a promise made without any intention of performing it;

(iv) any other act fitted to deceive; and

(v) any such act or omission as to law specially declared to be fraudulent

It is important to note that ‘fraud’ that results in a contract alone is covered by section17 of the

Act. If there is a ‘fraud’ but it does not result in a contract, it would not fall within the purview

of the Act.

The following can be taken as illustration of fraud:

♦ A director of a company issues prospectus containing misstatement knowing fully well

about such mis-statement. It was held any person who had purchased shares on the faith

of such misstatement can repudiate the contract on the ground of fraud.

♦ B discovered an ore mine in the Estate of ‘A’ He conceals the mine and the information

about the mine. ‘A’ in ignorance agrees to sell the estate to ‘B’ at a price that is grossly

undervalued. The contract would be voidable of the option of ‘A’ on the ground of fraud.

♦ Buying goods with the intention of not paying the price is an act of fraud.

♦ It will be interesting to know that not only Contract Act, but also other Acts have

specifically declared certain acts and omission as fraud. A seller of a property should

disclose any material defect in the property. Concealing the information would be an act of

fraud. Any other act committed to deceive is fraud.

Mere silence would amount to fraud under certain circumstances.

Although a mere silence as to facts which is likely to affect the willingness of a person to enter

into a contract is no fraud, where there is a duty to speak or where his silence is equivalent to

speech, then such silence amounts to fraud. This would be clearly seen from the explanation

to Section 17 of the Indian Contract Act,1872. This situation often arises in Insurance

contracts.

In the case of fire insurance contract between person standing in fiduciary relationship, non-

disclosure of certain information would amount to fraud as there is a duty to make special

disclosure. These are also know as uberrimae fidei contract.

In the case of marine insurance policy contract, where a charterer is shipping goods of high

The Indian Contract Act, 1872 1.29

value but fails to disclose such high value of the goods to the underwriter, there is fraud.

Similarly the insurer is not bound by the policy issued by him where he is misinformed about

insurance policy previously taken by the insured.

(d) Misrepresentation [Section 18]: “Misrepresentation’ does not involve deception but is

only an assertion of something by a person which is not true, though he believes it to be true.

misrepresentation could arise because of innocence of the person making it or because he

lacks sufficient or reasonable ground to make it. A contract which is hit by misrepresentation

can be avoided by the person who has been misled.

For example, A makes the statement on an information derived, not directly from C but from

M. B applies for shares on the faith of the statement which turns out to be false. The

statement amounts to misrepresentation, because the information received second-hand did

not warrant A to make the positive statement to B [Section 18 (1)]

Now let us analyse the difference between fraud and misrepresentation.

(i) Extent of truth varies: One of the important difference between fraud and

misrepresentation is that in case of fraud the person making the representation knows it fully

well that his statement is untrue & false. In case of misrepresentation, the person making the

statement believes it to be true which might later turn out to be untrue. In spite of this

difference, the end result is that the other party is misled.

(ii) Right of the person concerned who suffers: Fraud not only enables the party to avoid

the contract but is also entitled to bring action. Misrepresentation merely provides a ground

for avoiding the contract and not for bringing an action in court.

(iii) Action against the person making the statement: In order to sustain an action for

deceit, there must be proof of fraud. As earlier discussed fraud can be proved only by showing

that a false statement was made knowing it to be false or without believing it to be true or

recklessly without any care for truth. One is for action against deceit and the other is action for

recession of the contract. In the case of mis-representation the person may be free from

blame because of his innocence but still the contract cannot stand.

(iv) Defences available to persons: In case of misrepresentation, the fact that plaintiff had

means of discovering the truth by exercising ordinary diligence can be a good defence against

the repudiation of the contract, whereas a defence cannot be set up in case of fraud other

than fraudulent silence.

The tenuous difference between fraud and misrepresentation was beautifully brought out in

the famous case of Derry vs. Peek. In the said case the plaintiff brought an action of deceit

against the promoters of a tramway company.

According to him, the promoters in the prospectus had not mentioned that they had not

obtained the permission of the board of trade which was necessary for using mechanical

power [to run a train] and here this was deceit. The plea of the defendant was that it never

occurred to them to say anything about the consent of the Board of trade because they had a

right under the Act of parliament for using steam; they had presumed, they would also get the

1.30 Business Laws, Ethics and Communication

consent of Board of trade. The Court verified the position and concluded that there was no

deceit and the plea for action for deceit was dismissed.

1.14 General Consequences of Coercion, Fraud, Misrepresentation

Etc; (Section 19)

What is the effect and what the consequences of a contract hit by coercion, undue influence,

fraud or misrepresentations, are dealt by Section 19 of the Act. It is seen that in all these

cases though the agreement amounts to a contract, it is voidable. The injured party might

insist on being placed in the same position in which he might have been had the vitiating

circumstances not been present.

For example ‘A’ fraudulently informs ‘B’ that his estate is free from encumbrance, therefore ‘B’

buys the estate. But the estate is subject to mortgage. ‘B’ may avoid the contract or insist on

the debt being redeemed and mortgage being released.

But, where it is possible to discover the truth with ordinary diligence, and though the consent

might have been obtained by misrepresentation or silence, then the contract cannot be

avoided.

For instance where ‘A’ misrepresents to ‘B’ that his sugar factory can produce 500 tons of

sugar and whereas it actually produced 300 tones of sugar and if ‘B’ had the opportunity to

examine the accounts through which he could have found out the truth and if in spite of that he

had entered into a contract, he can not repudiate it.

Where a party to contract perpetrates fraud or misrepresentation, but the other party is not

misled by such fraud or misrepresentation, then the contract cannot be avoided by the latter.

Where for instance, the seller of specific goods deliberately conceals a fault in order that the

buyer may not discover it even if he inspects the goods, but the buyer in fact does not make

any inspection at all, the buyer cannot avoid the contract as he is not deceived by the seller.

Where a contract is voidable and the party entitled to avoid it decides to do so by rescinding it,

he must restore any benefit which he might have received from the other party. He cannot

avoid the contract and at the same time enjoy the benefit under the rescinded/avoided

contract.

However where a contract is sought to be rescinded on the ground of ‘undue influence’ the

court may set aside the contract partially or fully. Where the party seeking to rescind the

contract had received only benefit, the contract will be set aside by the court upon such terms

and conditions deemed fit.

Example: A student was induced by his teacher to sell his brand new car to the latter at less

than the purchase price to secure more marks in the examination. Accordingly the car was

sold. However, the father of the student persuaded him to sue his teacher. State on what

ground the student can sue the teacher?

Yes, the student can sue his teacher on the ground of undue influence under the provision of

The Indian Contract Act, 1872 1.31

Indian Contract Act, 1872. A contract brought about as a result of coercion, undue influence,

fraud or misrepresentation would be voidable at the option of the person whose consent was

so caused.

1.15 Mistake

The fifth significant element that vitiates consent is ‘Mistake’. Where parties to an agreement

are under a mistake as to a matter of fact which is essential to the agreement, then the

agreement is void. As we all know a void agreement cannot be enforced at all.

Example: ‘A’ agrees to sell certain cargo which is supposed to be on its way in a ship from

London to Bombay. But in fact, just before the bargain was struck, the ship carrying the cargo

was cast away because of storm and rain and the goods were lost. Neither of the parties was

aware of it. The agreement is void. [Couturier vs Hasite 5 H.L.C.673]

Mistake must be a matter of fact and not of law. Where ‘A’ and ‘B’ enter into contract believing

wrongly that a particular debt is not barred by law of limitation, then the contract is valid

because there is no mistake of fact but of law only. However a question on foreign law would

become a matter of question of fact. Similarly the existence of a particular private right though

depends upon rules of law, is only a matter of fact. For instance where a man promises to buy

a property which already belongs to him without him being aware of it, then such a promise is

not binding on him. However a family arrangements or a compromise of doubtful rights cannot

be avoided on the ground of mistake of law.

Yet another issue to remember in mistake is that it must be of an essential fact. Whether the

fact is essential or not would again depend on how a reasonable man would regard it under

given circumstances. A mere wrong opinion as to the value is not an essential fact.

While deciding whether a contract is hit by mistake or not it must be remembered that

‘Mistake’ is not unilateral. Both the parties should be under mistake. A unilateral mistake

would not render the contract invalid. For example where ‘A’ agrees to purchase from ‘B’ 18

carat gold thinking it to be pure gold but ‘B’ was not instrumental for creating such an

impression then contract between ‘A’ and ‘B’ should be treated as valid.

From the foregoing it is clear that:-

a. Mistake should be a matter of fact

b. Mistake should not be a matter of law

c. Mistake should be a matter of essential fact

d. Mistake should not be unilateral but of both the parties, and

e. Mistake renders agreement void and neither party can enforce the contract against each

other

1.32 Business Laws, Ethics and Communication

Key Points

♦ When two or more persons agree upon the same thing in the same sense,they are said

to have consent. Consent is said to be free when it has not been obtained by coercion,

undue influence, fraud, misrepresentation or mistake.

♦ Coercion –An act or threat of a person with an intention of causing any person to enter

into an agreement by –(i) committing / threatening to commit any act forbidden by IPC,

or (ii) unlawfully detaining or threatening to detain any property of another. Such a

contract is voidable.

♦ Undue influence –It is used by a dominant party on a weaker one to get an unfair

advantage in a contract. In the following circumstances, the party stand in a dominant

position-

Where party holds real/apparent authority over the others, or party stands in a fiduciary

relationship to the other,or where the party make a contract with a party in mental or

bodily distress.

A contract caused by undue influence is voidable. Even court is also empowered to set

aside such contract absolutely or conditionally.

♦ Fraud-Intentional misrepresentation or concealment of material facts of a contract with an

intention to deceive and induce the other party to enter into an agreement.

Silence merely not amount to fraud, except-it’s duty to speak,or silence is equivalent to

speech, or stating half truth.

♦ Misrepresentation- An innocent/ unintentional false statement/ assertion of fact in the

making of an agreement.

Remedies in the above cases are same, except the right to claim damages in case of

fraud.

♦ Mistake- An erroneous belief about something. It may be either of fact or of law. Mistake

renders the contract void. Unilateral mistake made by one of the parties. It is a valid

contract, unless it is caused by misrepresentation or fraud. Even unilateral mistakes as to

fact renders the contract void.

1.16 Capacity to Contract

The next issue for consideration is, who is competent to contract? Every person who (a) has

attained the age of majority (b) is of sound mind and (c) is not otherwise disqualified from

contracting, is competent to contract. Now let us discuss each one of these requirements.

(a) Age of majority: In terms of the Indian Majority Act, 1875, every domiciled Indian attains

majority on the completion of 18 years of age. However where a guardian is appointed by a

court to protect the property of a minor and the court takes charge of the property before the

person attains 18 years, then he or she would attain majority on completion of 21 years.

The Indian Contract Act, 1872 1.33

Now let us analyze the position with regard to the minor’s agreement -

(i) An agreement entered into by a minor is altogether void: An agreement entered into

by a minor is void against the minor and the question of its enforceability does not arise. The

Privy Council in Mohiri Bibee vs. Dharmodos Ghose [1903] LR 30, Cal 539, decided that an

agreement where minor is a party is altogether void. In this case a minor executed a

mortgage in favour of the husband of Mohiri Bibee. The question for consideration is whether

the mortgage is valid. Interpreting Sections 10 &11 of the Indian Contract Act, 1872 Privy

Council held that unless all the parties to an agreement were competent to contract, the

agreement would be void. The main reason for such a view is that a minor is incapable of

performing his part of the contract imposing a legal obligation.

(ii) Minor can be a beneficiary: Though a minor is not competent to contract, nothing in

the Contract Act prevents him from making the other party bound to the minor. Thus, a

promissory note duly executed in favour of a minor is not void and can be sued upon by him,

because he though incompetent to contract, may yet accept a benefit.

A minor cannot become partner in a partnership firm. However, he may with the consent of all

the partners, be admitted to the benefits of partnership (Section 30 of the Indian Partnership

Act,1932).

(iii) Minor can always plead minority: Any money advanced to a minor cannot be

recovered as he can plead minority and that the contract is void. Even if there had been false

representation at the time of borrowing that he was a major, the amount lent to him cannot be

recovered.

This position was upheld by Privy Council in Mohiri Bibee’s case where money was lent to a

minor with full knowledge of the borrower’s infancy and even request for payment of

compensation under sections 38 & 41 of the Specific Relief Act,1963 was refused. Privy

Council concurred with the views of Calcutta High Court that no discretion could be used even

under that Act to grant any kind of relief to the lender of money.

When the mortgage documents had to be cancelled at the instance of minor who mortgaged

the property fraudulently, Courts have ordered compensation under Specific Relief Act,1963 to

the other party to the instrument [Dattaram vs. Vinayak (1903) 28 bom.181., Manmatha Kumar

vs. Exchange Loan Co. 41 C.W.e.N 115]

If a minor had obtained payment fraudulently by concealing his age, he may be compelled to

restore the payment but he cannot be compelled for an identical sum as it would amount to

enforcing void contract.

(iv) Ratification of agreement not permitted: A minor on his attaining majority cannot

validate any agreement which was entered into when he was minor, as the agreement was

void. Similarly a minor cannot sign fresh promissory notes on his attaining majority in lieu of

promissory notes executed for a loan transaction when he was minor, or a fresh agreement

without consideration.

(v) Liability for necessaries: A person who supplied necessaries of life to a minor or his

1.34 Business Laws, Ethics and Communication

family, is entitled to be reimbursed from the properties of a minor, not on the basis of any

contract but on the basis of an obligation resembling a contract. Necessaries of life not only

include food and clothing but also education and instruction. They also include ‘goods’ and

‘services’.

(vi) Contract by guardian are valid: Though an agreement with minor is void, valid contract

can be entered into with the guardian on behalf of the minor. The guardian must be

competent to make the contract and the contract should be for the benefit of the minor. For

instance a guardian can make an enforceable marriage contract on behalf of the minor.

Similarly father of bride can enter the contract with the father of bridegroom for payment of

certain allowance to the bride.

But not all contracts by guardian are valid. A guardian cannot bind a minor in a contract to

purchase immovable properties [Mir Sarwarjan vs. Fakharuddan (1912) 39. Cal. 232].

However, a court appointed guardian can bind a minor is respect of certain sale of property

ordered by the court.

Key Points

♦ Capacity to contract -Legal capacity of parties to enter into a contract. A person is

competent to contract , where he is – (i) Major (ii) of Sound mind(iii) not disqualified by

any other law of the land.

♦ Nature of minor’s agreement- Minor’s agreement is absolutely void from very beginning,

so it has no enforceability.[ Mohiri Bibee v. Dharmodas Ghose].

♦ Minor can be a beneficiary.

♦ Minor cannot ratify his agreement even after attaining the age of majority.

♦ Minor can always plead his minority, as no rule of estoppel is applicable to minor.

♦ Minor, is not personally liable for the necessaries supplied to him/ or his legal

dependants

(b) Sound mind: The next important requirement by way of capacity to contract is “sound

mind”. A person will be considered to be of sound mind if he at the time of entering into a

contract is capable of understanding it and forming a rational judgment as to its effect upon his

interest. A person who is of unsound mind but occasionally of sound mind can enter into a

contact when he is in sound mind though for temporary periods. For example a person who is

in lunatic asylum during intervals of sound mind can enter into contracts. Similarly, a person

who is generally of sound mind, but occasionally of unsound mind cannot enter into a contract

when he is of unsound mind.

From the above it is clear that the period of lucidity would be crucial as much as the periods of

lunacy. But the burden of proof of ‘unsound mind’ is on the person who challenges the validity

of the contract.

A lunatic whose estate is managed by a committee or manager is not capable of entering into

The Indian Contract Act, 1872 1.35

a contract even during the periods of lucidity in view of special provisions of Lunacy Act.

The basic test for lunacy or lucidity is to see whether the person is able to understand the

implications of a contract which he enters into on his interest. Idiots, lunatics and drunken

persons are examples of persons of unsound mind.

Necessaries of life supplied to a person of unsound mind: In term of section 68 of the

Indian Contract Act,1872 if a person incapable of entering into a contract is supplied by

another person with necessaries of life, the person who has furnished such supplies is entitled

to be reimbursed from the property of such a person.

these are the others who are not capable of entering into contract either wholly or partially.

Contract by such persons are void.

An alien enemy, during war cannot enter into a contract with an Indian subject, unless he is

permitted by Central Government to do so he cannot sue in Indian Courts. This disability to an

alien enemy arises on account of public policy. Statutory corporations or Municipal bodies

cannot enter into contracts on matters which are beyond their statutory powers or ultra vires

the memorandum or articles through which they are created.

An Advocate in India can enter into contracts with his clients for recovery of fees or payment of

fees in certain manner unlike his counterpart in U.K where barristers are prohibited to enter into

contracts for recovery of fees from their clients [Nichal chand vs. Dilawar Khan 55. All 790]

Before entering into contract with the government, certain procedure and formalities are

required to be complied with. On default of it, such contract will be void. [Bikhraj vs.Union of

India (1962) 2 S.C.R.880, Karamshi vs. State of Bombay AIR (1964) S.C.1714]

Sovereign states, Ambassadors and Diplomatic Consuls enjoy certain privileges with the result

that they cannot be proceeded against in Indian Courts. However, they can, at their will enter

into contracts which may be enforceable in India.

Key Points

♦ Person is said to be of sound mind for the purpose of making a contract, where he is- (a)

capable of understanding the nature of the contract, and (b) capable of making a rational

judgement as to effect upon its interests.

♦ Insanity is required only at the time of making a contract.

♦ A person usually of unsound mind, but occasionally of sound mind- can make contract

when he is of sound mind.

♦ A person usually of sound mind, but occasionally of unsound mind- cannot make contract

when he is of unsound mind.

♦ The agreements made by a person of unsound mind are absolutely void.

♦ Certain persons who are disqualified from contracting by other laws are- Alien

enemy,Foreign diplomats & Consuls, Artificial persons, Insolvents, and Convicts.

1.36 Business Laws, Ethics and Communication

1.17 Lawful Object and Consideration

Now let us discuss two other important ingredients of a valid contract namely lawful object and

lawful consideration. Speaking generally all persons enjoy freedom for entering into contracts

of their choice. But this contractual freedom or their right to enter into agreements is not

absolute. There is a limitation on such contractual freedom as they are bound by certain

general provisions of law. The above observation can be illustrated with the following

example: suppose ‘A’ agrees to pay ` 100/- to B on ‘B’ stealing ‘C’s purse, then no Court can

compel ‘A’ to pay ‘B’ even if he manages to steal ‘C’s purse because it would amount to

encouraging these things.

While on the subject of ‘object’ and ‘consideration’ it must be said that in practice it is difficult

to distinguish between ‘object’ and ‘consideration’ especially when consideration consists of a

promise to do or, not to do something. Sometimes both ‘object’ and ‘consideration’ are seen

for evaluation. For example, where ‘A’ agrees to sell goods to ‘B’ who is insolvent and B

assigns the benefit of the contract for ` 100/- with a view to defrauding creditors, the

consideration for the assignment viz ` 100/- is lawful but the object namely defrauding

creditors is unlawful as it is to defeat the provision of insolvency law.

