Law of Contracts

Introduction

The law of contracts deals with agreements, which can be enforced through law courts. Law of contracts is the most important branch of mercantile law. It affects every person in the society. It affects us in every walk of our life every day.

The law of contract determines the circumstances in which promises made by the parties to a contract shall be legally binding on them.

However, the law of contract is of immense importance to people engaged in trade, commerce and industry as all their transactions are based on contracts.

The object of the law of contracts is to introduce definiteness in commercial and other transactions, and to ensure the realisation of reasonable expectation of the parties who enter into a contract.

Sir William Anson observed that: As the law relating to property had its origin in the attempt to ensure that what a man has lawfully acquired he shall retain, so the law of contract is intended to ensure that what a man has been led to expect shall come to pass; and that what has been promised to him shall be performed.

The Indian Contracts Act, 1872, governs the general law of contracts in India.

Law Anterior to Indian Contract Act

Before 1872 there was no uniform law on contracts.

The Charters of eighteenth century, which established Court of Justice for the three presidency towns of Calcutta, Madras and Bombay introduced into their jurisdictions the English common and statute law in force at that time so far as it was applicable to Indian circumstances. The indiscriminate application of English law to Hindus and Mohammadans within the jurisdiction of the Supreme Courts led to many inconveniences. To obviate this, the statute of 1781 empowered the Courts of Madras and Bombay to determine all actions and suits against the inhabitants of the said towns, provided that their succession and inheritance to lands, rents and goods and all matters of contract and dealing between the parties should be determined in the case of Mohammadans by the law and usages of Mohammadans and in case of Hindus by the law and usages of Hindus and where one of the parties was Hindu and the other Mohammedan, by the laws and usages of the defendant.

Besides, the Courts were bound, in absence of any specific rule, to decide according to justice, equity and good conscience. In the matters of contract, when they were not in conflict with these principles, the rules of English Law were also freely applied.

This practice continued invariably till the Indian Contract Act was enacted in 1872.

The Indian contract act, 1872

In 1865 Indian Law Commission in England drew the first

draft of law of contract.

The Indian Contract Act endeavours to codify the chief rules relating to the formation, rectification and discharge of all agreements enforceable by law made between two or more persons by which rights are required by one or other. It was enacted mainly with a view to ensure reasonable fulfillment of

Introduction to Law of Contracts | 3

expectations created by the promises of the parties and also en- forcement of obligations prescribed by an agreement between the parties. The Act states the circumstances under which a valid contract shall come into force and the rights and liabili- ties of parties under it.

The Act also aims at making the principles and practices relating to business transactions uniform throughout the country.

The Act came into force from 1st day of September, 1872 and applies to the whole of India except the state of Jammu and Kashmir.

Scheme of the Indian Contract Act

The Indian Contract Act deals with:

The general principles applicable to all contracts;

The conditions, which are essential for making a valid contract;

The principles applicable to quasi-contracts;

The principles, which are applicable to a few special contracts, namely,

the contracts of indemnity,

the contracts of guarantee, and

the contracts of bailment and agency.

The principles and provisions related to the contracts of sale of goods and partnership are no longer part of the Indian Contract Act, 1872, as separate statutes have been enacted to deal with these two subjects.

The Indian Contract Act is not Exhaustive

The Indian Contract Act 1872 is neither exhaustive nor retrospective. Neither does it deal with all the branches of contracts nor does it affect contracts, which were entered, before 1st September, 1872.

The Act defines and amends only certain parts of the law relating to contracts. It deals only with general principles of the law of contracts and some special contracts, such as those of indemnity, guarantee, bailment and agency. Contracts implied by law, i.e. quasi contracts also come under its purview, but a large number of other contracts are outside its scope, as there are special laws regulating them e.g. the Transfer of Property Act deals with contracts relating to transfer of immovable property; the Negotiable Instruments Act regulates contracts relating to cheques, bills of exchange and promissory notes.

The Sale of Goods Act deals with contracts of sale of goods; the Partnership Act deals with partnership agreements and the Insurance Act deals with contracts relating to insurance etc..

The present Contract Act does not affect particular customs and usages of trade, unless otherwise specifically agreed to by the parties. Thus, usages and customs of trade may prevail notwithstanding their inconsistency with the provisions of this Act.

