Law of Contracts

Contracts are an important part of commercial law because all commercial law transactions usually begin with an agreement or a contract.

Business transactions involving sale-purchase or exchange of services have become an integral part in day-to-day activities. In such instances, an agreement or a contract is necessary for determining the rights, obligations and liabilities of parties when they enter into any business transaction. The Indian Contract Act is the law governing contracts in India.

According to the Indian Contract Act, 1872, (ICA) an agreement that is enforceable by law is a contract [Section 2(h)]. An agreement, in simple words, is a promise. All agreements are not contracts. Agreements must meet certain criteria - like consideration, parties must be competent, free consent between parties, lawful object, and, not expressly declared void by law, in order to qualify as a contract.

All contracts are agreements but all agreements are not contracts.

In a leading case Balfour v. Balfour (1919, 5 KB 571), the validity of an agreement entered between a husband and wife was in question. The husband and wife went on leave to England and the wife fell ill in England. The doctors who treated the wife advised her to take full bed rest and remain in England in order to continue the treatment. The wife stayed in England. When the leave was over, the husband went to Ceylone where he was employed and promised to send a sum of money to the wife every month for her stay in England. He sent the amount for some time and later on due to differences and misunderstanding between them, the husband stopped sending the amount. The wife initiated action to recover the arrears due to her. The Court dismissed it on the ground that the agreement entered into between the husband and wife was not a contract. The arrangement between the husband and wife was only a moral obligation and the parties never intended to create any legal relationship.

Offer / Proposal and Acceptance

The offer or proposal is the first step in the formation of a contract. When one person signifies to another his willingness to do or not to do certain things, it is called an Offer [Section 2(a) of ICA]. The person making the proposal or offer is called the offeror and the person to whom the offer is made is called the offeree. The offer given must be with an intention to create a legal relationship.

An assent or consent given to an offer by the offeree is known as Acceptance [Section 2(b) of ICA]. By saying 'yes', 'ok' or clicking on 'I agree' on an offer on a website also amounts to acceptance. An offer when accepted becomes an agreement. An agreement is also called as promise.

Offer + Acceptance = Agreement

Illustration: A expresses his willingness to sell his cottage to B for Rs. 5 lakhs. Here, A's willingness is called offer. A is the offeror and B is the offeree. B accepts the offer to purchase the cottage. This is called Acceptance. A's offer when accepted by B becomes an Agreement.

An offer and acceptance must be definite and certain. If the offer or acceptance is not clear enough to conclude a contract, it is considered invalid. Also, an offer and acceptance must be communicated to the other person in order to be valid. A communication in electronic form or over emails also amount to communication of offer and acceptance. An offer lapses by revocation or withdrawal. Any offer can be revoked before acceptance.

In an English case Carlill v. Carbolic Smoke Ball Co. (1893, 1 B 256), the company was the manufacturer of a medicine called smoke ball which was used for the treatment of influenza. The company believed that the medicine completely cured influenza. An advertisement was put up offering a reward of £100 to anyone who got influenza again after using the smoke ball medicine continuously for fifteen days. In the advertisement, it was also stated that £1000 was deposited in a Bank, namely, Alliance Bank for paying the reward if such situation arose. Seeing the advertisement, Mrs. Carlill bought the smoke ball medicine and used it as per the directions provided. Mrs. Carlill got a fresh episode of influenza. Mrs. Carlill sued the company for the reward of £100. The manufacturing company stated that: (1) there was no intention to enter into a legal relationship with anyone through the advertisement, and the advertisement was put up only to boost the marketing of the smoke ball medicine; (2) the advertisement was not an offer as it was not made to any particular person and an offer cannot be made to the public at large or to the whole world; (3) acceptance by the offeree had not been communicated, and so there was no binding contract. The Court rejected these contentions of the company and allowed Mrs. Carlill's claim for £100. The Court also stated that deposit of £1000 in the Alliance Bank by the smoke ball company was evidence that the company had real intention to enter into a legal relationship with anyone who accepted the offer. An offer can also be made to the world at large. It is called a general offer and it is valid. In the case of general offer, there is no need for communicating acceptance to the offeror. Merely fulfilling the conditions of the offer itself is treated as acceptance to create a contract.