Although ‘object’ and ‘consideration’ are sometimes intertwined we have to, where ever it is

possible, separate them and identify whether they are lawful.

1.18 Unlawful Object

In terms of section 23 of the Act ‘consideration’ or ‘object’ is unlawful if it is forbidden by law;

or it would if permitted, defeat the provisions of any law or is fraudulent or involves injury to

the person or property of another or is immoral or opposed to public policy. Every agreement

where the object or consideration is unlawful is void. Thus section 23 has set out the limits to

contractual freedom. Following are examples of agreement which are void because the object

is unlawful.

(i) Where A, B & C enter into an agreement to share equally among themselves certain

gains acquired by fraud or loss acquired by fraud. The agreement is void because the

object being commission of fraud, is unlawful.

(ii) A promises to return the stolen property of ‘B’ if ‘B’ would withdraw the criminal case filed

against him, the agreement is void as its object namely withdrawing the case would

mean stifling prosecution.

1.19 Unlawful Consideration

Now let us consider circumstances which would make consideration and the object as well

unlawful. There are seven such circumstances namely -

(i) Agreement forbidden by law: Acts forbidden by law means acts that are punishable

under any Statute or Rules or Regulations made under any Statute.

The Indian Contract Act, 1872 1.37

For instance a plantation company that is commenced, for growing, felling and selling timber

cannot enter into any agreement to grow and fell sandalwood trees as felling of sandalwood is

prohibited by law viz the Forest Act.

Example: A license to cut grass is given to ‘X’ by Forest Department under the Forest Act.

The license provides for imposition of penalty in the events of ‘X’ choosing to assign his right.

However, if ‘X’ assigns his right, the agreement would still be valid since there is no prohibition

for such assignment as the consideration stipulating penalty is only to regulate the matter as a

matter of administrative measure.

(ii) Consideration defeats the provision of law: Where an agreement is entered into with

the object of defeating any provision of law then it is prohibited. “Law” here should mean any

Statute, Law, regulation etc, in force. This can be illustrated by the following-

(a) Where a debtor agrees not to plead limitation vis-à-vis his creditor, it is an agreement to

defeat the Limitation Act.

(b) An agreement between owner of land who has to pay land revenue in arrears and a

stranger that the stranger would purchase his estate for revenue’s sake and reconveys it

to the former on receipt of purchase money is void, as it would defeat the law relating to

revenue, which apparently prohibits defaulting owners from purchasing back the same

estate already sold due to his default.

allowance to natural parents would be in violation of Hindu Law and hence is unlawful.

(d) Any agreement by a Muslim with the wife before their marriage that the wife shall be at

liberty to live with her parents after marriage is void as it would defeat the provisions of

Muslim Law.

(iii) Consideration that would defeat any rule for the time being in force: This is a

situation not very different from point (ii) discussed above. The issue covered by this point can

be explained by following two examples:

(a) A ‘will’ must be proved in order to be probated by a court. A mere consent of parties by

way of agreement to except this requirement of proof of genuineness or proper execution

of will is not lawful and therefore cannot be enforced under C.P.C.

(b) A receiver is a court officer. Therefore his remuneration has to be fixed by the court.

Parties to certain litigations cannot add or deviate of the power of the receiver. Similarly

they cannot fix salary of a receiver without the leave of the court however unconditional it

may be. Such an act would be in contravention of law.

(iv) Where consideration is a fraud: Following are illustrations to prove where the object or

consideration of an agreement is unlawful on the ground of fraud -

(a) ‘A’ is an agent for Zamindar, the principal. He agrees for money to lease of land for ‘B’

from his principal, the Zamindar. The agreement between ‘A’ and ‘B’ is void as the

consideration is fraudulent

1.38 Business Laws, Ethics and Communication

(b) ‘A’ & ‘B’ are partners in a firm. They agree to defraud a Government department by

submitting a tender in the individual name and not in the firm name. This agreement is

void as it is a fraud on the Government department.

(v) Where object or consideration is unlawful because it involves or causing injury to

a person or loss of property: The term ‘injury’ means criminal or wrongful harm. Following

are the illustrations where the object or consideration is unlawful as it involves injury either to

person or property.

(a) ‘A’ agrees to buy a property from ‘B’ although A knows ‘B’ had agreed previously to sell

the property to ‘C’. The intention of ‘A’ here is to cause injury to the property of ‘C’

(b) ‘A’ agrees to print a book of ‘B’ which has clearly been published by “W” This agreement

is void as it is not only in violation of Copyright Act but also with the intent to cause injury

to the property of another.

Therefore he agrees to render manual labour for certain period failing which he agrees to

pay exorbitant interest. This agreement is void as rendering labour as consideration

amounts to agreeing to be a slave. Slavery is opposed to public policy as well. In other

words consideration involves ‘injury’ to ‘A’. Hence the agreement is void.

(vi) Where consideration is immoral: Following are illustration where the agreement is void

because the object or consideration is unlawful being immoral.

(a) Where ‘A’ agrees to let his house to a prostitute on rent, where with A’s knowledge she

carries on her vocation. ‘A’ cannot collect the rent as the agreement is void, the object

being void.

(b) Where ‘P’ had advanced money to ‘D’ a married woman to enable her to obtain a divorce

from her husband. He also promised to marry her after divorce. It was held that ‘P’ was

not entitled to recover the amount from ‘D’ as the agreement was against good morals.

(vii) Where consideration is opposed to public policy: Agreement, either because of their

object or consideration being opposed to public policy are void and not enforceable. Therefore

the meaning of the expression ‘public policy’ is very important. It can be interpreted in a

narrow sense or in a broad sense. If it is understood in a narrow sense, it would cut into rights

of people to enter into even genuine agreements. ‘Public policy’ as a concept is evolved

basically to develop an orderly society and for good of the community. But framing public

policy itself is a difficult exercise since a too restrictive approach would stifle the rights of

people and a too liberal approach would open the gate for many illegal transactions. Therefore

policy on ‘public policy’ has to be developed with circumspection. Public policy has been

described as “an unruly horse, which if not properly bridled, may carry its rider he knows not

where”. Time immemorial following activities/ agreements have been identified as “opposed to

public policy”.

(a) Trading with enemy: Any trading or business activity with a person who owes allegiance

to a Government of a country with whom India is at war without any license from Government

The Indian Contract Act, 1872 1.39

of India is void. This is because such a trade would be against the interest of Government of

India and people of India.

Any agreement made during peace time would be suspended automatically and cannot be

carried on further until hostilities come to an end.

(b) Stifling prosecution: Any agreement to stifle or prevent illegally any prosecution is void

as it would amount to perversion or abuse of justice. The principle is that one should not

make a trade of felony. It must be understood however that under the Code of Criminal

Procedure,1973 many offences are compoundable. Therefore any agreement towards

compounding of an offence to avoid prosecution is not void but is very much enforceable.

Thus, where ‘A’ agrees to sell certain land to ‘B’ in consideration of ‘B’ abstaining from taking

any criminal proceeding against ‘A’ with respect to an offence which is compoundable, the

agreement is not opposed to public policy.

litigant has no interest. Champerty is bargain whereby one party agrees to assist the other in

recovering property with a view to sharing the profit of litigation. These agreements for

maintenance and champerty are void in England but not in India. Hence these are not

opposed to public policy. But where such advances are made by way of gambling in litigation,

the agreement to share the subject of litigation is certainly opposed to public policy and

therefore is void.

(d) Interference with course of law and justice: Any agreement with the object of inducing

a judicial officer or administrative officer of the state to act corruptly or not impartially is void.

Similarly an agreement to use influence in a litigation in a underhand manner is void. For

instance through an agreement ‘A’ agrees to reward ‘B’ if he abstains from being a witness in

a suit against ‘A’ is void. But an agreement to pay for to a holy man for prayers for success of

a suit is valid.

(e) Marriage brokerage contract: An agreement to negotiate a marriage for reward is void.

Such marriage brokerage contracts are opposed to public policy.

(f) Interest against obligation: The following are examples of agreement that are void as

they tend to create an interest against obligation. The object of such agreements is opposed

to public policy.

(1) An agreement by an agent to receive without his principal’s consent compensation from

another for the performance of his agency is invalid.

(2) A promise by a trustee to do something in violation of his duty is unlawful

(3) A, who is the manager of a firm, agrees to pass a contract to X if X pay to A ` 2000

privately; the agreement is void.

(g) Sale of public offices: While appointing a person to certain important and high public

office, merit alone should be the criteria. Any attempt to influence or any agreement to

influence anyone in this regard should be seen as an act ‘opposed to public policy’. ‘Public

1.40 Business Laws, Ethics and Communication

policy’ also demands that there should be no money consideration and if it is there, it could be

opposed to public policy. This is for the reason presence of money consideration would

convert the situation as sale of public office.

Following are illustrations in this regard.

(1) An agreement to pay money to public servant in order to induce him to retire from his

office so that another person may secure the appointment is void.

(2) An agreement to procure a public recognition like Padma Vibhushan for reward is void.

(3) The sale of the office of a mutawali of wakf is opposed to public policy, because the

office of mutawali is connected with matters of public interest.

(h) Agreement for the creation of monopolies: Agreements having for their object the

establishment of monopolies are opposed to public policy and therefore void. It is also hit by

the MRTP Act.

(i) Agreement in restraint of marriage (Section 26): Every agreement in restraint of

marriage of any person other than a minor, is void. So if a person, being a major, agrees for

good consideration not to marry, the promise is not binding.

(j) Agreement in restraint of trade (Section 27): Any agreement through which a person

is restrained from exercising a lawful profession, trade or business of any kind is to that extent

void. The object of this law is to protect trade. The restraint, even if it is partial, will make the

agreement void. Example: X, a shop keeper, in a particular locality agrees to pay ‘Y’ his rival

in business certain compensation, if ‘Y’ close his business in that locality the agreement is

void.

The principle of law however has a number of exceptions which are discussed hereunder.

(i) where a person sells his business along with the goodwill to another person, agrees not

to carry on same line of business in certain reasonable local limits, such an agreement is

valid.

(ii) In terms of Section 36 of the Indian Partnership Act,1932 an agreement through which an

outgoing partner will not carry on the business of the firm for a reasonable time will be

valid, though it is in restraint of trade.

(iii) Again in terms of Section 54 of the Partnership Act,1932 partners among themselves

may agree that upon dissolution of the firm some of them may not carry on the business

of the firm. Such an agreement is valid.

(iv) Section 55 of the Indian Partnership Act,1932 provides that where a full firm is sold by

partners along with goodwill to a buyer, there can be an agreement that they would not

carry on the business of the dissolved firm for certain period and within certain local limits

and such an agreement will be valid.

(v) An agreement of service through which an employee commits not to compete with his

employer is not in restraint of trade. Example: ‘B’ is a Doctor and he employs ‘A’ a junior

The Indian Contract Act, 1872 1.41

Doctor as his assistant. ‘A’ agrees not to practice as Doctor during the period of his

employment with ‘B’ as a Doctor independently. Such an agreement will be valid.

(vi) An agreement between manufacturer and a wholesale merchant that the entire

production during a period will be sold by the manufacturer to the wholesale merchant is

not in restraint of trade.

(vii) An agreement among sellers not to sell a particular product below a particular price is not

an agreement in restraint of trade.

(k) Agreement in restraint of legal proceedings (Section 28): An agreement in restraint of

legal proceedings resulting in restriction of one’s right to enforce legal rights is void. Similarly

any agreement which abridges the usual period for commencing the legal proceedings is also

void. Further these agreement are also void in view of section 23 of the Indian Contract

Act,1872 as the object of the agreements are to defeat the provision of law.

Nevertheless, a clause in an fire insurance policy stipulating that if the claim is made and

rejected and if no suit is instituted within three months after such a rejection, all the benefits

under the policy will be forfeited, is valid. However, there are certain exceptions to the above

rule:

(i) A contract by which the parties agree that any dispute between them in respect of any

subject shall be referred to arbitration and that only the amount awarded in such

arbitration shall be recoverable is a valid contract. For instance, in agreement between

the holder of a fire insurance policy and the insurance company that no suit shall be

instituted until the question of the amount of damage sustained by the assured has first

been ascertained by a reference to an arbitrator is a perfectly valid agreement.

(ii) Similarly, a contract by which the parties agree to refer to arbitration any question

between them which has already arisen or which may arise in future, is valid; but such a

contract must be in writing.

Key Points

♦ An agreement with unlawful object or consideration is void.

♦ Where both the consideration and object of an agreement is partially unlawful and it can

not be severed from the agreement- Whole agreement is void.

♦ If unlawful part can be severed from the other lawful part of an agreement - Lawful part is

valid.

♦ Any agreement which is against the interest of the public or harmful to the society-Is an

agreement against public policy.

1.20 Agreement Expressly Declared as Void

We have already seen that certain agreements are void ab initio under the Contract Act, like

agreements by incompetent persons [Section 11], agreement with unlawful object or

consideration [Section 23], agreement made under mutual mistake of fact [Section 20],

agreement without consideration [Section 25], agreement in restraint of marriage, trade or

1.42 Business Laws, Ethics and Communication

legal proceedings etc., as they are opposed to public policy.

In addition to the above, there are also other agreements which are expressly declared as

void.

(a) Where consideration is unlawful in part: By virtue of Section 24 of the Indian Contract

Act, “If any part of a single consideration for one or more objects, or any one or any part of

any one of several considerations for a single object is unlawful, the agreement is void”.

This Section is obviously a corollary to Section 23 of the Act. Where the consideration is

unlawful, the entire agreement is void as the agreement has to be looked as a whole. The

general principle of law is where the legal part of an agreement can be separated from the

illegal part, then the legal part if it can be given effect by rejecting the bad part and retaining

the good part, then the good part is given effect. But where no such separation is possible,

the contract is altogether void.

Example: ‘A’ has business interest in Indigo, as a manufacturer. He also has interest in illegal

traffic of other goods. Where ‘A’ employs ‘B’ for a salary of ` 2000/- to act as superintendent

of A’s entire business, the agreement is void as the object of A’s promise unlawful in part.

(b) Agreement the meaning of which is uncertain (Section 29): Where the meaning of the

terms of an agreement is uncertain or if it is not capable of being understood with certainty,

then the agreement is void. But where the meaning is capable of being made certain, then the

agreement is valid. For example where ‘A’ enters into an agreement to supply 100 tones of

oil, the agreement is not valid as the meaning of it is uncertain since what type of oil that is

promised to be supplied is not clear. But on the other hand if ‘A’ is a dealer of coconut oil

only, then the meaning of the agreement would crystallize very easily and then the agreement

would be valid.

wagering agreements from speculative transactions and mere ‘gambling’.

Wagering agreement is one which involves payment of a sum of money upon the

determination of an uncertain event. The essence of wagering agreement is where there are

two parties, one wins, the other loses upon an uncertain event taking place in which neither of

them has legitimate interest.

For example ‘A’ agrees to pay ` 500/- to ‘B’ if it rains and similarly ‘B’ agrees to pay ‘A’ if it

does not. This is a classic case of a wagering agreement. But where one of the parties has

control over the event, the agreement is valid. An agreement by way of a wager is void. A

good definition of wagering agreement would be the one given by Anson: “A promise to give

money or money’s worth upon determination or ascertainment of an uncertain event”.

Now let us see the position with regard to transaction of “purchase of lottery ticket” and “horse

racing”. Section 30 of the Act provides that an agreement [to buy lottery tickets] is one by way

of wager and is void. However any subscription or contribution or agreement towards such

subscription or contribution towards any plate or prize or sum of money, of the value of ` 500

or more to be awarded to a winner of a horse race is not unlawful.

The Indian Contract Act, 1872 1.43

Speculative transactions: While as clearly seen, wagering contracts are void, speculative

transactions are valid. It is often difficult to distinguish between the two. There are two bare

elements of a speculative transaction. They are (a) mutual intention of parties to acquire or

deliver goods or commodities and (b) undertaking of risk arising from movement of prices. In

wagering contract, only the element of risk is seen.

Now let us take an example:

‘A’ enters into a agreement with ‘B’ to buy 100 bales of jute at ` 150/- per bale for forward

delivery after six months. This is a proposed transaction of purchase @ ` 150/- per bale.

What if the price at the time of delivery goes up to ` 200/- ‘A’ has the following two options:

(i) to take delivery of 100 bales at the contracted rate of ` 150/- and sell it to some other

buyer and make a profit of ` 50/ -per bale or

(ii) to simply collect the difference of ` 50/- per bale from ‘B’

Similarly what if the price at the time of delivery goes down to ` 125/- per bale. ‘A’ has the

following two options:

(i) to take delivery of 100 bales at the contracted rate of ` 150/- [and perhaps sell it to

some buyer and incur a loss of ` 25 per bale] or

(ii) to pay the difference of ` 25/- per bale to ‘B’ & close the contract.

In the above example if the original intention of the parties was only to settle the difference in

price, than it would be a wagering contract which would be void. Thus by now it would be

clear that wagering postulates only incurring of risk. It is void because it is opposed to public

policy.

While gambling and wagering are prohibited by law, speculation is not.

Now let us consider other peculiar situations to see whether they are wagering contracts or

speculative contracts or valid contracts.

Insurance policy: An insurance policy is a valid contract. But if an insurance policy is taken

by a person who has no insurable interest, then it is void. For instance a person who has no

insurable interest in a ship, takes a policy against it being sunk, then the contract is void.

Promissory notes on a wagering contract: While a wagering contract is void ab initio, it is

but automatic that a promissory note given out of a wagering contract is not enforceable by

way of a suit. A promissory note of this character is one without consideration and hence is

null and void.

Suit to recover deposit: A winner of bet cannot recover the amount which he has won even if

the amount is kept by way of deposit by the loser with the stakeholder. Such earmarking or

identification of funds does not enhance the validity of the contract which is void. In the above

example the loser can recover the amount from stakeholders as long as the amount has not

been made over by the stakeholder to the winner.

Wager and collateral transactions: The validity of a collateral transaction cannot be

1.44 Business Laws, Ethics and Communication

challenged because the main contract is a wager and void. For instance in a wagering

contract, the broker is entitled to collect his brokerage. Similarly the principal can recover the

prize money from his agent received by him on account of a wagering transactions.

The acid test of validly of a collateral transaction is whether the main transaction is illegal or

legal but void. If the main transaction is illegal, the collateral transaction cannot be valid. For

example security given for regular payment of the rent of a house let out for the purpose of

gambling cannot be recovered; the recovery of security being tainted with the illegality of

original transaction cannot be enforced.

A promise made by the loser of a wager to pay the amount lost in consideration of the winners

forbearance to sue him as defaulter can be enforced as a fresh contract, separate and distinct

from original wagering contract though collateral to it.