Contract Act Deals with Right in Personem Only

The rights of a person are classified into two types:

Rights in rem- i.e those rights, which are available to a person against the whole world. For example, the owner of a house has right of quite possessions and enjoyment against the whole world.

Rights in personem- i.e those rights, which are available to a person only against another particular person. For example, where a person lends some money to another, he has right to recover that money from that another person only.

The Indian Contract Act deals with the right in personem

only and does not deal with the rights in rem.

General Principles of Contracts

What is a Contract?

A contract is an agreement enforceable by law, which offers personal rights and imposes personal obligations, which the law protects and enforces against the parties to the agreement.

Definition of Contract

Section 2(h) of the Indian Contract Act defines a contract as an agreement enforceable by law.

The Blacks Law Dictionary defines a contract as an agreement between two or more parsons, which creates an obligation to do or not to do any particular thing.

Salmond defines a contract as an agreement creating and defining obligations between the parties.

Sir William Anson observes, A contract is an agreement enforceable at law made between two or more persons, by which rights are acquired by one or more to acts or forbearances on the part of the other or others.

According to Sir Frederick Pollock, Every agreement and promise enforceable at law is a contract.

David M. Walker defines contract as an agreement between two or more persons intended to create a legal obligation between them and to be legally enforceable.

Essential Elements

From the definitions of contract, it is clear that every contract

must have three essential elements:

An Agreement

Two parties, and

Some Legal Obligation.

A contract creates rights and obligations between the parties to the contract, which are correlative. Refusal by one party to honour a contracted obligation gives rights of action to the other party.

An Agreement

An  offer  when  accepted  becomes  an  agreement.  Thus,  an agreement implies an ‘offer’ and ‘acceptance’.

The term ‘offer’ means the willingness of a person to do or not to do something and its communication to the other, while acceptance means assent by the party to whom the offer has been made.

Example

If A says to B that he is willing to sell him his house for a sum of Rs. 10,000, it is an offer from A, if B gives his assent to this offer, it will be said that he has accepted the offer and an agreement will come into existence.

For a valid agreement, parties must agree upon the same thing in the same sense.

Two Parties

There are two parties to a contract; one who makes the promise and the other to whom the promise is made.

The person, who makes the promise, is known as the Promisor and the person to whom the promise is made is known as the Promisee. As a matter of fact, in a contract, each party is a promiser as well as a promisee.

Example

When A promises to sell his house for a sum of Rs. 50,000 to B, A is a promisor because he has promised to sell his house while he is also a promisee because there is a promise from B to pay a sum of Rs. 50,000 to him. The same is also applicable to B.

Legal Obligation

An agreement should give rise to a legal obligation, i.e. obligation which is enforceable at law.

Agreements, which give rise only to domestic or social obligations cannot be termed as contract. An agreement to go to attend a marriage ceremony is not a contract as it does not give rise to any legal obligation. They are often not intended to be binding in law.

However, parties standing in a domestic or social relationship may enter into an enforceable contract if they have intended their agreements to have legal consequences.

According to Lord Atkin, "the most usual form of agreements, which do not constitute a contract, are the agreements made between husband and wife. They are not contract because the parties do not intend that they should be attended by legal consequences. But, where A agrees with B to supply him 1,000 bales of cotton at Rs. 100 per bale, there is a contract because if any party is not prepared to fulfill his part, the other party can have recourse to legal remedies.

However, there are certain other essential elements of a valid contract, which are discussed hereunder:

Essential Elements of A Valid Contract

Section 2(h) of the Indian Contract Act defines a contract as an agreement enforceable by law. In order that an agreement may be enforceable at law, it is necessary that it satisfies certain essentials of a valid contract.

According to Section 10 of  the  Act,  All  agreements are contracts if they are made by the free consent of parties, competent to contract for a lawful consideration and with a lawful object, and not hereby expressly declared to be void.

Thus, the following are the essential elements of a valid contract:

Agreement i.e. proposal and acceptance.

Intention to create legal relationship.

Free consent.

Capacity of parties.

Lawful consideration.

Legal object.

Not expressly declared void.

Certainty.

Possibility of performance.

Legal formalities.

1.  Agreement—Proposal and its acceptance

For a valid contract it is necessary that there must be at least two parties because one person cannot enter into an agreement with himself. There must be a lawful offer by one party and a lawful acceptance of that offer by the other party thus resulting in an agreement. The terms of offer and acceptance must be unconditional and in accordance with the mode prescribed and must be communicated to the proposer.