Key Points

♦ An agreement not enforceable by law is void. In the public interest, some of the

agreements have been expressely declared to be void under the Act.

♦ Any agreement in restraint of marriage of a person, other than minor is void.

♦ Every agreement by which any person is restrained from exercising a lawful profession,

trade or business of any kind is void.

♦ Wagering agreements have been declared to be void. However, an agreement to subscribe

towards and plate, prize or a sum of money of ` 500 /more to be awarded to the winner of

any horse race, is not unlawful. Contract of insurance is not a wager, it falls under the

category of contingent contract.

The Indian Contract Act, 1872 1.45

UNIT – 4 : PERFORMANCE OF CONTRACT

Learning objectives

After studying this unit, you would be able to -

♦ Understand how obligations under a contract must be carried out by the parties.

♦ Be familiar with the various modes of performance.

♦ Be clear about the consequence of refusal of performance or refusal to accept

performance, by either of the parties.

♦ Understand rights of joint promisees, liabilities of joint promisors, and rules regarding

appropriation of payments.

A contract being an agreement enforceable by law, creates a legal obligation, which subsists

until discharged. Performance of the promise or promises remaining to be performed is the

principal and most usual mode of discharge. This unit explains, who must perform his

obligation; what should be the mode of performance; and what shall be the consequences of

non performance.

Basic tenet of performance: In a contract where there are two parties, each one has to

perform his part and demands the other to perform. This obligation is the primary tenet. The

parties would be treated as having been absolved only under the provisions of any law or by

the conduct of the other party. Until such time, the performance is neither excused nor

dispensed with. Not only the promisor has a primary duty to perform, even the representative

in the event of death of a promisor, is bound by the promise to perform, unless a contrary

intention appears from the contract [Section 37].

1.21 By Whom a Contract may be Performed

The promise under a contract can be performed by any one of the following:

(i) Promisor himself: Invariably the promise has to be performed by the promisor where

the contracts are entered into for performance of personal skills, or diligence or personal

confidence, it becomes absolutely necessary that the promisor performs it himself.

(ii) Agent:Where personal consideration is not the foundation of a contract, the promisor or

his representative can employ a competent person to perform it.

(iii) Representatives: Generally upon the death of promisor, the legal representatives of the

deceased are bound by the promise unless it is a promise for performance involving

personal skill or ability of the promisor. However the liability of the legal representative is

limited to the value of property inherited by him from the promisor.

(iv) Third Person: The question here is whether a total stranger to a contract who is

identified as a third person can perform a promise. Where a promisee accepts

performance from a third party he cannot afterwards enforce it against the promisor.

1.46 Business Laws, Ethics and Communication

Such a performance, where accepted by the promisor has the effect of discharging the

promisor though he has neither authorized nor ratified the act of the third party.

(v) Joint promisors: Where two or more persons jointly promise, the promise must be

performed jointly unless a contrary intention appears from the contract.

Where one of the joint promisors dies, the legal representative of the deceased along with the

other joint promisor(s) is bound to perform the contract.

Where all the joint promisors die, the legal representatives of all of them are bound to perform

the promise.

The law set out above can be illustrated with the following examples:

1. A promises B to pay ` 1000/- on delivery of certain goods. A may perform this promise

either himself or causing someone else to pay the money to B. If A dies before the time

appointed for payment, his representative must pay the money or employ some other

person to pay the money. If B dies before the time appointed for the delivery of goods,

B’s representative shall be bound to deliver the goods to A and A is bound to pay

` 1000/- to B’s representative.

2. A promises to paint a picture for B for a certain price. A is bound to perform the promise

himself. He cannot employ some other painter to paint the picture on his behalf. If A

dies before painting the picture, the contract cannot be enforced either by A’s

representative or by B.

3. A delivered certain goods to B who promise to pay ` 5000/-. Later on B expresses his

inability to clear the dues. C, who is known to B, pays ` 2000/-to A on behalf of B.

Before making this payment C did tell B nothing about it. Now A can sue B only for the

balance and not for the whole amount.

1.22 Distinction between Succession and Assignment

This discussion arises in the context of the observation that the obligations of a promisor

would bind the legal representative also (only) to the extent of value of property inherited by

them. This became the law that legal representatives are successors.

Succession: When the benefits of a contract are succeeded by a process of law, both the

burden and the benefit would some times devolve on the legal heir. For example ‘B’ is the son

of ‘A’. Upon A’s death ‘B’ will inherit all the assets and liabilities of ‘A’ [These assets and

liabilities are also referred to as debts and estates]

Thus ‘B’ will be liable to all the debts of ‘A’, but if the liabilities inherited are more than the

value of the estate [assets] inherited it will be possible to pay only to the extent of assets

inherited.

Assignment: Unlike succession, the assignor can assign only the assets to the assignee and

not the liabilities. Because when a liability is assigned, a third party gets involved in it. The

debtor cannot through assignment relieve himself of his liability to creditor.

The Indian Contract Act, 1872 1.47

However there cannot be any assignment of benefit of a contract coupled with a liability or

when a personal consideration has entered into making of the contract then the contract

cannot be assigned. In Zaffer Mehar Ali vs Budge Budge Jute Mills Company Ltd. 33 Cal., ‘A’

agreed to sell certain gunny bags to ‘B’ which were to be delivered in monthly installments for

a period of 6 months and the contract contained certain options for the buyer as regards

quality and packing. It was held that the clause relating to the buyer’s option did not preclude

the assignment of the contract.

1.23 Effects of Refusal to Accept Offer of Performance

In any promise, the promisor should act first by offering performance also known as ‘tender’.

In terms of section 38 of the Act, where the promisee has not accepted the offer or tender of

performance by the promisor then the promisor is not responsible for non performance. In this

case the promisor does not also lose his rights under a contract.

The promisor should however ensure that his tender or offer to perform his part should satisfy

following conditions.

(i) the offer is unconditioned.

(ii) the offer is made at a proper time and place under such circumstances that the person to

whom it is made may have a reasonable opportunity of ascertaining that the person by

whom it is made is able and willing to do what he is bound to do, then and there.

(iii) if the offer is an offer to deliver any thing to the promisee, then the promisee must have a

reasonable opportunity of seeing that the thing offered is the thing that the promisor is

bound by his promise to deliver.

The above legal principles were settled in the famous English case Start up vs.Macdonald

1843 6 Man. & G. 593, 610 thus “The law considers a party who has entered into a contract to

deliver goods or pay money to another as having substantially performed it, if he has tendered

the goods or money to the party to whom the delivery or payment was to be made, provided

only that the tender has been made under such circumstances that the party to whom, it has

been made, has had a reasonable opportunity of examining the goods or the money tendered

in order to ascertain that the thing tendered is really what that it is purported to be”.

An offer to any one of the several joint promisees has the same legal consequence as an offer

to all of them.

1.24 Effect of a Refusal of a Party to Perform Promise

Where a party to a contract has refused to perform the promise he has made or had disabled

himself from performing his promise in its entirety, the promisee may put an end to the

contract, unless his acquiescence in the continuance of the contract has been conveyed either

by words or by deeds [conduct] [Section 39]. Thus from the above it could be seen that the

following two rights accrue to the aggrieved party- (i) to terminate the contract and (ii) to

indicate by words or conduct that he is interested in its continuance.

1.48 Business Laws, Ethics and Communication

In case the promisee decides to continue the contract, he would not be entitled to put an end

to the contract on this ground immediately. In either case, the promisee would be able to

claim damages that he suffers as a result of the breach for it is not incumbent on the promisee

to decide immediately in case of an anticipated breach that the contract may be ended. He

may, however, choose to do so. In that event, the loss (if any) suffered by him will have to be

made good by the promisor. On the other hand, if he indicates that he is interested in the

performance of the contract, then he would be entitled to claim damages which accrue on the

date the contract is due to be performed. It would, therefore, be clear that the rights that we

have just stated above accrue to a promisee when the promisor decides not to perform the

promise.

It has been held by the Privy Council in Muralidhar Chatterjee vs. International Film Company

47 Cal.W.N.407 that when a promisee puts an end to a contract being rightly entitled to do so,

it shall be deemed as if he has rescinded a voidable contract. In view of Section 64 of the Act,

the promisee, in the events of his putting an end to the contract, is bound to return all the

benefits received under the contract and in turn is entitled for compensation for all damages

sustained by him for breach of contract by the promisee.

1.25 Liability of Joint Promisor & Promisee

The legal liability of a joint promisor, joint promisee and other connected issues are set out in

Sections 42, 43 & 44 of the Indian Contract Act,1872.

In terms of Section 42 of the Act “when two or more persons have made a joint promise then

unless a contrary intention appears from the contract, all such person, during their joint lives,

and after the death of any one of them, his representative jointly with the survivor or survivors

and after the death of last survivor, representatives of all jointly must fulfill the promise”.

The above law can be illustrated with the following example. Where ‘A’, ‘B’ and ‘C’ jointly

borrow a sum of money from ‘X’ all of them are jointly liable to repay the amount. Where in

the above example, ‘A’ dies, his legal representative, ‘L’ would be liable to repay the loan

along with ‘B’ and ‘C’, the remaining joint borrowers.

Now let us consider the position whether the promisee can enforce his right against any one of

the joint promisors and if so what are the rights and duties of the other promisors to make

contributions.

In terms of Section 43 of the Act,

(i) when two or more persons make joint promise, the promisor can compel any one of the

joint promisors to perform the whole of promise.

(ii) in the above situation, the performing promisor can enforce contribution from other joint

promisors, in the absence of express agreement to the contrary.

Example: Where A,B and C have jointly signed a promissory note for ` 3000/-, and where ‘A’

is compelled to pay the entire amount of ` 3000/- , he is entitled recover by way of

contribution of ` 1000/- each from the other two joint promisors namely B and C unless

The Indian Contract Act, 1872 1.49

agreed to otherwise mutually.

In the above situation again, if one of the joint promisors namely ‘B’ is unable to contribute `

1000/-, ‘A is entitled to recover ` 1500/- from ‘C’ who is the remaining joint promisor instead of

` 1000.

From the above, it is clear that the liability of joint promisors is joint and several and in the

absence of any special contract to the contrary, the amount due can be recovered from any

one of the joint promisors.

For example X,Y and Z jointly borrow from P, ` 3000/-, Because the liability of the borrower is

joint and severed, ‘P’ can recover the amount either from X or from Y or from Z or from all of

them jointly. A joint promisor cannot claim that he be sued along with all other joint promisors

only. If, however the promisee sues one of the promisors and obtains a decree against him,

he is precluded from bringing a fresh suit against the remaining borrowers.

In the matter of release of one of the joint promisors, by another joint promisor, it must be

understood that such a release does not discharge other joint promisors nor does the released

joint promisor would stand released to other joint promisor or promisors. [Section 44 of the

Act].

1.26 Rights of Joint Promisees

The rights of two or more promisees who are known as joint promisees is discussed in Section

45 of the Act. In terms of the said section “When a person has made a promise to two or more

persons jointly, then unless a contrary intention appears from the contract, the right to claim

performance rests, as between him and them, with them during their joint lives, and after the

death of any of them with the representatives of such deceased person jointly with the survivor

or survivors, and after the death of the last survivor, with the representatives of all jointly”.

For example, A, in consideration of ` 5,000 lent to him by B and C, promises B and C jointly to

repay the sum with interest on a specified day but B dies. In such a case right to demand

payment shall rest with B’s legal representatives, jointly with C during C’s lifetime and after the

death of C, with the legal representatives of B and C jointly as ‘B’ and ‘C’ both are joint

promisees”.

The above principle of joint promises is applicable for partners, joint mortgagees and members

of a Hindu Undivided Family. In all these cases there is no single promisee. Therefore in

order to enforce a promise all the joint promisees should sue the promisor. If any one of the

joint promisees refuses to sue the promisor he would not be a plaintiff but be treated as

defendant. [Ashinsa Bibi vs Abdul Kadar (1902) 25.Mad 26,35, Mohammed, Isaq vs. Shekh

Haq (1908) 12 C.W.N. 84, 86, 93].

1.27 Time and Place for Performance of the Promise

Sections 46 to 50 of the Act deal with this issue of “Time and place” for performance of a

promise. Following are the rules of performance where the promisee has not applied for

1.50 Business Laws, Ethics and Communication

performance. Where no time is specified for performance of a promise, it must be

performed within a reasonable time. What is reasonable time would depend on the facts and

circumstances of each case [section 46]. Where a promise is to be performed on a

specified date but no time is mentioned, then it can be performed any time on that day but

during business hours only.

A promisee may refuse to accept delivery (of goods), if it is delivered after business hours.

For example if the promisor wishes to deliver goods at a time which is beyond business hours,

the promisee can refuse.

As regards the place of performance, where no place is fixed for the performance of a

promise, it is the duty of the promisor to ask the promisee to fix a reasonable place. No

distinction is made between an obligation to pay money and an obligation to deliver goods or

discharge any other obligation. But generally the promise must be performed or goods must

be delivered at the usual place of business.

Where the promisor has not undertaken to perform the promisee without an application

by the promisee and the promise is to be performed on a certain day, it is the duty of the

promisee to apply for performance at a proper place and with in usual hours of business.

The above are subject to the position that promisor can perform any promise at any place, in

any manner, at any time which the promisee prescribes or sanctions.

1.28 Performance of Reciprocal Promise

The law relating to reciprocal promise as set out in Sections 51 to 54 of the Indian Contract

Act,1872.

General observation: A contract may consist of (i) an act and a promise or (ii) two promises

one being the consideration for the other.

The second type of contract which involves two promises, one promise from each to the other

party is known as “Reciprocal promise”. This can be illustrated with the following.

When ‘A’ sells 500 quintals of rice to ‘B’ and ‘B’ promises to pay the price on delivery, the

contract would consist of two promises one by ‘A’ to ‘B’ and another by ‘B’ to ‘A’. These

promises are reciprocal promises. Here the promise of ‘A’ is the consideration for the promise

of ‘B’ and vice versa.

The above is in contrast to another situation. In the above example if ‘B’ promises to pay the

price after a month, the contract would have two parts one is the act of ‘A’ and the second is

promise of ‘B’. This is not a reciprocal promise.

The performance of reciprocal promise can take in different forms-

(i) Simultaneously performance of reciprocal promise [Section 51]: In this case,

promises have to be performed simultaneously. The conditions and performances are

concurrent. If one of the parties does not perform his promise, the other also need not

perform his promise. For example where ‘A’ promises to deliver rice and ‘B’ promises to pay

The Indian Contract Act, 1872 1.51

the price on delivery, both have to be performed simultaneously. Here both ‘A’ and ‘B’ must

be willing and ready to perform their accepted part.

(ii) Performance of reciprocal promise where the order is expressly fixed: Where the

order of performance is expressly fixed, the promise must be performed in that order only.

Where ‘A’ promises to build a house for ‘B’ and ‘B’ promises to pay after construction, here ‘A’

must perform his promise before he can call upon ‘B’ to fulfill his promise of payment of

money. A’s performance of the promise is a condition precedent to ‘B’ performing his part of

the promise. Any breach of promise by ‘A’ would enable ‘B’ to avoid the contract.

(iii) Performance of reciprocal promise by implication: Where the performance of

reciprocal promise is not fixed expressly, some times the order is understood by implication.

For example where ‘A’ agrees to make over certain stock in trade to ‘B’ and ‘B’ agrees to

provide certain security for the value of stock in trade, then ‘A’ need not make over the stock

until ‘B’ provides the security as by implications ‘B’ is required to perform his part first;

otherwise ‘A’ in the absence of any security will not make over the stock to ‘B’.

(iv) Effect of one party preventing another from performing promise [Section 53]: When

in a contract consisting of reciprocal promises one party prevents the other from performing

his promise, the contract becomes voidable at the option of the party so prevented. The

person so prevented is entitled to get compensation for any loss he may have sustained for

the non-performance.

The above can be illustrated with the following illustrations by way of two case laws.

(a) Where there is a contract for sale of standing timber and as per the terms seller is

expected to cut and cord the standing timber before the buyer takes delivery but seller

cords only a part of it, but neglects to cord the rest of it, then the buyer has a right to

avoid the contract and claim compensation for any loss sustained.

(b) In the well known case of O ‘Nell vs. Armstrong, an Englishman was engaged by the

Captain of a Japanese ship to act as fireman on a voyage from England to Japan.

During the course of the voyage Japan declared war against China. The Englishman had

to leave service because had he continued in service he would have incurred penalties

under Foreign Enlistment Act. In effect because of the war, the Englishman was

prevented from discharging his part of the contract. The suit filed by him was decreed in

his favour in spite of being opposed by the Japanese shipping company. It should be

appreciated that the Captain of Japanese ship could not have brought a case against the

Englishman for non-performance as the Japanese themselves were responsible for

preventing the Englishman from performing his part of the contract.

Sometimes the parties would be prevented from discharging a part of the contract but not the

entire contract. In such a case, the party so prevented need not avoid the full contract but

perform the rest of it.

(v) Effects of default as to promise to be performed first: Section 54 of the Act provides

that promises may be such that:

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(i) one of them cannot be performed or

(ii) its performance cannot be demanded till the other has been performed.

Example: Where ‘B’ a ship owner agrees to convey A’s cargo from Calcutta to Mauritius for a

freight. Here the beginning part of the transaction is on ‘A’ as he has to provide the cargo to

‘B’ to enable ‘B’ to perform his promise. Thus until cargo is handed over by ‘A’. A cannot

expect ‘B’ to perform his promise nor would ‘B’ be in a position to perform his promise. This

peculiar position arises because of default on the part of one of the parties. Here ‘B’ is

entitled to put an end to the contract and claim compensation for any loss he may have

suffered.

(vi) Position of legal and illegal parts of Reciprocal promises: Reciprocal promise to do

certain things that are legal and certain others that are not legal –

Section 57 of the Act provides that if reciprocal promises have two parts, the first part being

legal and the second part being illegal, the legal part is a valid contract and the illegal part is

void.

Example: Where ‘A’ agrees to sell his house to ‘B’ for ` 50000/- and further ‘A’ insists and it is

agreed that if the house is used as a gambling house, then ‘B’ would pay another ` 75000/-.

In this case the first part is valid as it is legal, the second part is void as it is illegal.

(vii) Alternative promise one branch being illegal: “In the case of the alternative promise,

one branch of which is legal and the other illegal, the legal branch alone can be enforced”.

For example, in the nearest reversionary heir of B, agreed to transfer his inheritance to C, if he

succeeded to B; and he did not transfer his own estate to C. It was held that first promise was

not enforceable, as it amounted to an agreement to transfer an estate on the mere chance of

succession prohibited by Section 6 of the Transfer of Property Act, but the second promise

was enforceable under Section 58 as an alternative promise. [Mahadeo Prasad Singh vs.

Mathura 132 L.C. 321 A]

1.29 Effects of Failure to Perform at a Time Fixed in a Contract in

which Time is Essential

Section 55 of the Act regulates the position of performance of contract where time is of

essence. In terms of this Section, where it is understood between parties that time is an

essential element, and where one party is unable to perform his part of the promise either in

full or in part within the time specified, then the contract is voidable at the option of the party

either in full or in part to the extent of non performance of the contract within the time. In

these cases the contract is not voidable if time is not of essence of the contract, but the

promisee is entitled for compensation for loss if any suffered on account of such failure.

In a contract where time is of essence and promisor is unable to perform his part within the

time, as already stated the contract becomes voidable at the option of the other party.

However the other party agrees that the promisor would perform his part subsequently after

The Indian Contract Act, 1872 1.53

the time fixed, the promisee cannot claim any compensation for loss or damage or injury

unless he gives any notice to the promisor of his intention to do so.

The next question for consideration is how to determine whether time is essence of a

contract?

Ordinarily from a plain examination of a contract it would be difficult to ascertain from the

terms of the contract whether time is essence of the contract. A promisee may have failed to

perform his contract within the specified time. Yet time may not be treated as essence of the

contract in that case. Whether time is essence of a contract has to be decided from the terms

of the contract.

In mercantile contracts, as business world is ruled by ‘time’ and ‘money’ any stipulation as to

‘time’ and ‘money’ is an essential condition.

The general principles that are followed can be enunciated as under.

(i) In transaction on sale of gold, silver, blue chip shares, time of delivery is of essence.

Here time will be treated as essence of contract.

(ii) In transaction involving sale of land, redemption of mortgages, though certain time frame

is fixed, any delay is not valued seriously provided justice can be done to parties. Of

course even in sale of land, time can be made as on essence of contract by express

words.

Contract cannot be avoided where time is not of essence: When there is delay in

performing promise on executing a contract where the time is not of essence, parties

concerned cannot avoid the contract. However in such cases promises must be performed

with in a reasonable time other wise it becomes voidable at the option of the promisee.

Effect of acceptance of performance out of time: Even where time is of essence, the party

who is entitled to avoid the contract can waive the condition relating to “performance within

time”; but in such cases he cannot claim any compensation for loss if any suffered unless he

has put the other party on notice.

Key Points

♦ Performance of contract- It is the performing of all the promises and fulfilling all the

obligations by all the parties as per the term of the contract.

♦ Actual performance- When both the parties to a contract perform their promises and

nothing remains to be done in future by them.

♦ Attempted performance- When tender or offer of performance of goods/ services is not

accepted or rejected by the promisee, In such situation the promisor is discharged from

his obligation. However, where promisee fails to accept tender of money/price, the

promisor is not discharged from his obligation to pay.

♦ Contract can be performed by the parties personally, through agent, representative or

third party.

1.54 Business Laws, Ethics and Communication

♦ In case of joint promise- Promisee may compel any of the joint promisors to perform

unless otherwise agreed by the parties.

♦ Where no time for performance of contract- The contract must be performed within a

reasonable time.

♦ Where time is essence- Failure to perform the contract at an agreed time will amount to a

breach of condition of the contract and will be voidable.

♦ Reciprocal promises- Where one promise form the consideration/ part of consideration

for each other.

1.30 Impossibility of Performance

Agreements become void when it becomes impossible to perform them due to a variety of

reasons. This is known as “impossibility of performance” and dealt with by section 56 of the

Act

In terms of Section 56 of the Act “An agreement to do an act impossible in itself is void. A

contract to do an act which, after the contract is made, becomes impossible, or, (by reason of

some event which the promisor could not prevent,) unlawful, becomes void when the act

becomes impossible or unlawful.

Where one person has promised to do something which he knew, or with reasonable

diligence, might have known, and which the promisee did not know to be impossible or

unlawful, such promisor, must make compensation to such promisee for any loss which such

promisee sustains through the non-performance of the promise”.

(1) Impossibility existing at the time of contract: Even at the time of entering into the

agreement, it may be impossible to perform certain contracts at the beginning or inception

itself. The impossibility of performance may be known or may not be known to the parties

(i) If the impossibility is known to the parties : Where ‘A’ agrees to pay ‘B’ ` 5000/- to ‘B’ if

he would swim from Bombay in Indian ocean to ‘Aden’ in 7 days time, this is an agreement

where both the parties known that it is impossible to swim the distance between ‘Bombay’ to

‘Aden’ in 7 days time and hence is void.

(ii) If unknown to the parties: Even where both the promisor and the promisee are ignorant

of the impossibility the contract is void.

(iii) If known only to the promisor: Where the promisor alone knows it is impossible to

perform or even if he does not know but he should have known about the impossibility with

reasonable diligence, the promisee is entitled to claim compensation for the loss suffered

because of failure of the promisor to perform.

(2) Supervening impossibility: When performance of a promise becomes impossible on

account of subsequent developments of events or change in circumstances, which are beyond

the contemplation of parties, the contract becomes void. Supervening impossibility can arise

due to a variety of circumstances as stated below.

The Indian Contract Act, 1872 1.55

(i) Accidental destruction of the subject matter of the contract : ‘A’ had agreed with ‘B’ to

hire for rent his music hall for holiday concerts on certain specified dates. The music hall was

destroyed before the specified dates and hence it became impossible to hold stage concerts.

It was held that as the music hall ceased to exist; it is a case of supervening impossibility and

both the parties were excused from the performance of the contract [Taylor vs. Caldwell

3B&S826].

(ii) Non-existence or non occurrence of a particular state of things: It was agreed to by the

defendant through a contract to have from the plaintiff a flat for specified days for witnessing

the coronation procession of King Edward VII. The said procession was cancelled and it did

not take place. Therefore the defendant refused to pay the balance rent. It was held that the

foundation of the contract had totally failed and here the balance of rent amount cannot be

recovered from the defendant. [Krell vs. Henry 2 KB. 740]

(iii) Incapacity to perform a contract of personal services: In case of contract of personal

service, disability or incapacity to perform, caused by an Act of God e.g. illness, constitutes

lawful excuse for non-performance of the contract [Robinson vs. Davison L.R.6Ex.269]

(iv) Change in law: Performance of a contract may also become impossible due to change in

law subsequently. The law passed subsequently may prohibit the act which may form part as

basis of contract. Here the parties are discharged from their obligations. For example ‘A’ and

‘B’ may agree to start a business for sale of lottery and contribute capital for the business. If

the business of sale of lottery ticket is banned by a subsequent law, parties need not keep up

their legal obligations.

(v) Outbreak of war: Out break of war may affect the enforceability of contracts in many

ways like

(a) emergency legislations controlling prices

(b) relaxation of trade restrictions and

Doctrine of Frustration: The idea of “supervening impossibility” is referred to as ‘doctrine of

frustration’ in U.K. In order to decide whether a contract has been frustrated, it is necessary to

consider the “intention of parties as are implied from the terms of contract”.

However in India the ‘doctrine of frustration’ is not applicable. Impossibility of performance

must be considered only in term of section 56 of the Act. Section 56 covers only ‘supervening

impossibility and not implied terms’. This view was upheld by Supreme Court in Satyabrata

Ghose vs Mugneeram Bangur A.I.R.(1954) S. C. 44 and Alopi Prasad vs Union of India A.R.

1960 S.C.588.

What would not constitute ground of impossibility: Various decisions which have identified

certain situations as not constituting grounds of impossibility -

(a) ‘A’ promised to ‘B’ that he would arrange for ‘B’s marriage with his daughter. ‘A’ could not

persuade his daughter to marry ‘B’. ‘B’ sued ‘A’ who pleaded on the ground of

1.56 Business Laws, Ethics and Communication

impossibility that he is not liable for any damages. But it was held that there was no

ground of impossibility. It was held that ‘A’ should not have promised what he could not

have accomplished. Further ‘A’ had chosen to answer for voluntary act of his daughter

and hence he was liable.

(b) The defendant agreed to supply specified quantity of ‘cotton’ manufactured by a mill with

in a specified time to plaintiff. The defendant could not supply the material as the mill

failed to make any production at that time. The defendant pleaded on the ground of

impossibility which was not approved by the Privy Council and held that contract was not

performed by the defendant and he was responsible for the failure. [Hamandrai vs

Pragdas 501A]

as soon as they were supplied to him by the mills. It was held by Supreme Court that the

contract between defendant and plaintiff was not frustrated because of failure on the part

of Victoria Mills to supply goods [Ganga Saran vs Finn Rama Charan, A.I.R 1952 S.C.9]

(d) A dock strike would not necessarily relieve a labourer from his obligation of unloading the

ship within specified time.

(e) In Satyabrat Ghosh vs Mugneeram Bangur & Co. A.I.R 1954 S.C.44, Calcutta High

court held in a context of impossibility of performance that “having regard to the actual

existence of war condition, the extent of the work involved and total absence of any

definite period of time agreed to the parties, the contract could not be treated as falling

under impossibility of performance. In the given case the plaintiff had agreed to

purchase immediately after outbreak of war a plot of land. This plot of land was part of a

scheme undertaken by the defendant who had agreed to sell after completing

construction of drains, roads etc. However the said plot of land was requisitioned for war

purpose. The defendant thereupon wrote to plaintiff asking him to take back the earnest

money deposit, thinking that the contract cannot be performed as it has become

impossible of being performed. The plaintiff brought a suit against the defendant that he

was entitled for conveyance of the plot of land under condition specified in the contract.

It was held that the requisition order did not make the performance impossible.

While judging the impossibility of performance issue, the Courts would be very cautious since

contracting parties often bind themselves to perform at any cost of events without regard to

price prevailing and market conditions.

Key Points:

A contract is discharged by impossibility of its performance.

♦ Impossibility may be of two types :

(i) Initial Impossibility-existed at the time of making the agreement.

(ii) Subsequent or supervening impossibility-arises after formation of contract.

♦ The contract becomes void when the performance of the contract becomes impossible.

The Indian Contract Act, 1872 1.57

♦ Doctrine of frustration applies in the case of supervenning impossibility, where- the

performance of contract has become impossible, and where the object of the contract

has failed.

♦ This doctrine does not apply- where the performance simply becomes difficult

/commercially impossible/ impossibility induced by the act or the conduct of any person

etc.

1.31 Appropriation of Payments

Where a person [Debtor] owes a number of debts to another person [Creditor], and when he

releases certain payments, then the question arises as to how to adjust the receipt against so

many dues. This issue is considered and answered in Sections 59, 60 and 61 of the Act

under the heading ‘Appropriation of payments’.

(i) Application of payment where debt to be discharged is indicated: In term of section

59 of the Act “Where a debtor, owing several distinct debts to one person, makes a payment

to him either with express intimation or under circumstances implying that the payment is to be

applied to the discharge of some particular debt, the payment, if accepted, must be applied

accordingly”.

Where a debtor owes a number of debts and he pays an amount with express or implied

instructions towards appropriation, the debtor is at will to appropriate to any debt and the

creditor is bound by it. This is set out in the Latin Maxim of “quicquid sovitur, sovit

sectionundum modum solventis” meaning that whatever is paid, is paid according to intention

or manner of party paying. The right of debtor to decide the appropriation is also known as

decision in Clayton’s case.

What is the position if the debtor does not expressly state the method of appropriation? Then

we have to go by the circumstances of the case. For example a debtor who owes among

other debts ` 2000/- to a creditor and pays ` 2000/- on a given day when the debt of ` 2000/-

falls due, then the amount must be accordingly applied and the debt be discharged

accordingly.

(ii) Application of payment where debt to be discharged is not indicated: “Where the

debtor has omitted to intimate and there are no other circumstances indicating to which debt

the payment is to be applied, the creditor may apply it at his discretion to any lawful debt

actually due and payable to him from the debtor whether its recovery is or is not barred by the

law in force for the time being as to the limitation of suits”.

From the above it can be seen that the creditor enjoys the right to appropriate even to a debt

which is barred by limitation.

It was held by Lord Macnaughten in Cory Bros. & Co. vs. Owner of the Mecca (1817) A.C.286

& 293, that if the debtor does not make any appropriation, at the time of payment, the right

devolves on the creditor. Creditors have a right to decide till the very last moment. The above

1.58 Business Laws, Ethics and Communication

decision was followed in a number of important cases including in the famous case of

Vinkatadri Appa Rao vs Parthasarthi Appa Rao [(1921) L.R. 48. I.A. 150; 44 Mad 570 and

573.. In the said case it was held that creditor can decide at his discretion on the appropriation

of payment towards any lawful debt even if barred by limitation. If there is any debt carrying

interest and if there are no express or implied instructions the amount paid should be

appropriated towards payment of interest and then to capital.

(iii) Application of payment when neither party appropriates: In terms of section 61 of the

Act, where neither party appropriates-

(a) the payment shall be applied in discharge of debts in order of time, and

(b) if the debts are of equal standing the payment shall be applied in discharge of each

proportionately.

The above appropriation takes place whether or not the debt is barred by limitation.

For example where there are two debts one ` 500/- and another ` 700/- falling due on the

same day, and if the debtor pays ` 600/- the appropriation shall be prorata of ` 250/- and

` 350/- for the two debts.

1.32 Contract, Which Need not be Performed

A contract would not require performance under circumstances spelt out in Sections 62 to 67

of the Act. These circumstances are (i) novation, (ii) rescission,(iii) alteration and (iv)

remission.

Section 62 of the Act provides that “if the parties to a contract agree to substitute a new

contract for it or to rescind or alter it, the original contract need not be performed”.

(a) Effect of novation: Novation means substitution. Where a given contract is substituted

by a new contract it is novation. The old contract, on novation ceases. It need not be

performed. Novation can take place with mutual consent. However novation can take place

by substitution of new contract between the same parties or between different parties.

Novation results in discharge of old contract. This can be illustrated as follows -

A owes money to B under a contract. It is agreed between A, B and C that B shall thenceforth

accept C as his debtor, instead of A. The old debt of A to B is at an end, and a new debt from

C to B has been contracted.

(b) Effect of rescission: In case of rescission, the old contract is cancelled and no new

contract comes in its place. A contract is also discharged by rescission. Some times parties

may enter into an agreement to rescind the previous contract. Sometimes, the contract is

rescinded by implication or by non- performance for a long time without each other

complaining about it.

Difference between novation and rescission: While novation involves rescission, there is

no novation in rescission. Both in novation and rescission the contract is discharged by mutual

agreement. In both cases parties enter into a new contract to come out of the old contract.

The Indian Contract Act, 1872 1.59

The new agreement is the consideration for rescission.

Hence the old one need not be performed whereas the new one has to be performed.

Alteration involves both rescission and novation. The line of difference between alteration and

novation is very thin. While there can be very minor alterations, there can not be unilateral

material alteration to a contract. If it is done it will be void.

Novation and alteration: Both in novation and in alteration the old contract need not be

performed.

The main difference between the two are:

Novation

Alteration

Novation involves changes in the terms of

contract. It also sometimes means

change in the parties to contract. It infact

operates as a substitution of the old

contract.

In alteration there are only changes in the

term of contract by mutual consent. The

parties to contract remain the same. There is

no substitution of old terms; only some terms

and conditions change. There are remission

of performance in alteration.

Remission means waiver. Section 63 of the Act deals with remission. It provides that “every

promisee may dispense with or remit wholly or in part, the performance of the promise made

to him or may extend the time for such performance or may accept instead of it any

satisfaction which it thinks fit”. Thus the promisee can waive either in full or in part the

obligation of the promisor or extend the time for performance. For example where ‘A’ owes ‘B’

a sum of ` 1 lakh, ‘B’ may accept a part of it in full and final settlement of the due or waive his

entire claim.

While granting the time to the promisor, the promisee cannot do so for his benefit but can do

so only for the benefit of the promisor. For example where ‘A’ promises ‘B’ that he would

deliver certain goods by a certain date, ‘B’ can extend the time but he cannot take advantage

to charge interest on the extended time.

Similarly a promisee can accept any other performance to his satisfaction instead of the

specified stipulated performance.

For example where A promises to sell his horse for a consideration of ` 5000/- to ‘B’, ‘A’ may

instead of cash consideration of ` 5000/-may accept jewellery worth Rs 5,000/-in full

satisfaction of the consideration. In a situation like this the essential element of ‘satisfaction’

is that the promisee must accept the consideration unequivocally. If a promisor tenders some

thing in full satisfaction but the promisee does not accept it or accepts in part performance,

such satisfaction will fall outside the ambit of section 63 of the Act. [ Shyamnagar tin Factory

vs Snow White Food Products, A.I.R (1965) Cal 54]

It should be noted that novation, rescission or alteration cannot take place without

consideration but in case of part or complete rescission no consideration is required. The

1.60 Business Laws, Ethics and Communication

promisee can dispense with performance without consideration and without a new agreement.

1.33 Restoration of Benefit under a Voidable Contract

It has already been seen that certain contracts referred to in Sections 19, 19A, 39, 51, 54 & 55

are voidable. The question for consideration is what is the effect of recession of contract by

that person at whose option the contract is voidable. The following are the effects of such an

action-

(i) The other party need not perform the promise

(ii) Any benefit received by the person rescinding it must restore it to the person from whom

it was received.

A voidable contract which is voidable either at its inception or subsequently comes to an end

when it is avoided by the party at whose option it is avoided. In such a case, not only the

contract need not be performed there is also restoration of benefit.

(a) the injured party on account of non performance of the contract is entitled to recover

compensation for damages suffered and

(b) benefits received must be restored.

In Murlidhar vs. International Film Co. A.I.R 1943 P.C. 34, the plaintiff having wrongfully

repudiated the contract, the defendants rescinded it u/s 39 of the Act. The plaintiff brought a

suit to recover ` 4000/- paid to the defendant. Held defendant was bound to restore the

amount after setting off such damages.

When an insurance company has rescinded the policy because the policy holder could not

disclose material information, it should refund the premium after making necessary

adjustments for expenses already incurred.

1.34 Obligations of Person who has Received Advantage under Void

Agreement or one Becoming Void.

In terms of section 65 of the Act, where

(a) an agreement is discovered to be void or

(b) a contract becomes void

any person who received an advantage must

(a ) restore it or

(b) pay compensation for damages in order to put the position prior to contract.

In Dhuramsey vs. Ahgmedhai (1893) 23 Bom 15, the plaintiff hired a godown from the

defendant for 12 months and paid the advance in full. After about seven months the godown

was destroyed by fire, without any fault on the part of plaintiff. When the plaintiff claimed

The Indian Contract Act, 1872 1.61

refund of the advance, it was upheld that he was entitled to recover the rent for the unexpired

term.

The next issue is the benefit which has to be returned must have been received under the

contract. Any benefit received which is ancillary to main contract need not be returned. For

example, the deposit paid for a transaction of sale of house between parties, need not be

returned just because the sale transaction could not take place. This was on the ground that

the deposit is only a security and not part of main contract.

1.35 Discharge of a Contract

A contract may be discharged in eight ways as discuss hereunder.