2.  Intention to create legal relationship

There must be an intention to create legal relationship i.e. a duty or obligation enforceable by law.

Agreements of a moral or social nature do not contemplate legal relations and as such they are not contracts. An agreement to dine at a friend’s house or to go to a movie together are social agreements and there is no intention to create legal relationship.

Agreements between husband and wife are of the domestic nature where there is no intention to create legal relationship. The case of Balfour vs Balfour is worth noting in this connection.

In this case the husband, who was employed in Ceylon, made a promise to his wife to send her £30 every month for her maintenance. Later on, the husband failed to send the money. The wife sued her husband for breach of agreement. She could not succeed because it was not a contract since there was no intention to create legal relationship.

The intention of the contracting parties is to be seen from the terms of the agreement and the surrounding circumstances. It is for the law courts to decide whether there was an intention to create legal relationship.

In social agreements, we always presume that  there was never any intention to create legal obligations. But in commercial agreements, there is always a presumption to create legal obligations. But even in commercial agreements, if the parties have expressly agreed that the agreement shall not give rise to legal consequences, then even a business agreement will not become a contract.

Case Law

In the case of Rose & Frank Co. vs J.R. Crompton, the agreement contained the clause: This agreement is not entered into as a formal legal agreement and shall not be subject to legal jurisdiction in the law courts . It was held that there was no binding contract as there was no intention to create legal relationship.

3.  Free consent

For the creation of a valid contract, it is essential that the consent of the parties must be free. ‘Consent’ means that the parties must have agreed upon the same thing in the same sense (Sec. 13).

The consent is said to be free when it is not caused by

coercion, undue influence, fraud, misrepresentation or mistake.

If the consent of a party is obtained by any of the first four factors, the contract could be avoided by the aggrieved party. If the agreement is caused by mistake which is material to the agreement, then the agreement will be void.

4.  Capacity of parties

For a contract to be valid, the parties must have the legal capacity to enter into a contract. Every person is competent to contract if he (i) is of the age of majority, (ii) is of sound mind, and (iii) is not disqualified from contracting by any law to which he is subject. In other words, every person, who has attained the age of majority, who is of sound mind and who is not subject to any legal disqualifications, is competent to enter into a valid contract.

The legal presumption is that every party to the contract is competent to contract unless contrary is proved and the presumption is rebutted. Incompetency must be proved by the party claiming the benefit of it and until proved the ordinary presumption shall hold good.

5.  Lawful consideration

An agreement to be enforceable by law must be supported by consideration. The term ‘consideration’ means something in return. It is said to be the price paid by one party for the promise of the other. The agreement shall be enforceable only when both the parties give something and get something in return.

The consideration need not necessarily be in cash or in kind. It may be an act (doing something) or forbearance (not doing something) or a promise to do or not to do something. It may be past, present or future, but the consideration must be lawful.

The consideration must be real i.e. it must have some value in the eyes of law but it need not be adequate.

6.  Lawful object

For a binding contract, the object of the agreement must be

lawful. The object of the agreement must not be fraudulent or illegal or immoral or opposed to public policy or must not imply injury to the person or property of another. If the object is unlawful the agreement will be void. Thus, if A engages B to cause some damage to the property of X for a consideration of Rs. 5,000. Here the promise cannot be enforced because the object is unlawful.

7.  Not expressly declared void

The agreement must not have been expressly declared to be void under the Act. The Act has specifically declared certain type of agreements to be void. For example, an agreement in restraint of trade, wagering agreements, agreements in restraint of marriage have expressly been declared void by the Act.

8.  Certainty

The agreement must be certain and it must not be vague or uncertain. If the meaning of the agreement is not certain or it cannot be ascertained, the agreement shall be void by the Act.

For example, A agrees to sell a horse to B, here it is not clear as to which horse is to be sold, hence the agreement is void for uncertainty.

9.  Possibility of performance

The agreement should be such that is is capable of performance. If an agreement is made to do an act which is impossible in itself, the agreement shall be void.

For example, A agrees with B to double his money by magic, since this is impossible, the agreement shall be void.

10.  Legal formalities

A contract may be oral or in writing. But if the law requires a particular contract to be written and registered, then it must comply with the legal formalities. If these legal formalities are not carried out, then the contract shall not be enforceable at law.

For example, as per Arbitration Act, the arbitration agreement must always be in writing, similarly under the Transfer of Property Act, the agreement to be enforceable must be in writing and registered.

If any one of the above mentioned essential is missing then the agreement shall not be enforceable.

All Agreements are not Contracts but all Contracts are Agreements

When an offer made by one person is accepted by another person, an agreement takes place.

The Indian Contract Act defines a contract as "an agreement

enforceable by law."

Thus for a contract there must be two things: (1) an agreement, and (2) enforceability by law. There can be agreements which are not enforceable by law, such as social, moral or religious agreements. When A invites B for a cup of tea or they agree to go for a walk together, these are social agreements and they are not enforceable because they do not create legal relationship.

Thus to become a contract, the agreement must be capable of creating legal obligations between the parties.

The agreement is a wider term than the contract. All agreements need not necessarily become contracts but all contracts shall always be agreements.

All Agreements Are Not Contracts

When there is an agreement between the parties it is not necessary that they intend to create legal relationship. For example, A invites B to see a football match and B agrees. But A could not manage to get the tickets for the match, now B cannot enforce this promise against A i.e. no compensation can be claimed because this was a social agreement where there was no intention to create legal relationship.

The case Balfour vs Balfour (1919) 2 KB 571 is a landmark case in this connection. The details of this case are as follows:

The husband, who was employed in Ceylon, made a promise to this wife to send her £30 every month for her maintenance. Later on the husband failed to send the money. The wife sued her husband for breach of agreement. She could not succeed because it was not a contract since there was no intention to create legal relationship.

Lord Atkins observed while deciding this case that in agreements between husband and wife there is never any intention to create legal relationship. Thus it is right to say that all agreements are not contracts.

All obligations also do not constitute contracts

Any obligation, which arises independently of an agreement, cannot be the basis of a valid contract. According to Anson, only that obligation is a contract which directly contemplates and creates an obligation and is intended to have any legal consequences. Obligation to maintain wife and children does not arise out of contract.

Therefore, a contract results from a combination of agreement and obligation. But, it is not necessary that all agreements should create an obligation between the parties. An agreement may exist without any legal obligation, but a contract cannot. In order that an agreement should be a contract, it must create legal obligation on both the parties. It must impose compulsion upon a person or persons to do or not to do a certain act.

Obligation may also relate to either social or legal matters. But the law of contract is confined only to such legal obligations as are traceable only to agreements. Agreements giving rise to social obligations will also not constitute binding contracts. Obligations arising from a trust, a decree or from statutes do not fall within the scope of Contract Act. According to Sir John Salmond, "the law of contracts is not the whole law

of agreements nor is it the whole law of obligations. It is the law of those agreements which create obligations, and those obligations which have their sources in agreements."

All contracts are agreements

We cannot think of a contract without having an agreement. To create a contract there must be an agreement. Therefore, it is true to say that all contracts are agreements.

Thus, we can say that when an agreement is enforceable by law a contract comes into existence. There can be an agreement without it becoming a contract, but we cannot have a contract without an agreement.

Classification of Contracts

Classification of Contracts

Section 2 of the Act, which is called the ‘interpretation clause’, besides defining a contract in clause (h), also provides the basis for the classification of contracts.

Contracts may be classified as follows:

On the basis of enforceability:

Valid contracts

Void contracts

Voidable contracts

Illegal contracts

Unenforceable contracts

On the basis of mode of creation:

Express contracts

Implied contracts

Quasi contracts

On the basis of the extent of execution:

Executed contracts

Executory contracts

On the basis of the form of the contract:

Formal contracts

Simple contracts.

Classification of Contracts on the Basis of

Enforceability

(a)  Valid contracts

A contract, which satisfies all the legal requirements laid down in Section 10 of the Act, is a valid contract. Such a contract creates rights in personem, which can be enforced against the party on whom a legal obligation to do or not to do a definite act is imposed.

(b)  Void contracts

According to Section 2(j) of the Act, "a contract which ceases to be enforceable by law becomes void when it ceases to be enforceable.’

An agreement may be enforceable at the time it was made but, due to certain reasons, it may become void and unenforceable later on. Such agreements are called void contracts.

The examples of void contracts may be given as follows:

(i)  A contract becomes void by supervening impossibility or illegality (Sec. 56).

Example.