(a) Discharge by performance: Discharge by performance will take place when there is (i)

Actual performance or (ii) Attempted performance

Actual performance / discharge takes place when parties to the contract fulfill their obligations

within time and in the manner prescribed. Here each party has done what he has to do under

the contract. In attempted performance the promisor offers to perform his part but the

promisee refuses to accept his part. This is also known as tender.

(b) Discharge by mutual agreement: Discharge also takes place where there is

substitution [novation] rescission, alteration and remission. In all these cases old contract

need not be performed.

existed at the time of entering into the contract or it may have transpired subsequently (also

known as supervening impossibility)

Impossibility can arise when

(i) there is an unforeseen change in law.

(ii) destruction of subject matter.

(iii) non-existence or non occurrence of a state of thing to facilitate happening of the

agreement.

(iv) personal incapacity of the promisor.

(v) declaration of war.

(d) Discharge by lapse of time: Performance of contract has to be done within certain

prescribed time. In other words it should be performed before it is barred by law of limitation.

In such a case there was no remedy for the promisee. For example, where then the debt is

barred by law of limitation.

(e) Discharge by operation of law: Where the promisor dies or goes insolvent there is a

discharge by operation of law.

(f) Discharge by breach of contract: Where there is a default by one party from

performing his part of contract on due date then there is breach of contract. Breach of

1.62 Business Laws, Ethics and Communication

contract can be actual breach or anticipatory breach. Where a person repudiates a contract

before the stipulated due date, it is anticipatory breach. In both the events, the party who has

suffered injury is entitled for damages. Further he is discharged from performing his part of

the contract.

(g) A promisee may remit the performance of the promise by the promisor. Here there is a

discharge. Similarly the promisee may accept some other satisfaction. Then again there is a

discharge on the ground of accord and satisfaction

(h) When a promisee neglects or refuses to afford the promisor reasonable facilities or

opportunities for performance, promisor is excused by such neglect or refusal.

Key Points

♦ Peformance of contract leads to discharge of contract. There are other alternative

methods of discharge where a contract would not require performance These

circumstances are (i) novation, (ii) rescission,(iii) alteration and (iv) remission. A contract

may also be discharged by agreement of the parties or by lapse of time for performance

or by operation of law,or impossibility of performance or by breach of contract.

♦ A voidable contract which is voidable either at its inception or subsequently comes to an

end when it is avoided by the party at whose option it is avoided. In such a case, no

contract need to be performed but there is a restoration of benefit.

♦ Any agreement which is discovered to be void or a contract which becomes void, there

any person who received an advantage must restore it or pay compensation for damages

in order to put the position prior to contract.

The Indian Contract Act, 1872 1.63

UNIT – 5 : BREACH OF CONTRACT

Learning objectives

After studying this unit, you would be able to -

♦ Understand the concept of breach of contract and various modes thereof.

♦ Understand the rule laid down in 'Hadley vs. Baxendale' for award of compensation.

♦ Be clear about how the damages are to be measured.

♦ Note the circumstances when vindictive damages are awarded.

Let us now examine breach of contract and the methodology for estimation of compensation

for such breach of contract.

1.36 Anticipatory Breach of Contract

Where the promisor refuses to perform his obligation even before the specified time for

performance and signifies his unwillingness, then there is an anticipatory breach.

Leading case on this point is Hochester vs.De La Tour(1853) 2 E & B 678. In this case

defendant had engaged the services of plaintiff as his attendant for a tour of the continent

from June 1st on a fee of £10 per month for three months. However defendant changed his

mind before June 1st and informed the plaintiff that his services are not required. This is thus

a case of anticipatory breach of contract. It was held in this case that plaintiff could put an

end to the contract even before the due date viz 1st June and he need not wait for the date

meant for performance of the promise.

The principle of anticipatory breach was well summed up in Frost vs. Knight (1872) LR 7

Ex.111. In the above case it was held that promisee could wait till the due date of performance

also before he puts an end to the contract. In such a case the amount of damages will vary

depending on the circumstances. This can be explained with the following illustration: ‘X’

agrees to sell ‘Y’ certain quantity of wheat at a certain price. viz @ ` 100/- per quintal by 3rd

March. However on 2nd February X gives notice of his unwillingness to sell the given goods.

Price of wheat on that date is ` 110/- per quintal. ‘Y’ has a right to repudiate the contract on

the same day instead of waiting for the date of performance. On that day 2nd February, he is

entitled to recover damages of ` 10/- per quintal this being the difference between market

price and contracted price. If on the other hand, he chooses to wait till 3rd March and the price

on that date is ` 125/-, he can recover damages @ ` 25/- per quintal. The third possibility is

that if between 2nd February and 3rd March, Government prohibits sale of wheat, then the

contract becomes void and Y will not be able to recover any damage whatsoever. Hence from

this illustration it would be clear that when the promisee postpones his right to repudiate the

promise, it would operate to the advantage of the promisor also depending on circumstances.

1.64 Business Laws, Ethics and Communication

1.37 Actual Breach of Contract

Where one of the parties breaches the contract by refusing to perform the promise on due

date, it is known as actual breach of contract. In such a case the other party to contract

obtains a right of action against the one who breached the contract.

1.38 Measurement of Damages

In cases where there is a breach of contract, the promisor who breaches is liable to pay

compensation for damages suffered by the promisee. The compensation can be classified as:

(i) those for damages that usually arise in the event of breach of contract and

(ii) those for damages which parties know and anticipated at the time of entering into the

contract called special damages. This kind of special damages can be claimed only on

previous notice.

However no compensation is payable for any remote or any indirect loss. While assessing the

damage the inconvenience caused to the aggrieved party on account of non-performance

should be assessed carefully, as the party entitled for compensation, he has a duty to take

steps to minimise the loss.

The rules relating to compensation were enunciated in detail in Hadley vs. Baxendale (1854) 9

Ex. 341. In this case, the mill of the plaintiff had to be stopped because of a broken crank

shaft. The plaintiff sent the crank shaft as a pattern for manufacturing a new one. Till the

arrival of the new crank shaft, the mill could not be resumed. Hence mill incurred losses.

However this position was not properly conveyed to the defendant, the carrier. There were

some delay on the part of the defendant in delivering the crank shaft to the manufacturer

which in turn delayed the reopening of the mill. As a result of this, there were losses to the

mill. The defendant claimed compensation for loss in profit of the mill. However this was not

accepted by court on the ground the plaintiff did not explain to defendant that delay in

delivering the crank shaft would delay resumption of the mill and this would result in losses to

the plaintiff.

Madras High Court in Madras Railway Company vs. Govind Ram, Mad. 176 upheld the same

principle as above. In that case a tailor had given his sewing machine to railways to be

delivered at a station as a consignment. He did not mention that any delay in delivering the

sewing machine would result in damages for the business of the tailor as he had planned to do

good business at the place proposed where a festival was to be held. The sewing machine

was delivered after the festival was over. Held Railways were not responsible for the damages

as the Railway authorities were not informed of the specific purpose of delivery of the sewing

machine namely business during a festival.

The Indian Contract Act, 1872 1.65

1.39 Liability for Damages

The liability to pay damages is of four kinds. They are:

(i) liability for special damages

(ii) liability for exemplary damages

(iii) liability to pay nominal damages and

(iv) liability to pay damages for deterioration caused by delay.

Now let us discuss each one of them-

(i) Liability for special damages: Where it is understood between parties that in the event

of breach of contract, there would be special damages also in addition to normal damages,

then special damages would be payable. In our given example above if the tailor had

informed about the special circumstances, special damages would have become payable.

(ii) Liability for exemplary damages: These situations may arise mainly in two cases

namely (i) breach of promise to marry and (ii) wrongful dishonour of cheques of customer by

bank.

In case of breach of promise to marry the damages are awarded taking into account the injury

or humiliation which the aggrieved person would have suffered.

In case of wrongful dishonour of cheques the damages would depend upon the loss of credit

and reputation suffered by the customer. The damages could be very heavy if loss had been

suffered by a businessman, when compared to a non-businessman customer. For example

Mrs. G, a non-trader paid a cheque for £90 and 16 shillings drawn on Westminster Bank to her

landlord for rent. The cheque was dishonoured by the bank. But she was awarded damages

of only 40 shilling as nominal damages. [Gibbons vs. Westminster Bank (1939) 2 K.B. 882]

Similarly where the value of cheque is small the damages could be very heavy in comparison

to a situation where the value of cheque is heavy. This is on the theory that dishonour of a

small value of cheque would cause more damages to the honour of the customer.

(iii) Liability to pay nominal damages: Nominal damages are awarded in those cases of

breach of contract where no damage has been suffered. Such damages are awarded only to

establish the right to decree for breach of contract. Such damages are for nominal amounts

like ten rupees or even ten paise.

(iv) Damages for deterioration caused by delay: Compensation can be recovered even

without notice for damages or ‘deterioration’ caused to goods on account of delay by carriers

amounting to breach of contract. Here the word “deterioration” means not only physical

damages but also loss of opportunity. In Wilson vs. Lancashire and Yorkshire Railway

Company 50 LJCP 232, the plaintiff bought velvet with a view to making it into caps for sale

during spring. But due to delay in transit, he was unable to use the velvet for making caps for

sale during season.

1.66 Business Laws, Ethics and Communication

It was held that the fall in value of sale of cloth in consequence of the same having arrived

after the season amounted to deterioration. It was here held that the plaintiff is entitled for

compensation without notice.

1.40 How to Calculate the Damage

In case of a contract for sale of good- ,(i) where the buyer breaks the contract, the damages

would be the difference between contract price and market price as on the date of breach. (ii)

where the seller breaks the contract, the buyer can recover the difference between market

price and contract price as on date of breach.

Where if the seller retains the goods after the contract has been broken by the buyer- there

the seller cannot recover from the buyer any further loss even if the market falls. Again he is

not liable to have the damages reduced if the market rises.

In Jamal vs. Mulla Dawood (1961) 43.I.A. 6, the defendant agreed to purchase from the

plaintiff, certain shares on December 30, but wrongfully rejected them when tendered on date.

The difference between the contract price and market price amounted to ` 1,09,218; the

plaintiff recovered a part of the loss by selling those shares in a rising market and the actual

loss amounted to ` 79,882. The plaintiff, however, sued the defendant claiming ` 1,09,218 as

damages and the Privy Council allowed the claim in full.

Duty to mitigate loss: The person who suffers losses on account of breach of contract by the

other party must take all reasonable steps to mitigate the loss.

1.41 Compensation for Breach of Contract where the Penalty is

stipulated for

The compensation for breach of contract falls into two broad categories namely liquidated

damage and penalty.

Liquidated damage is a genuine pre-estimate of compensation for damages for certain

anticipated breach of contract. This estimate is agreed to between parties to avoid at a later

date detailed calculations and the necessity to convince outside parties.

Penalty on the other hand is an extravagant amount stipulated and is clearly unconscionable

and has no comparison to the loss suffered by the parties.

In terms of Section 74 of the Act “where a contract has been broken, if a sum is named in the

contract as the amount to be paid in case of such breach, or if the contract contains any other

stipulation by way of penalty, the party complaining of the breach, can claim whether or not

actual damages or loss is proved to have been caused thereby, from the other party, a

reasonable compensation not exceeding the amount so named, or as the case may be the

penalty stipulated for.

Any stipulation for payment of increased interest is a stipulation for payment of penalty which

has to be paid.

The Indian Contract Act, 1872 1.67

In terms of Section 74, courts are empowered to reduce the sum payable on breach whether it

is ‘penalty’ or “liquidated damages” provided the sum appears to be unreasonably high.

Supreme Court in Sri Chunni Lal vs. Mehta & Sons Ltd. A.I.R.1962 S.C. 1314 laid down the

ratio that the aggrieved party should not be allowed to claim a sum greater than what is

specific in the written agreement. But even there the court has powers to reduce the amount if

it considers it reasonable to reduce.

Liquidated damages and penalty: Following are the important differences between

liquidated damages and penalty.

Liquidated damages

Penalty

Imposed by way of compensation

Imposed by way of punishment

It is an assessed amount of loss based on

actual or probable calculation

It is not based on actuals or probables. It

is imposed to prevent parties from

committing the breach.

English Law recognizes the difference

between the two

(liquidated damages &

penalty)

Section 74 of the act does not recognize

any difference between the two(liquidated

damages & penalty)

Apart from claiming damages for breach of contract, the following other remedies are also

available.

(i) Rescission of contract; Where one party breaches the contract, the other party can

treat it as rescinded. In this case the other party is absolved of his obligation and is entitled to

compensation for damages which he suffered.

(ii) Suit upon quantum meruit: The phrase ‘quantum meruit’ literally means “as much as

earned” or “according to the quantity of work done”. A person who has begun a civil contract

work and has to later stop the work because the other party has made the performance

impossible, is entitled to receive compensation on the principle of ‘Quantum Meruit’.

Following are instances where ‘quantum meruit’ may arise:

(a) Where the work has been done and accepted under a contract which is subsequently

discovered to be void. In such a case, the person who has performed his part of the

contract is entitled to recover the amount for the work done and the party, who receives

and accepts the benefit under such contract, must make compensation to the other party.

(b) Where a person does some act or delivers something to another person with the

intention of receiving payment, the other person is bound to make payment if he accepts

such services or goods or enjoys the benefits.

refuses to perform the remaining part, the party in default may sue the other party who

enjoyed the benefit of the part performance.

(iii) Suit for specific performance: Where damages are not an adequate remedy in the

1.68 Business Laws, Ethics and Communication

case of breach of contract, the court may in its discretion on a suit for specific

performance direct the party in breach, to carry out his promise according to the terms of

the contract.

Key Points

♦ Breach of contract means failure or refusal of any one party to perform his contractual

obligations under the contract. It is either actual or anticipatory breach of contract.

♦ Actual Breach-Failure/refusal of any one party to perform his contractual obligations

under the contract when it is due. Here the contract is voidable.

♦ Anticipatory breach of contract- Where the promisor refuses to perform his obligation

even before the specified time for performance and signifies his unwillingness, then there

is an anticipatory breach. Here the aggrieved party may immediately treat the contract

voidable or wait till the time when the performance is due.

♦ Aggrieved party has following remedies on the breach of contract- Rescission of the

contract, suit for damages, suit for quantum meruit, specific performance and for

injunction.

♦ Rescission- Cancellation of a contract by the consent of all parties/ by aggrieved party.

♦ Damages- Monetary compensation payable to the injured party for the loss due to breach

of contract by the defaulted party.

♦ Liquidated Damages-Pre-estimated amount of a damges that are mentioned in a contract

and are paid on the breach of contract.

♦ Penalty-Amount specified in a contract which is high and disproportionate from the

amount of damages in the event of its breach. This amount is paid as of punishment to

avoid the breach of contract.

The Indian Contract Act, 1872 1.69

UNIT – 6: CONTINGENT AND SPECIAL CONTRACTS

Learning objectives

After studying this unit, you would be able to -

♦ Have clarity about the basic characteristics of 'Contingent contract' and 'Quasi-contract'

so that you are able to distinguish between a contract of any of these types and a simple

contract.

♦ Be familiar with the rules relating to enforcement of these in order to gain an

understanding of rights and obligations of the parties to the contract.

In this unit we shall briefly examine

(a) ‘Contingent contracts’ and the rules regarding their enforceability and

(b) Quasi contracts

1.42 Contingent Contract

In terms of Section 31 of the Act contingent contract is a contract to do or not to do something,

if some event collateral to such contract does or does not happen. Contracts of indemnity and

contracts of insurance fall under this category.

For instance if ‘A’ contracts to pay ‘B’ ` 100000/- if B’s house is destroyed by fire then it is a

contingent contract.

Essentials of a contingent contract

(a) The performance of a contingent contract would depend upon the happening or non-

happening of some event or condition. The condition may be precedent or subsequent

(b) The event referred to is collateral to the contract. The event is not part of the contract.

The event should be neither performance promised nor a consideration for a promise.

Where ‘A’ agrees to deliver 100 bags of wheat and ‘B’ agrees to pay after delivery, this is

a conditional contract and not a contingent contract. Similarly where ‘A’ promises to pay

‘B’ ` 10000/- if he marries ‘C’ is not a contingent contract but a conditional contract.

contingent in addition to being the will of the promisor.

For example if ‘A’ promises to pay ‘B’ ` 10000/- if ‘A’ left for Delhi from Mumbai on a particular

day, it is a contingent contract because though ‘A’s leaving for Delhi is his own will, it cannot

happen only at his will.

1.43 Rules Relating to Enforcement

The rules relating to enforcement of a contingent contract are laid down in sections 32, 33, 34

and 36 of the Act.

1.70 Business Laws, Ethics and Communication

(a) Contingency is the “happening of an event”: Where a contract identifies happening

of a future contingent event, the contract cannot be enforced until and unless the event

‘happens’. If the happening of the event becomes impossible, then the contingent contract is

void. For instance ‘X’ enters into a contract to buy ‘Y’s car provided ‘Y’ survives ‘A’. Here ‘Y’

surviving ‘A’ or ‘A’ dying before ‘Y’ is the event on which the contract is contingent and they

cannot be enforced until ‘A’ dies.

(b) Contingency is the non-happening of an event: Where a contingent contract is made

contingent on a non-happening of an event, it can be enforced only when its happening

becomes impossible. For example where ‘P’ agrees to pay ‘Q’ a sum of money if a particular

ship does not return, the contract becomes enforceable only if the ship sinks so that it cannot

return.

enforceable if it is contingent upon the conduct of a living person when that living person does

some thing to make the ‘event’ or ‘conduct’ as impossible of happening. For example where

‘A’ agrees to pay ‘B’ a sum of money if ‘A’ marries ‘C’. ‘C’ marries ‘D’. This act of ‘C’ has

rendered the event of ‘A’ marrying ‘C’ as impossible; it is though possible if there is divorce

between ‘C’ and ‘D’.

(d) Contingent on an impossible event: A contingent agreement to do a thing or not to do

a thing if an impossible event happens is void and hence is not obviously enforceable. The

situation would not change even if the parties to the agreement are not aware of such

impossibility. ‘A’ agrees to pay ‘B’ ` one lakh if sun rises in the west next morning. This is an

impossible event and hence void.

Difference between a contingent contract and a wagering contract

1. A wagering agreement is a promise to give money or money’s worth with reference to an

uncertain event happening or not happening.

A contingent contract is a contract to do or not to do something with reference to a

collateral event happening or not happening.

2. A wagering agreement consists of reciprocal promises whereas a contingent contract

may not contain reciprocal promises.

3. In a wagering contract the uncertain event is the core factor whereas in a contingent

contract the event is collateral.

4. A wagering agreement is essentially contingent in nature whereas a contingent contract

may not be wagering in nature.

5. In a wagering agreement, the contracting parties have no interest in the subject matter

whereas it is not so in a contingent contract.

6. A wagering contract is a game, losing and gaining alone matters whereas it is not so in a

contingent contract.

The Indian Contract Act, 1872 1.71

7. A wagering agreement is void where as a contingent contract is valid.

Key Points

♦ A contract may be either absolute or contingent.