On 10 January, A agrees with B to sell him his horse for a sum of Rs. 1,000 on 15 February. The horse dies on 21 January. The performance of the agreement was possible at the time when it was made, but now its performance becomes impossible on account of supervening impossibility. It is, therefore, a void contract.

(ii)  A voidable contract becomes void, when the  party, who had the option to avoid it, decides to repudiate the contract.

Example

A, by exercising coercion over B makes him agree to sell his horse worth Rs. 5,100 for a sum of Rs. 100 only. The agreement

is voidable at the option of B. He may at his option adopt or rescind the contract. In case B decides to rescind the contract, the contract between A and B would be void.

(iii)  A contingent contract to do or not to do something on the happening of an event becomes void when the event becomes impossible (Sec. 32).

Example

A agrees to sell 1,000 tonnes of wheat to B at the rate of Rs. 500 per tonne in case his ship reaches the port safely by 15 February. The ship fails to reach by the stipulated date. The contract between A and B is void.

Void agreement

According to Sec. 2(g), ‘An agreement not enforceable by law’ is said to be void’. Such an agreement does not create any legal rights between the parties. It is void ab initio i.e. from the very beginning.

An agreement made with a minor is void ab initio because a minor is not capable of entering into a valid contract.

Example

A agrees with B, in consideration of Rs, 100, to draw two parallel lines in such a way as to cross each other. The agreement is impossible to perform and therefore, void.

Distinction between Void Agreements and Void Contracts

A void agreement and a void contract are distinct.

A void agreement is altogether void and no rights are created by such an agreement. Such agreement is a total nullity and is destitute of legal effects whatsoever. A void agreement is void ab initio.

A void contract is a contract, which was valid at the time of making, but because of some subsequent events it ceases to be enforceable by law.

Thus, a void agreement is void from the very beginning whereas a void contract is not void from the beginning but becomes void subsequently.

(c)  Voidable contract

According to Sec. 2(i), an agreement which is enforceable by law at the option of one or more of the parties thereto, but not at the option of the other or others, is a voidable contract.

Thus, a voidable contract is one which is enforceable by law at the option of one of the parties and it remains valid till it is repudiated by the party entitled to do so.

A contract becomes voidable when the essential element of free consent is missing. In other words, when the consent of one of the parties to the contract is obtained by coercion, undue influence or a misrepresentation or fraud, the contract is voidable.

In a voidable contract, a right or option is open to the aggrieved party i.e the party whose consent is not free that either to repudiate  the contract  or to abide  by it.  Thus, a voidable contract continues to be valid and enforceable till it is repudiated by the aggrieved party.

Example

A threatens to shoot B if he refuses to sell his horse to A for Rs. 500. B agrees. Here the consent of B is obtained by coercion and this contract is voidable at the option of B. This contract will remain valid till it is repudiated by B.

When we examine Sec 64 of the Act, which lays down the principle of restitution in integrum, i.e. restoring to the original position, it is clear that when the aggrieved party avoids the contract, the other party thereto, need not perform any promise and the party avoiding the contract has to restore any benefi which he has received under the contract, to the other party.

Example

A forces B to sell 100 bags of rice at Rs. 100 per bag, and pays Rs. 2,000 in part payment of the price, B, being the aggrieved party can rescind the contract. However, he has to pay back Rs. 2,000 to B and B need not pay the balance. In effect, this is the same as the parties being put back in their original position as though there was no agreement between them.

The party rescinding the contract is entitled to get damages for any loss, which he might have suffered from the other party on account of that contract. However, in case the aggrieved party has received some benefit under the contract, the same he must be restored to the person from whom such benefit was received.

Distinction between Void Agreements and Voidable Contracts

The following important points of distinction between a void agreement and a voidable contract may be noted:

A void agreement is void from the very beginning. While a void contract is valid at the time, when it is made but because of some subsequent event, such as supervening impossibility or illegality of objects, it becomes void. A voidable contract, on the other hand, is voidable at the option to the aggrieved party, if he decides to repudiate it.

A void agreement is a total nullity. It cannot be enforced at all. A voidable contract, on the other hand, can be enforced till it is repudiated by the aggrieved party.

In case of void agreements restitution is allowed, unless the illegality or the void nature of the agreement comes to the knowledge of the parties at the time of making the agreement. However, in case of a voidable contract, when the contract is rescinded, benefit is restored as far as possible.

In the case of void agreements, the question of compensation does not arise on account of non- performance of the agreement. But in the case of voidable contract if the person