♦ Contingent contract- Where the promisor undertakes to perform the contract which is

depended on the happening/ non-happenning of a specified future uncertain event, which

is collateral to the contract. Also termed as conditional contract because of its uncertain

nature.

♦ Contract of indemnity, guarantee and insurance are contingent contracts, even LIC to a

certain extent is contingent contract.

♦ All wagering agreements are basically contingent agreements but all the contingent

contracts are not wagering agreements.

1.44 Quasi – Contracts

Even in the absence of a contract, certain social relationships give rise to certain specific

obligations to be performed by certain persons. These are known as quasi contracts as they

create same obligations as in the case of regular contract.

Quasi contracts are based on principles of equity, justice and good conscience.

Salient features of quasi contracts are:

(a) In the first place, such a right is always a right to money and generally, though not

always, to a liquidated sum of money.

(b) Secondly, it does not arise from any agreement of the parties concerned, but it imposed

by the law; and

person or persons only, so that in this respect it resembles a contractual right.

1.45 Types of Quasi Contract

There are five circumstances which are identified by the Act as quasi contracts. These five

circumstances do not result in regular contracts.

(a) Claim for necessaries supplied to persons incapable of contracting: Any person

supplying necessaries of life to persons who are incapable of contracting is entitled to claim

the price from the other person’s property. Similarly where money is paid to such persons for

purchase of necessaries, reimbursement can be claimed.

For example if ‘A’ supplies necessaries of life to ‘B’ a lunatic or to his wife or child whom ‘B’ is

liable to protect and maintain, then ‘A’ can claim the price from the property of ‘B’. For such

claim to be valid ‘A’ should prove the supplies were to the actual requirements of ‘B’ and his

dependents. No claim for supplies of luxury articles can be made. If ‘B’ has no property ‘A’

1.72 Business Laws, Ethics and Communication

obviously cannot make his claim.

(b) Right to recover money paid for another person: A person who has paid a sum of

money which another is obliged to pay, is entitled to be reimbursed by that other person

provided the payment has been made by him to protect his own interest.

Here the person who makes the payment must honestly believe that his own interest demands

payment. [Muni Bibi vs. Trilokinath].

In a case the plaintiff agreed to purchase certain mills and to save it from being sold to

outsiders paid certain arrears of municipal dues. Here the payment made by the plaintiff was

held to be recoverable as he had interest in the property as prospective buyer.

of the Act “where a person lawfully does anything for another person, or delivers anything to

him not intending to do so gratuitously and such other person enjoys the benefit thereof, the

latter is bound to pay compensation to the former in respect of, or to restore, the thing so done

or delivered.

The above can be illustrated by a case law where ‘K’ a government servant was compulsorily

retired by the government. He filed a writ petition and obtained an injunction against the

order. He was reinstated and was paid salary but was given no work and in the mean time

government went on appeal. The appeal was decided in favour of the government and ‘K’ was

directed to return the salary paid to him during the period of reinstatement. [Shyam Lal vs.

State of U.P. A.I.R (1968) 130]

(d) Responsibility of finder of goods: In terms of section 71 ‘A person who finds goods

belonging to another and takes them into his custody is subject to same responsibility as if he

were a bailee’.

Thus a finder of lost goods has:

(i) to take proper care of the property as men of ordinary prudence would take

(ii) no right to appropriate the goods and

(iii) to restore the goods if the owner is found.

Where ‘P’ a customer in ‘D’s shop puts down a brooch worn on her coat and forgets to pick

it up and one of ‘D’s assistants finds it and puts it in a drawer over the week end. On

Monday, it was discovered to be missing. ‘D’ was held to be liable in the absence of ordinary

care which a prudent man would have taken.

(e) Liability for money paid or thing delivered by mistake or by coercion: In terms of

Section 72 of the Act, “a person to whom money has been paid or any thing delivered by

mistake or under coercion, must repay or return it. Every kind of payment of money or delivery

of goods for every type of ‘mistake’ is recoverable. [Shivprasad vs Sirish Chandra A.I.R. 1949

P.C. 297]

A payment of municipal tax made under mistaken belief or because of mis- understanding of

The Indian Contract Act, 1872 1.73

the terms of lease can be recovered from municipal authorities. The above law was affirmed

by Supreme Court in cases of Sales tax officer vs. Kanhaiyalal A.I.R.1959 S.C.835

Similarly any money paid by coercion is also recoverable. The word coercion is not

necessarily governed by section 15 of the Act. The word is interpreted to mean and include

oppression, extortion, or such other means [Seth Khanjelek vs National Bank of India].

In a case where ‘T’ was traveling without ticket in a tram car and on checking he was asked to

pay ` 5/- as penalty to compound transaction. T filed a suit against the corporation for

recovery on the ground that it was extorted from him. The suit was decreed in his favour.

[Trikamdas vs. Bombay Municipal Corporation A.I.R.1954]

In all the above cases the contractual liability arose without any agreement between the

parties.

Key Points

♦ Quasi contracts / Constructive contracts are the contract presumed by law. These are the

contracts which are imposed by law and the Act describes such contract as “Certain

relations resembling those created by contracts”.

♦ Quasi contract may be exercised under following five conditions-

- Necessaries of life supplied to incapable person and to his dependents.

- Person pays money on behalf of the one, who is legally bound to pay.

- Person enjoying the benefits of non-gratuitous act.

- Person finds goods belonging to other.

-Person to whom money has been paid or anything delivered by mistake or under

coercion.

1.74 Business Laws, Ethics and Communication

UNIT – 7 : CONTRACT OF INDEMNITY AND GUARANTEE

Learning objectives

After studying this unit, you would be able to –

♦ Be conversant with the two special type of contracts i.e. Indemnity contracts and

Guarantee contracts and also the nature of obligations and rights of each of the parties to

the contracts.

♦ Be clear about distinction between these contracts.

Contract of Indemnity and Guarantee are the special types of contracts given under sections

124 to 147 of the Indian Contract Act,1872.

In this unit, the law relating to indemnity and guarantee are disscused.

1.46 Contract of Indemnity

In terms of Section 124 of the Act, ‘a contract by which one party promises to save the other

from loss caused to him by the conduct of the promisor himself or the conduct of any person is

called a “contract of indemnity”. This is also a known as typical form of contingent contract.

There are two parties in this form of contract. The party who promises to indemnify/

save the other party from loss is known as ‘indemnifier’, where as the party who is

promised to be saved against the loss is known as ‘indemnified’.

For examples, (1) A may contract to indemnify B against the consequences of any

proceedings which C may take against B in respect of a sum of ` 5000/- advanced by C to B.

In consequence, when B who is called upon to pay the sum of money to C fails to do so, C

would be able to recover the amount from A as provided in Section 124.

(2) X, a shareholder of a company lost his share certificate. He applied for the duplicate.

The company agreed to issue the same on the term that X will compensate the company

against the loss where any holder produces the original certificate. Here there is

contract of indemnity between X and the company.

In a contract of indemnity, the promisee i.e., indemnity- holder acting within the scope of his

authority is entitled to recover from the promisor i.e., indemnifier the following rights:

(a) all damages which he may be compelled to pay in any suit

(b) all costs which he may have been compelled to pay in bringing/ defending the suit and

It may be understood that the rights contemplated under section 125 are not exhaustive. The

indemnity holder/ indemnified has other rights besides those mentioned above. If he has

incurred a liability and that liability is absolute, he is entitled to call upon his indemnifier to

save him from the liability and to pay it off.

The Indian Contract Act, 1872 1.75

1.47 Contract of Guarantee

A contract of guarantee is a contract to perform the promise made or discharge liability

incurred by a third person in case of his default (Section 126).

There are three parties in a contract of guarantee. Surety- person who gives the

guarantee, Principal debtor- person in respect of whose default the guarantee is given,

Creditor- person to whom the gurantee is given.

Any guarantee given may be oral or written.

For examples, (1) where ‘A’ obtains housing loan from LIC Housing and if ‘B’ promises to pay

LIC Housing in the event of ‘A’ failing to repay, it is a contract of guarantee.

(2)X and Y go into a car showroom where X says to the dealer to supply latest model of

zen to Y. In case of his failure to pay, he will be paying for it. This is a contract of

guarantee because X promises to discharge the liability of Y in case of his defaults.

The principle of implied promise to indemnify surety(one who gives guarantee) is contained in

Section 145 of the Act which provides that ‘in every contract of guarantee there is an implied

promise by the principal debtor to indemnify the surety and the surety is entitled to recover

from the principal debtor whatever sum he has rightfully paid under the guarantee but no sum

which he has wrongfully paid.

The right of surety is not affected by the fact that the creditor has refused to sue the principal

debtor or that he has not demanded the sum due from him.

What constitutes consideration in a case of guarantee is an important issue and is laid down in

Section 127 of the Act. As per Section 127 of the Act “anything done or any promise made for

the benefit of the principal debtor may be sufficient consideration to the surety for giving the

guarantee.

For example ‘A’ had advanced money to ‘B’ on a bond hypothecating B’s property stating that

C is the surety for any balance that might remain due after realization of B’s property. C was

not a party to the bond. He, however signed a separate surety bond two days subsequent to

the advance of the money. It was held that the subsequent surety bond was void for want of

consideration(Nanak Ram vs. Mehinlal 1877, I Allahabad 487).

1.48 Nature of Surety’s Liability

As per Section 128 of the Act, the liability of the surety is co-extensive with that of the principal

debtor unless it is otherwise provided by the contract. Thus it can be seen:

(i) the liability of surety is the same as that of principal debtor

(ii) where a debtor cannot be held liable on account of any defect in the document, the

liability of the surety also ceases

(iii) surety’s liability continues even if the principal debtor has not been sued or is omitted

1.76 Business Laws, Ethics and Communication

from being sued. This is for the reason that the liability of the surety is separate on the

guarantee.

1.49 Continuing Guarantee

A guarantee which extends to a series of transactions is called a ‘continuing

guarantee’(Section 129). Examples: 1. Where ‘A’ promises ‘B’ to be responsible, so long ‘B’

employs only ‘C’ to collect his rentals from tenants for an amount of ` 5000/-, there is a

continuing guarantee by A to B so long ‘C’ is employed as rent collector. In other words A

stands a guarantor to ‘B’ for rent collected by ‘C’.

In the continuing guarantee, the liability of surety continues till the performance or the

discharge of all the transactions entered into or the guarantee is withdrawn.

There are two important aspects regarding the revocation of continuing guarantee are:

1.The first aspect is “the continuing guarantee may at any time be revoked by the surety as to

future transactions by notice to creditors”. However no revocation is possible where a

continuing relationship is established. For instance where ‘A’ becomes surety of ‘C’ for B’s

conduct as manager in C’s bank and ’B’ is appointed on the faith of this guarantee, ‘A’ is

precluded from annulling the guarantee so long as B acts as manager in C’s bank.

2. The second aspect is upon the death of surety, the continuing guarantee is revoked for all

future transactions in the absence of any contract to the contrary.

1.50 Discharge of a Surety

Sections 133 to 139 of the Act lay down the law as to when a surety would be discharged.

These are as follows:

(i) where there is any variance in the terms of contract between the principal debtor and

creditor without surety’s consent it would discharge the surety in respect of all

transactions taking place subsequent to such variance.

Where ‘A’ stands to ‘C’ as surety for ‘B’ for rent payable by ‘B’ to ‘C’ for ‘C’s house and if

B & C agree on a higher rent without A’s consent, ‘A’ would stand discharged for the

entire rent amount accruing after the date of variance.

(ii) the surety is discharged if the principal debtor is discharged

(a) by a contract or

(b) any act or

For instance where ‘A’ contracts with ‘B’ to build a house for him and if ‘C’ stands as surety

for ‘B’, ‘C’ as surety will stand discharged if ‘A’ discharges ‘B’ of his obligation to build house.

Yet another example could be where ‘A’ agrees to build a house for ‘B’ if ‘B’ supplies the

necessary timber and if ‘C’ stands as surety for A’s performance. If ‘B’ fails to supply the

The Indian Contract Act, 1872 1.77

timber, both ‘A’ and ‘C’ stand discharged.

There are certain exceptions to the above rule. These are given hereunder: -

(a) A mere forbearance on the part of a creditor to sue the debtor or to enforce any other

remedy would not discharge the surety in the absence of any specific provision.

(b) Even where the claim is barred by limitation, surety is still responsible. In Krishto Kishore

vs. Radha Romun I.L.R. 12 Cal.330, the plaintiff sued the principal debtor and the surety

for arrears of rent. The plaintiff also made the legal representatives of the principal

debtor a party after knowing about the death of the principal debtor to avoid the debt

being barred by limitation. It was held that even if debt is barred by limitation on account

of death of principal debtor, the surety is still liable. The same view was confirmed by

Privy Council in Mahant Singh vs U Ba Yi A.I.R 1939 P.C 110 where it was held that

omission of the creditor to sue within the period of limitation does not discharge the

surety.

(iii) Where the principal debtor compounds [settles] with the creditor regarding the amount or

promises not to sue, the surety will be discharged. But a contract for giving time to a

debtor is entered into with a third party, the surety will not be discharged. Where there

are co-sureties release of one co-surety would not automatically discharge the other co-

sureties. Further in between other co-sureties, the released co-surety is not absolved of

his liability vis a vis other co-sureties.

(iv) the surety would be discharged if the creditor does anything or acts in a manner which

(a) is inconsistent with the rights of surety and

(b) impairs the eventual remedy of the surety.

For example, ‘A’ puts ‘M’ as the cashier under B and agrees to stand as surety provided ‘B’

checks the cash every month. ‘M’ embezzles cash. ‘A’ was not held to be responsible as B

failed to verify the cash every month.

1.51 Rights of Surety against the Principal Debtor and Creditor

After the performing of the promise or discharging of the liability of the principl debtor,

surety acquires various rights against the parties.

The rights of surety are contained in sections 140 and 141 of the Act. These are

(1) Against the principal debtor

(a) Right of subrogation: where a guaranteed debt has become due or default of the

principal debtor to perform a guaranteed duty has taken place, the surety upon payment

or performance of all that he is liable for, is vested with all the rights which the creditor

had against the principal debtor. The right of the surety is known as the right of

subrogation namely the right to stand in the shoes of the creditor.

(b) Right to securities: the surety is entitled to the benefit of all securities made available to

1.78 Business Laws, Ethics and Communication

the creditor by the principal debtor whether the surety was aware of its existence or not.

from the principal debtor whatever sums he has rightfully paid. In this connection the

following principles were laid down in Reed vs. Norris

(i) the claim of the surety is restricted to that smaller amount which he may have paid

under the principle of “accord and satisfaction”. Surety is not entitled for higher

amount than what he has paid.

(ii) surety can also claim indemnity for any special damages which he has suffered

while discharging his duties

(iii) surety can claim even if he has paid a time barred debt as it is a rightful payment

though there are contrary views on this issue.

In all the above instances surety can claim reimbursements only if actual payments have been

made and not where he has merely executed promissory notes. [Panth Narayana Murthy vs.

Marimuthu (1902) 26 Mad. 322,328]

Where surety becomes surety without the knowledge of principal debtor, he is entitled for all

the rights against the principal debtor but not the right to claim an indemnity against the

principal debtor.

(2) Sureties right against the creditor: Following are the rights of sureties against the

creditor:

(a) Right of subrogation: the surety gets the right of subrogation for all payments and

performances he is liable. This right would accrue only when the surety has paid the

amount of liability in full. For example where a creditor had the right to stop the goods or

sellers lien, surety would enjoy the same right after he has paid the amount [Imperial

Bank vs. SL Kathereine Docks 1877 5 Ch.D]

(b) Right to securities: surety is entitled for all securities which the debtor has provided to

creditor whether surety is aware of it or not. Where a creditor loses any of the security

by default or negligence the liability of the surety abates proportionately. If a creditor

does not hand over the securities to surety he can be compelled to do so. Classic

examples of surety’s right are: he is entitled for all mortgage rights which the secured

creditor has. But the surety is not entitled for any security provided subsequent to the

contract of guarantee

guaranteed debt. This right of surety is known as right to file a ‘Quia timet action’ against

the debtor. There is of course an inherent risk of having to indemnify the creditor for

delay and expense

(d) Right to dismiss: surety has a right to call upon the creditor to dismiss the person from

service if the person whose fidelity is guaranteed by surety is persistently dishonest

(e) Right to claim set-off: surety has a right of set off against the principal debtor exactly as

The Indian Contract Act, 1872 1.79

a creditor would have.

(f) Right of option on the claim of the funds: surety also can compel the creditor where

he has claim on two funds, to resort to that fund first on which surety has no claim.

(g) Right to claim : surety can claim that he is not liable on the guarantee to the creditor, if

it can be proved that principal debtor was incapable of entering into a contract, say

because he was a minor.

This is on the principle that the liability of the surety is co-extensive with that of the principal

debtor.

Guarantee when valid: Following are the circumstances when a guarantee can be treated as

invalid.

(i) Mis-representation: when the guarantee has been obtained by means of mis-

representation made directly by the creditor or made with his knowledge and the mis-

representation relates to a material part of the transaction.

(ii) Silence as to material circumstances: when the creditor has obtained any guarantee

by means of keeping silence as to material circumstances.

The expression “keeping silence” implies intentional concealment of a material fact, as

distinct from a mere non-disclosure thereof. There must exist some element of fraud.

[Balakrishna vs. Bank of Bengal (1891) 15 Bom. 585]. Thus, A engages B as clerk to

collect money for him and B fails to account for some of his receipts. Thereupon, A calls

upon B to furnish security for his duly accounting the receipts. C gives the required

guarantee. A does not tell C of the fact of a previous misappropriation by B and

thereafter B again makes a default. The guarantee would be invalid.

(iii) Failure of joining of other person as co-surety: when a contract of guarantee is

entered into on the condition that the creditor shall not act upon it until another person

has joined in it as co-surety and that other party fails to join as such.

1.52 Contribution as between Co-Sureties

As per section 146 of the Act “when two or more persons are co-sureties for the same debt, or

duty, either jointly, or severally and whether under the same or different contracts and whether

with or without the knowledge of each other, the co-sureties in the absence of any contract to

the contrary, are liable, as between themselves, to pay each an equal share of the whole debt,

or of that part of it which remains unpaid by the principal debtor”.

A co- surety gets a right to recover from other sureties only when he has paid more than his

share of debt to the creditor.

1.80 Business Laws, Ethics and Communication

Liability of two sureties is not affected by mutual arrangements : As per section 132 of

the Act “where two persons contract with a third person to undertake a certain liability and also

contract with each other that one of them shall be liable only on the default of the other, third

person not being a party to such contract, the liability of each of such two persons to the third

person under the first contract is not affected by the existence of the second contract,

although such third person may have been aware of its existence”.

The foregoing is the position of law applicable when the liability is undertaken jointly by two

parties in respect of the same debt. But it is not so when it is in respect of different debts. For

example, a party who accepts a Bill of Exchange for the accommodation of another would

plead that he was the accommodating party. This is because the liability undertaken by the

acceptor and drawer of the bill is in no sense a joint liability. Though they contract to pay the

same sum of money, they contract severally in different ways and subject to different

conditions. [Pages vs. Bank of Bengal (1877) 3 Cal. 174].

1.53 Distinction between a Contract of Indemnity and a Contract of

Guarantee

We have in previous para learnt in detail about the contract of indemnity and a contract of

guarantee. Now let us analyse the differences between the two.

(i) Number of parties: In a contract of indemnity there are only two parties namely the

indemnifier [promisor] and the indemnified [promisee]. In a contract of guarantee there are

three parties creditor, principal debtor and surety.

(ii) Extent of liability: The liability of the indemnifier is primary and independent. The

liability of the surety is secondary as the primary liability is that of the principal debtor.

(iii) Time of liability: The liability of the indemnifier arises only on the happening of a

contingency. In the case of guarantee, liability is already in existence but specifically

crystallizes when principal debtor fails.

(iv) Time to Act: The indemnifier need not necessarily act at the request of indemnified. In

case of guarantee surety must act by extending guarantee at the request of debtor.

(v) Right to sue third party: In case of contract of indemnity, indemnifier cannot sue a third

party for loss in his own name as there is no privity of contract. Such a right would arise only

if there is an assignment in his favour. On the other hand in the case of contract of guarantee

surety can proceed against principal debtor in his own right because he gets all the right of a

creditor after discharging the debts.

The Indian Contract Act, 1872 1.81

Key Points

♦ A contract of indemnity- A contract where one party promises to indemnify the other from

loss caused to him by the conduct of the promisor or by the conduct of any other person.

♦ A contract of guarantee- A contract to perform the promise or discharge the liability of a

third person in case of his default.

♦ Contract of guarantee must be supported by consideration.The consideration received by

the prinicipal debtor may be sufficient consideration to the surety for giving guarantee.

♦ The liability of surety is co-extensive with that of principle debtor. In certain cases surety

will be liable though principal debtor is not liable- (i) prinicipal debtor is incompetent to

contract.(ii) principal debtor is adjudged insolvent.(iii) the debts becomes time-barred.

♦ Specific/ simple guarantee-Guarantee for single debt/particular transaction.

♦ Continuing guarantee-Guarantee that extends to a series of transactions.

♦ A contract of guarantee becomes invalid,when -(i) Obtained by misrepresentation (ii)

Obtained by concealment of material facts (iii) Co-surety does not join (iv) When

consideration fails.

1.82 Business Laws, Ethics and Communication

UNIT – 8 : BAILMENT AND PLEDGE

Learning objectives

After studying this unit, you would be able to –

♦ Understand the general principles underlying contracts of bailment and pledge.

♦ Grasp the duties and rights of the parties to the contracts.

1.54 What is bailment?

Bailment etymologically means ‘handing over’ or ‘change of possession’. As per Section 148

of the Act, bailment is an act whereby goods are delivered by one person to another for some

purpose, on a contract, that the goods shall, when the purpose is accomplished, be returned

or otherwise disposed of according to the directions of the person delivering them. The

person who delivers the goods is the bailor and the person to whom the goods are delivered is

the bailee.

For example where ‘X’ delivers his car for repair to ‘Y’, ‘X’ is the bailor and ‘Y’ is the bailee.

The essential characteristics of bailment are-

(a) Bailment is based upon a contract. Sometimes it could be implied by law as it happens

in the case of finder of lost goods.

(b) Bailment is only for moveable goods and never for immovable goods or money.

physical delivery or by any action which has the effect of placing the goods in the

possession of bailee.

(d) In bailment bailor continues to be the owner of goods as there is no change of ownership.

(e) Bailee is obliged to return the goods physically to the bailor. The bailee cannot deliver

some other goods, even not those of higher value.

General issues: In bailment both custody and possession must change but not the

ownership. But where a person is in custody without possession he does not became a

bailee. For example servants of a master who are in custody of goods of the master do not

become bailees.

Possession and custody do not however mean physical delivery of goods. Constructive

delivery could also create a bailor and bailee relationship. This arises in situations where the

bailee is already in possession of goods but agrees to be a bailee through a contract.

Deposit of money in a bank is not bailment since the money returned by the bank would not be

identical currency notes.

Similarly depositing ornaments in a bank locker is not bailment, because ornaments are kept

in a locker whose key are still with the owner and not with the bank. The ornaments are in

The Indian Contract Act, 1872 1.83

possession of the owner though kept in a locker at the bank.

Different forms of Bailment: Following are the popular forms of bailment

(1) Delivery of goods by one person to another to be held for the bailor’s use.

(2) Goods given to a friend for his own use without any charge

(3) Hiring of goods.

(4) Delivering goods to a creditor to serve as security for a loan.

(5) Delivering goods for repair with or without remuneration.

(6) Delivering goods for carriage.

1.55 Bailor’s Duties and Rights

Duties of Bailor: The duties of bailor are spelt out in a number of Sections. These are

enumerated hereunder:

(i) the bailor must disclose all defects/faults in the goods bailed. If the bailor does not

disclose, he would be responsible for any loss or damage suffered by the bailee while

keeping the goods in his custody. The bailor is particularly responsible for defects in

goods hired to bailee whether bailor was aware of such defects or not.

(ii) where the bailment is gratuitous, the bailor must reimburse the bailee for any expenditure

incurred in keeping the goods.

(iii) the bailor should reimburse any expense which the bailee may incur by way of loss in the

process of returning the goods or complying with other directions for returning the goods.

(iv) the bailor must compensate the bailee for the loss or damage suffered by the bailee that

is in excess of the benefit received, where he had lent the goods gratuitously and

decides to terminate the bailment before the expiry of the period of bailment.

(v) the bailor is bound to accept the goods after the purpose is accomplished. If bailor fails,

he is responsible for any loss or damage to the goods and has to reimburse for expenses

incurred by the bailee for keeping the goods safely.

Rights of Bailor: The following are the rights of bailor:

(1) Bailor has a right to enforce the duties of the bailee such as -

(a) right to claim damages for loss caused to the goods by the negligence of bailee;

(b) right to claim compensation for loss caused by an unauthorized use of the goods

bailed;

goods.

(2) Bailor has a right to terminate the contract if the bailee does anything which is

inconsistent with the conditions of bailment. For example ‘A’ lets on hire his horse to ‘B’

1.84 Business Laws, Ethics and Communication

for his own riding but ‘B’ uses the horse for driving his carriage. ‘A’ has a right to

terminate the contract of bailment.

(3) Bailor in the case of gratuitous bailment has a right to demand the goods back even

before the expiry of the period of bailment. If in the process, loss is caused to the bailee,

bailor is bound to compensate.

(4) Bailor has a right to claim the increase or profit from the goods bailed which may have

occurred from the goods value. For example where ‘A’ bails his cow to ‘B’ and if the cow

gives birth to a calf, ‘B’ is bound to return the cow and the calf to ‘A’.

1.56 Care to be taken by Bailee

The bailee is bound to take as much care of the goods bailed to him as a man of ordinary

prudence with regard to quantity, bulk and value would take.

In such a case he will not be responsible, in the absence of special contract, for any special

loss or destruction or deterioration of the goods bailed, since he has taken as much care as a

man of ordinary prudence.

For example if X bails his ornaments to ‘Y’ and ‘Y’ keeps these ornaments in his own locker at

his house along with his own ornaments and if all the ornaments are lost/stolen in a riot ‘Y’

will not be responsible for the loss to ‘X’. If on the other hand ‘X’ specifically instructs ‘Y’ to

keep them in a bank, but ‘Y’ keeps them at his residence, then ‘Y’ would be responsible for

the loss [caused on account of riot].

Bailee has right to terminate: The bailee has the right to terminate a contract of bailment if

the bailor does any thing inconsistent with bailment conditions.

1.57 Duties and Rights of a Bailee.

In addition to the two important duties of having to take care of the goods bailed and being

responsible for loss/injury/damage to goods, bailee has other following duties under the Act.

(i) Bailee has no right to make unauthorized use of goods bailed

(ii) Bailee has no right to mix the goods bailed with his own goods without the consent of the

bailor.

(iii) Bailee has to return the goods on expiration of period of bailment

(iv) Bailee has a duty to return any extra profit accruing from goods bailed. Where A bails his

cow to ‘B’ and if the cow gives birth to a calf, ‘B’ must return both the cow and the calf to

‘A’

(v) Bailee has duty not to do anything inconsistent with the condition of bailment.

Rights of bailee: The bailee has the following rights [These rights are also the duties of the

bailor]-

(i) to claim compensation for any loss arising from non-dislosure of known defects in the

The Indian Contract Act, 1872 1.85

goods

(ii) to claim indemnification for any loss or damage as a result of defective title.

(iii) to deliver back the goods to joint bailors according to the agreement or directions

(iv) to deliver the goods back to the bailor whether or not the bailor has the right to the --

goods

(v) to exercise his ‘right of lien’. This right of lien is a right to retain the goods and is

exercisable where charges due in respect of goods retained have not been paid. The

right of lien is a particular lien for the reason that the bailee can retain only these goods

for which the bailee has to receive his fees/remuneration.

(vi) to take action against third parties if that party wrongfully denies the bailee of his right to

use the goods

Suit by bailor & bailee against wrong doers

Both bailor and bailee have right to sue a third party who has deprived the bailee to the use

or possession of goods bailed. Any relief obtained against such deprivation or injury can be

shared between the bailor and bailee according to their respective interest.

1.58 Rights and Duties of Finder of Goods

We have already seen in an earlier study unit, that the duties of ‘finder of lost goods’ are that

of the bailee. Such a ‘finder of lost goods’ is as good as a bailee and he enjoys all the rights

and carries all the responsibilities of a bailee.

Apart from the above, the ‘finder of lost goods’ can ask for reimbursement for expenditure

incurred for preserving the goods but also for searching the true owner. If the real owner

refuses to pay compensation, the ‘finder’ cannot sue but retain the goods so found.

Further where the real owner has announced any reward, the finder is entitled to receive the

reward. The right to collect the reward is a primary and a superior right even more than the

right to seek reimbursement of expenditure.

Lastly the finder though has no right to sell the goods found in the normal course, he may sell

the goods if the real owner cannot be found with reasonable efforts or if the owner refuses to

pay the lawful charges subject to the following conditions:

a) when the article is in danger of perishing and losing the greater part of the value or

b) when the lawful charges of the finder amounts to two-third or more of the value of the

article found.

1.59 General Lien and Particular Lien

A general lien is the right to retain the property of another for a general balance of account. In

contract the particular lien is the right to retain the particular goods bailed for non-payment of

1.86 Business Laws, Ethics and Communication

charges/remuneration.

Bankers, factors, wharfingers, policy brokers and attorneys of law have a general lien in

respect of goods which come into their possession during the course of their profession.

For instance a banker enjoys the right of a general lien on cash, cheques, bills of exchange

and securities deposited with him for any amounts due to him. For instance ‘A’ borrows

` 500/- from the bank without security and subsequently again borrows another ` 1000/- but

with security of say certain jewellery. In this illustration, even where ‘A’ has returned ` 1000/-

being the second loan, the banker can retain the jewellery given as security to the second loan

towards the first loan which is yet to be repaid.

Under the right of general lien the goods cannot be sold but can only be retained for dues.

The right of lien can be waived through a contract.

Interestingly, Chartered Accountants have a general lien against the books of their clients

which come into their possession against professional fees not paid to them by those clients.

Particular lien: In accordance with the purpose of bailment if the bailee by his skill or labour

improves the goods bailed, he is entitled for remuneration for such services. Towards such

remuneration, the bailee can retain the goods bailed if the bailor refuses to pay the

remuneration. Such a right to retain the goods bailed is the right of particular lien. He

however does not have the right to sue.

Where the bailee delivers the goods without receiving his remuneration, he has a right to sue

the bailor. In such a case the particular lien may be waived. The particular lien is also lost if

the bailee does not complete the work within the time agreed.

Difference between general lien and particular lien: The difference between the two can be

summarised as follows:

General lien

Particular lien

It is a right to detain/retain any goods of the

bailor for general balance of account

outstanding

It is a right exercisable only on such goods in

respect of which charges are due.

A general lien is not automatic but is

recognized

through on agreement. It is

exercised by the bailee only by name

It is automatic

It can be exercised against goods even

without involvement of labour or skill.

It comes into play only when some labour or

skill is involved

Bankers, factors, wharfingers, policy brokers

etc. are entitled to general lien

Bailee, finder of goods, pledgee, unpaid

seller, agent, partner etc are entitled to

particular lien

The Indian Contract Act, 1872 1.87

Key Points

♦ Bailment-Delivery of goods by one person to another for some purpose upon a contract

that they shall be returned after the purpose is over or disposed off according to the

directions of the person delivering them.

♦ Bailor- Person who delivers goods for bailment.

♦ Bailee- Person to whom goods are delivered under the contract of bailment.

♦ Depositing currency notes in a bank- It is not a bailment as currency notes or moneys are

not goods as per the definition of goods given under the Sale of Goods Act,1930 and

also no same notes is returned to the depositor by the bank.

♦ Keeping of ornaments/valuables in a bank locker- It’s not a bailment as there is no

transfer of possession of ornaments or valuables.

♦ Gratuitous bailment- No consideration passes between the bailor and the bailee and the

bailor is not responsible for the damages in respect of the faults which were not known to

him.

1.60 Pledge

Pledge is a variety or specie of bailment. It is bailment of goods as security for payment of

debt or performance of a promise. The person who pledges[or bails] is known as pledgor or

also as pawnor, the bailee is known as pledgee or also as pawnee. In pledge, there is no

change in ownership of the property. Under exceptional circumstances, the pledgee has a

right to sell the property pledged. Section 172 to 182 of the Indian Contract Act,1872 deal

specifically with the bailment of pledge.

For example: A lends a money to B in lieu of a jewellary deposited by B as security to

A. This bailment of jewellary is a pledge as security for lending the money. B is a

pawnor and the A is a pawnee.

Let us now examine the essentials of pledge and rights of pawnee and pawnor.

Essentials of contract of pledge:

There must be bailment for security for payment of debt/ performance of a promise.

Goods must be the subject matter of the contract of pledge.

The goods pledged must be in existence.

There must be a delivery of goods from pawnor to pawnee

Pawnee’s rights

(a) Right of retainer: Pawnee has right to retain the goods pledged not only for payment of

debt or performance of a promise but also for recovery of debts and all expenses incurred for

1.88 Business Laws, Ethics and Communication

preservation of goods pledged. Where ‘M’ pledges stock of goods for certain loan from a

bank, the bank has a right to retain the stock not only for adjustment of the loan but also for

payment of interest.

(b) Right to retention to subsequent debts: Pawnee has a right to retain the goods

pledged towards subsequent advances as well, however subject to such right being

specifically contemplated in the contract.

reimbursement of extraordinary expenses incurred. However his right to retain the goods shall

not extend to such extraordinary expenses but is restricted to ordinary expenses.

(d) Right to sue: In the event of pawnor failing to redeem the debt or perform the promise,

the pawnee has a right to sue the goods which he has retained. He can in the alternative,

under certain circumstances, sell the goods after giving a reasonable notice, to the pledgor.

The two rights namely the right to sue and the right to sell are alternative rights and not

cumulative rights.

Rights of a pawnor

(a) Right to redeem: Pawnor has a basic right to redeem the goods pledged by performing

his promise.

(b) Right to sue: Pawnor has a right to sue, but within a period of 3 years in view of

provision of Limitation Act only in the event of pawnee refusing to return the goods even after

payment of debt etc.

reasonable care and preservation of the goods pledged.

(d) Right to receive increase or profit from the goods: Pawnor is entitled to receive the

increase or profit from the goods if there is any increase/profit relating to it during the

pledged period

1.61 Pledge by Mercantile Agents

Though generally only a owner of goods can pledge, the Act recognizes the right of certain

mercantile agents to pledge provided it is done with the consent of the owner of the goods.

Such a pledge done in the ordinary course of business is valid. Pledge in this case can be

effected through pledge of documents like a bill of lading or a railway receipt etc.

1.62 Distinction between Bailment and Pledge

There are three distinctions between bailment and pledge. These are

(a) As to purpose: Pledge is a variety of bailment. Under pledge goods are bailed as a

security for a loan or a performance of a promise. In regular bailment the goods are bailed for

other purpose than the two referred above. The bailee takes them for repairs, safe custody

etc.

The Indian Contract Act, 1872 1.89

(b) As to right of sale: The pledgee enjoys the right to sell only on default by the pledgor to

repay the debt or perform his promise, that too only after giving due notice. In bailment the

bailee, generally, cannot sell the goods. He can either retain or sue for non-payment of dues.

terms so provide, use the goods.

(d) Consideration: In pledge there is always a consideration whereas in a bailment

there may or may not be consideration.

(e) Discharge of contract: Plegde is discharged on the payment of debt or

performance of promise whereas bailment is discharged as the purpose is

accomplished or after specified time.

Key Points

♦ Pledge- Bailment of goods as security for payment of a debt/performance of a promise.

♦ Pawnor- Person who pledges goods as security.

♦ Pawnee- Person who receives the goods as security.

♦ Rights of Pawnor - To get back the goods, redeem the goods, take care and preserve the

goods, receive increase or profits from the goods.

♦ Rights of Pawnee- To retain goods, to receive extra-ordinary expenses, to sue, to sell

goods.

♦ Some non-owners may also create a valid pledge of goods, such as- Mercantile agents,

co-owner, by person having a limited interest, by person having a possession of goods

under voidable contract.

♦ Basic distinction between bailment and pledge- All the pledges are bailments but all the

bailments are not a pledges.

1.90 Business Laws, Ethics and Communication

UNIT – 9 : AGENCY

Learning objectives

After studying this unit, you would be able to –

♦ Understand the relationship between agent and principal and the intention behind

adoption of such course of agency.

♦ Note that consideration is not at all necessary for validity of agency contracts.

♦ Learn various modes of creation, especially agency by ratification.

♦

Understand rights and obligations of an agent as well as the circumstances when the

agent is personally liable for the acts done by him on behalf of the principal and the legal

position of the agent, the principal and the third parties involved.

♦ Be familiar with the terms ‘sub-agent’ and ‘substituted agent’ and to distinguish between

the two.

In the modern world conduct of business is not possible without the help of agents. Therefore

it is necessary to know the law relating to agency.The law of agency is contained in sections

182 to 238 of the Indian Contract Act,1872.

1.63 What is Agency?

The Indian Contract Act,1872 does not define the word ‘Agency’. However the word ‘Agent’ is

defined as “a person employed to do any act for another or to represent another in dealings

with third persons”. The third person for whom the act is done or is so represented is called

“Principal”.(Section 182)

Thus ‘Agency’ is a comprehensive word used to describe the relationship between one person

and another, where the first mentioned person brings the second mentioned person into legal

relation with others.

The Rule of Agency is based on the maxim “Quit facit per alium, facit per se:” i.e., he

who acts through an agent is himself acting

Salient features of agency: Following are the four salient features of agency

(i) Basis: The basic essence of ‘agency’ is that the principal is bound by the acts of the

agent and is answerable to third parties.

(ii) Consideration not necessary: Unlike other regular contracts, a contract of agency does

not need consideration. In other words, the relationship between the ‘principal’ and

‘agent’ need not be supported by consideration.

(iii) Capacity to employ an agent: A person who is competent to contract alone can employ

The Indian Contract Act, 1872 1.91

an agent. In other words, a person in order to act as principal must be a major and of

sound mind.

(iv) Capacity to be an agent: A person in order to be an agent must also be competent to

contract. In other words, he must also be a person who has attained majority and is of

sound mind.

1.64 Modes of Creation of Agency

There are five general methods of creating agency. These are (i) agency by actual authority

(ii) agency by ratification (iii) agency of ostensible authority (iv) agency by necessity and (v)

agency by actual authority and apparent authority.

Let us briefly discuss these five modes of creation of agency.

(a) Agency by actual authority: A contract of agency can be express or implied. Whether it

is express or implied, it can be by words spoken or written. While the express contract is often

expressed in clear terms, implied contracts are created by circumstances.

For example, ‘A’ owns a shop and ‘B’ manages that shop. Though ‘A’ being the owner orders

purchases for that shop and pays through his bank account, ‘B’ by virtue of his position can

also purchase as an agent, express or implied.

(b) Agency by ratification: Agency is also created by subsequent ratification or approach.

The subsequent ratification becomes necessary because the agent acts without the

knowledge or the approval of the principal. Following are the rules of ratification.

(i) Ratification can be made only by a person who was in existence at the time of act.

(ii) Ratification must be by a person for whom the act was done, professing him to be a

principal. This implies competency on the part of the person ratifying the act.

(iii) Ratification would date back to the date of the act, and validate it

(iv) Ratification may either be express or even implied by the conduct of the person on

whose behalf the act was done.

(v) Ratification must be of the whole act and not just for a part of the act.

(vi) Ratification [by the purported principal] of the acts of an agent can not be such as to

create any liability to third parties or cause any injury or damage to third parties

(vii) Ratification cannot be done if the person ratifying is in knowledge of facts which are

materially defective.

(viii) Illegal acts cannot be ratified.

(ix) Acts which are void ab initio cannot be ratified

1.92 Business Laws, Ethics and Communication

(x) Ratification would be restricted to certain limitations to which original acts are limited and

ratification can be to that portion of exceeded authority by the agent.

conduct of the principal, there the agency through ostensible authority is born. Here the

agent’s authority is ostensible and the principal is bound by the act of the agent. Ostensible

authority happens on account of estoppel and holding out. Let us analyse these two types

with examples-

(i) Agency by estoppels: If a person permits or represents another to act on his behalf, so

that a reasonable person would infer that the relationship of principal and agent had been

created then he will be stopped from denying his agent’s authority and getting himself relieved

from his obligations to a third party by proving that no such relationship infact existed.

For instance where ‘A’ informs ‘B’ in the presence and within hearing of ‘P’ that ‘P’ is his

agent. Later ‘B’ enters into contract with ‘P’ thinking that ‘P’ is the agent of ‘A’. In a situation

like this neither ‘P’ nor ‘A’ can refuse the obligations under the contract. ‘P’ had become the

agent of ‘A’ by estoppel. ‘P’ will be treated as agent of ‘A’ even if he was not an agent at all.

Where a master permits his servant to pledge his credit, there is an agency on account of

estoppel. Even if the servant had on occasion pledged without the authority of master, the

master is still bound because of estoppel. Similarly where a married woman co-habits with her

husband, there is a presumption that she has the authority to pledge his credit for

necessaries.

A principal cannot privately revoke or restrict the authority of his agent, which he has allowed

in public.

(ii) Agency by Holding out: Under the principle of holding out, any one who holds himself out

as an agent of another, then a relationship of agent and principal gets in place. The process

of holding out happens through willful conduct done to create a deliberate impression. In such

a case person concerned is estopped from denying that he is the agent of a principal. The

doctrine of holding out is also applicable in case of partnerships. The law of partnership also

adopts the principle of agency to a large extent. However under “holding out” principle

following conditions are required to be present:

(a) statement or conduct of misrepresentation

(b) a genuine not necessarily a fraudulent misrepresentation and

statement so made.

(d) Agency by necessity: Sometimes circumstances would compel and a relation of agency

would fall in place. This is often out of necessity. For example a captain of a ship can borrow

The Indian Contract Act, 1872 1.93

money at other ports where there are no agent to act on behalf of the owner, to carryout

repairs. The captain becomes an agent by necessity. To constitute an agency by necessity

following conditions must be fulfilled.

(i) agent should be in a position of not being able to communicate in time with the principal

(ii) there must have been an actual and definite commercial necessity

(iii) the agent must have acted bonafide and for the benefit of principal

(iv) the agent must have adopted most reasonable and practicable course of action.

(e) Actual authority and apparent authority: Actual authority to act as agent stems from a

consent. The consent to act may be oral or in writing. Some time the authority can also be

‘implied authority’. The implied authority is incidental or usual or customary. It would depend

on the circumstance of the case.

The authority of the agent is ‘apparent’ where the principal represents or is regarded by law as

having represented that another has, authority. Under the doctrine of ‘apparent authority’, the

‘principal’ is bound to third parties by the acts of that person though he had not given such

authority or had limited the authority by instructions not made known to third party. The notion

of apparent authority is essentially confined to relationship between the principal and third

party.

1.65 Extent of Agent’s Authority

The agent’s authority is governed by two principles namely (a) in normal circumstances and

(b) in emergency.

Let us examine these two situations -

(i) Agent’s authority in normal circumstances: An agent has the power and authority to

do all acts lawful and necessary in the normal circumstances in discharge of his functions.

For instance, where ‘A’ who lives in Andamans employs ‘B’ as his agent to collect his debts in

Kanyakumari, ‘B’ has all the authority including the authority to pursue legal proceedings.

Similarly ‘B’ can also give valid discharge. Again for example, where ‘A’ executes a power of

attorney in favour of ‘B’ in running a silk factory, but the power of attorney did not authorize ‘B’

to borrow and if ‘B’ borrowed, it was stated to be an act in excess of his authority [Ferguson

vs. Uma Chand Bold (1905) 33 Cal. 343]

(ii) Agent’s authority in emergency: An agent has the authority in an emergency to do all

such acts as a man of ordinary prudence would, for protecting his principal from losses under

similar circumstances.

A typical case is where the ‘agent’ who handles perishable goods like ‘mangoes’ can decide

1.94 Business Laws, Ethics and Communication

the time, date and place of sale, not necessarily as per instructions of the principal but with the

intention of protecting the principal from losses. Here the agent acts in an emergency and

acts as a man of ordinary prudence.

Notice to an agent: Any notice given to an agent or information obtained by him will be

deemed to be given to the principal. Thus where the agent of an insurance company

negotiates with a customer who had lost an eye in an accident, the insurance company is

deemed to have knowledge of the fact.

1.66 Duties and Obligations of an Agent

Following are the duties of an agent:

(i) Duty in conducting principal’s business: The agent should conduct the business of the

principal as per directions of the principal or in the absence of any directions as per the

custom prevalent in the business

(ii) The agent is liable to the principal for any loss if he deviates from the above duty/

obligation where he did not act according to instruction of the principal. It was held by the

Supreme Court in a case that the agent had to compensate the principal where the agent

did not act according to the instructions of the principal. In the given case the agent was

under instruction to insure the goods of the principal but he did not. There was an

explosion in the Bombay dock and as a result all the goods of the principal, along with

others, was destroyed. The Government passed an ordinance that where ever there was

a fire insurance policy, full amount would be paid to the owners and where there was no

insurance cover, half the amount would repaid. The principal was paid half the losses

and he sued the agent for the balance loss and the agent was ordered by court to pay

the balance amount to compensate him for loss.

(iii) Requirements as to skill and diligence: Agent must act always as a person with diligence

and skill normally exercised in the trade. He would otherwise be responsible to

compensate the principal for any loss suffered by the principal for want of his skill.

Where ‘A’ acts as an agent for ‘B’ and sells rice to ‘C’ in the usual course of business

without verifying about C’s solvency and if ‘C’ goes insolvent, then ‘A’ is responsible for

losses arising to ‘B’.

(iv) Agents duty to account: The agent has to maintain and render proper accounts to

principal whenever demanded. He is bound to pay the principal all sums received. He is

bound to maintain accounts even if the contract is illegal or void.

(v) Duty to communicate: The agent must in order to obtain instruction, communicate and

contact the principal as a man of ordinary diligence.

The Indian Contract Act, 1872 1.95

1.67 Rights of An Agent

Following are the rights of an agent

(i) Right of lien on principal’s property: An agent is entitled to retain the goods,

properties and books for any remuneration, commission etc due to him. The possession of

such property should be however lawful.

(ii) Right of indemnification for lawful acts: The principal is bound to indemnify the agent

against all consequences of lawful acts done in exercise of his authority. For example ‘A’ of

Delhi appoints ‘B’ of Mumbai as agent to sell his merchandise. As a result ‘B’ contracts to

deliver the merchandise to various parties. But ‘A’ fails to send the merchandise to ‘B’ and ‘B’

faces litigations for non-performance. Here ‘A’ is bound to protect ‘B’ against the litigations

and all costs, expenses arising out of that.

(iii) Right of indemnification against acts done in good faith: Where the agent acts in

good faith on the instruction of principal, agent is entitled for indemnification of any loss or

damage from the principal. Where ‘P’ appoints ‘A’ as his agent and directs him to sell certain

goods which in fact turned out to be not those belonging to ‘P’ and if third parties sue ‘A’ for

this act, ‘A’ is entitled for reimbursement and indemnification for such act done in good faith.

However the agent cannot claim any reimbursement or indemnification for any loss etc arising

out of acts done by him in violation of any penal laws of the country.

(iv) Right of retention: The agent can retain, out of the sums received from the principal,

such amounts towards reimbursement of expenditure, remuneration and advances paid by him

on account towards the business and render accounts only for the balance.

(v) Right of remuneration: The agent in the normal course is entitled for remuneration as

per the contract. In the absence of any agreed amount of remuneration, he is entitled for

usual remuneration which is customary in the business. However he is not entitled for any

remuneration for acts done through misconduct/negligence.

1.68 Personal Liability of the Agent

We have already seen that basic principle of agency is that agent acts on behalf his principal

and therefore cannot personally enforce the contract. Similarly he is also not personally

bound for any act.

However under certain circumstances like, where the agent exceeds his authority, or has no

authority or the principal does not ratify the act of the agent, the agent is personally liable .

This is known as doctrine of implied warranty of authority. The rules with regard to personal

liability of an agent are set out hereunder.

1.96 Business Laws, Ethics and Communication

(i) where the contract expressly provides for personal liability of the agent

(ii) where the agent signs the negotiable instrument without indicating that he is signing it for

the principal

(iii) where the agent works for a foreign principal

(iv) where the agent acts for a principal who cannot be sued viz Ambassador of a country

etc.

(v) where a Govt. servant enters into a contract on behalf of Union of India in disregard of

Article 299(1)

(vi) where according to usage in trade in certain kinds of business agents are personally

liable.

(vii) where the agency is coupled with interest. An agency will be treated as such where the

agent himself has interest in the subject matter. The ‘interest’ of the agent to come

under this category should not be an ordinary ‘interest’ like towards remuneration etc.,

but should be a special interest.

1.69 Undisclosed Principal

An ‘undisclosed principal’ comes into play where an agent having the authority to contract,

does not disclose the fact, concealing not only the name of the principal but also the fact that

there is a principal; here the agent gives an impression that he acts on his own.

In ‘undisclosed principal’, the mutual rights, of principal, agent and third party are as follows:

(a) the liability of the agent is his own since he has not disclosed that there is a principal

(b) where the third party comes to know about the existence of the principal he can sue the

agent or the principal.

principal surfaces and intervenes at a later date.

(d) third party has a right to refuse, if the principal discloses himself, on the ground that had

he known about the principal he would not have entered into the contract.

1.70 Principal’s Liability for Agent’s Act to Third Parties

The liability of the principal to third parties would fall under following categories -

(a) When agent acts within the scope of his authority: The principal is liable for the acts

of the agent done within the scope of his actual or apparent authority. Where there are

specific restrictions on the authority of the agent, then the principal is not bound by it.

The Indian Contract Act, 1872 1.97

(b) Principal is bound by notice given to agent: The principal is bound by the notice given

to the agent. Knowledge of the agent is knowledge of the principal. Knowledge of a bank

manager is knowledge of the bank. Therefore the principal is bound except where the agent

does acts that are fraudulent.

bound by the same doctrine.

(d) Liability for misrepresentation: The principal is liable for any fraud or

misrepresentation done by the agent within his authority regardless of the fact that the act has

resulted in benefit to the agent or the principal.

No liability where agent exceeds the authority

The principal is not liable for acts of agent done in excess of authority. Some times the acts

can be separated as ‘within the authority’ and ‘beyond the authority’. Principal is bound for

those acts which are within the authority. But where acts are not separable, the principal may

repudiate the entire transactions.

(e) Unnamed principal: Where the existence of the principal is known but his name is not

known, the principal is liable for the acts of the agent. Third parties can sue the principal for

the acts of the agent, unless agent refuses to disclose the identity of the principal.

1.71 Termination of Agent’s Authority.

The termination of the agency arises and is based on the doctrine of revocation.

In terms of Section 201 of the Act, following are the circumstances when the authority

conferred on the agent gets terminated:

(a) Revocation of authority by the principal

(b) Renunciation of agency by the agent

(d) Death or insanity of principal or agent and

(e) Insolvency of the principal

The rights of the principal to revoke the authority of the agent and the right of the agent to

renounce are each exercised at their will and pleasure.

Following are the general principles in this regard:

(a) Even where the agent gets interested in the subject matter, that would not be a ground

for the principal to terminate the agency. The agency becomes an agency coupled with

interest.

1.98 Business Laws, Ethics and Communication

(b) The principal cannot revoke the authority after the authority has been exercised.

(d) Where there is an implied or express contract, agency may continue for a period of time.

The agency can not be terminated without compensation.

(e) Reasonable notice must be given for termination, otherwise the agent is entitled for

compensation.

(f) Revocation and Renunciation must be express or implied.

1.72 Irrevocable Agency

Where the agency cannot be terminated, it is called irrevocable agency.

(a) Where agency is coupled with interest then it is a case where the agent has interest in

the subject matter of agency. In this case, agency cannot be terminated except where

there is an express provision, to cause prejudice to the interest of the agent. For the

agency coupled with interest does not come to an end on the death, insanity, or the

insolvency of the principal.

(b) Where the agent has incurred personal liability, principal cannot revoke the agency

leaving the agent to face the liability. For instance where ‘A’ appoints ‘B’ as his agent

and ‘B’ purchases as per orders of ‘A’ some rice in his personal name, A cannot revoke

the authority

where ‘A’ appoints ‘B’ as his agent to procure 10 bags of rice and ‘B’ procures in the

name of ‘A’ then ‘A’ cannot revoke his authority.

1.73 Sub- Agent

Sub agency refers to case where an agent appoints another agent. The appointment of sub

agent is not lawful, because the agent is a delegatee and a delegatee cannot further delegate.

This is based on the Latin principle “delegatus non potest delegare”.

The appointment of a sub agent would be valid if the terms of appointment originally

contemplated it. Sometimes customs of the trade may provide for appointment of sub agents.

In both these cases the sub agent would be treated as the agent of the principal.

Position of sub agent vis a vis third parties where the sub agent is properly appointed

(a) Where the sub-agent is properly appointed: Where a sub agent is properly appointed,

the principal is bound by his acts and is therefore responsible to third parties as if he were an

agent originally appointed by the principal.

The Indian Contract Act, 1872 1.99

(b) In the case of appointment without authority: In case where the appointment of sub

agent takes place without authority, the principal is not bound by the acts of sub agent and

sub agent is not bound to the principal. It is the agent who is the principal of sub agent.

Where the sub-agent purportedly acts in the name of first principal, that first principal may

ratify the act of sub agent. However if the sub agent acts in his own name or in the name of

the agent who has without authority delegated to the sub agent the business which is in fact

of the principal, the principal cannot ratify such acts of sub agent.

1.74 Substituted Agent

Substituted agents are not sub agents. They are agents of the principal. Where the principal

appoints an agent and if that agent identifies another person to carry out the acts ordered by

principal, than the second person is not to be treated as a sub agent but only as an agent of

the original principal.

For example, ‘A’ directs ‘B’ his solicitor to sell his property by auction and ‘B’ appoints ‘C’ an

auctioneer. In this regard, ‘C’ is an agent of ‘A’ and not a sub agent.

While selecting a “substituted agent” the agent is bound to exercise same amount of diligence

as a man of ordinary prudence and if he does so he will not be responsible for acts or

negligence of the substituted agent.

For example ‘X’ consigns goods to ‘Y’ a merchant for sale. ‘Y’ in due course employs an

auctioneer in goods to sell goods of ‘X’ and also allows him to receive the proceeds of sale.

The auctioneer becomes insolvent afterwards without handing over the proceeds. Here ‘Y’ will

not be responsible to ‘X’ as he has discharged his duties as a man of ordinary prudence and

diligence.

Key Points

♦ Agency- Relation between an agent and his principal created by an express/ implied

agreement authorising an agent by his principal to create contractual relations with third

parties. Person so appointed to represent the principal is called as agent whereas a

person who appoints an agent to represent him as per his directions and authority is

called as principal.

♦ Any person (competent/incompetent to contract) can be appointed as agent whereas

principal needs to be competent to contract.

♦ Mode of creation- Agency can be either expressed or implied. It also arises by

subsequent ratification or acceptance of the agent acts by the third person without the

authority of the principal. Where a prinicipal by his conduct or act causes a third person

to believe that a ceratin person is his authorized agent, the agency is created by

estoppel. The agency which is the result of principal’s conduct as to the agent, there

agency is said to be created by holding out. Agency by necessity comes into existence

1.100 Business Laws, Ethics and Communication

when certain circumstances compel a person to act as an agent for another without his

express authority. It also arise by operation of law.

♦ Undisclosed principal- Where agent not discloses the existence of his principal and the

fact of his being agent of the principal, there the principal of such agent is known as

undisclosed principal. Where agent discloses his representation to the principal but not

discloses the principal’s name, there the principal is known as unnamed principal.

♦ Sub-agent-person appointed by the original agent in the business of agency under his

direction and control and being responsible to the principal for acts of a sub-agent.

♦ Substituted agent/Co-agent –person is named by the agent expressely or impliedly to act

for the principal in the business of agency.

♦ Irrevocable agency- agency which cannot be terminated by the prinicipal.

1 1872 Chapter The Indian Contract Act 2

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