Consideration

Consideration is an important element in a contract. A contract without consideration is not valid. Consideration means 'something in return' for the offer. Consideration can be in the nature of an act or forbearance. The general rule is that, an agreement without consideration is void and not enforceable by law because in such cases, one party is getting something from the other without giving anything to the other. There should always be a mutual consideration.

In other words, each party must give and also take. There are exceptions to this general rule in certain situations such as a written and registered agreement out of natural love is not void, even if it is without consideration. Consideration need not be adequate, but should be real. Consideration may be past, present or future and should not be illegal, immoral or opposed to public policy.

Illustration: A offers to sell his car for Rs.50,000 to B. B accepts the offer. In this case, the consideration of A is his car and the consideration of B is Rs.50,000.

Illustration: A, for natural love and affection, promises to give his son, B, Rs.1,000. A puts his promise to B in writing and registers it. This is a contract and absence of consideration does not make it void.

In an Indian case - Durga Prasad V. Baldeo (1880, 3All 221), the plaintiff constructed some shops at the request of the District Collector in a town. The constructed shops were given for rent for doing business to the defendant. The defendant, apart from the rent, promised to give 5% commission to the plaintiff on all articles sold through the shop in consideration of the huge amount spent by the plaintiff in the construction of the building. The defendant failed to pay the commission and the plaintiff initiated action to recover the commission. The Court rejected the action of the plaintiff on the ground that the construction of shop was done at the desire of the District Collector and not on the desire of the defendant and hence there was no consideration to give commission. Accordingly, there is no valid contract to pay commission to the plaintiff.

Capacity to Contract

Any person who is a major, i.e., above 18 years of age, is competent to enter into a contract and minors are not competent to enter into a contract. The exception to this rule is that, if a minor enters into a contract and the enforcement of such contract is beneficial for the minor then it will not be held to be void.

Furthermore, a person should also have a sound mind and should not be disqualified by any law in force. At the time of making the contract, if the person is capable of understanding the contract and making a rational judgment, he is said to have a sound mind. The following persons are not competent to enter into a contract:

Minor - Persons who are less than 18 years of age
Persons with unsound mind - (a) Idiots, (b) Lunatics, (c) Drunkards
Persons disqualified by law - (a) Alien enemies, (b) Foreign sovereign, (c) Insolvents, (d) Convicts, (e) Corporation, (f) Barristers

Illustration: A (major) offers to sell his coat for Rs.3,000 to B (minor). B accepts the offer and pays Rs.3.000. A states that the contract is entered into with a minor and hence void. In this case, even if the contract is entered into with a minor, it is enforceable because it is beneficial to the minor and the minor has performed his part of the obligation in the contract.

Consent

Consent is an important criterion while entering into a contract. When two persons agree on the same thing in the same sense, it is termed as consent [Section 13]. Consent should be free and not caused by coercion, undue influence, misrepresentation, fraud or mistake. If consent is obtained by the influence of any one of the above said, then the consent so obtained is not free. It becomes voidable (avoid enforcement of contact) for the person whose consent is not free.

Illustration: A threatened to kill B if he does not sell his house to A. B out of fear signs the contract for selling his house to A. Here, the consent of B is not free. B can later avoid the sale on the ground that he was compelled to agree to the sale and the consent given was not free consent.

Unlawful Agreements

If the object of the agreement is to perform an unlawful act, then the contract is unenforceable. The object of the agreement should not be illegal, immoral or opposed to public policy.

Illustration: A enters into an agreement with B to share the profits by giving false assurance to the public to get them a job in Singapore. The agreement involves cheating which is a fraudulent act. The agreement is unlawful and hence it is void.

As per the Indian Contract Act, agreements entered into which are against public policy of the State are said to have an unlawful object and hence are unlawful agreements making them unenforceable.

Illustration A agrees to give to B Rs.1,000 as penalty if minor daughter is not given to A in marriage. This agreement is opposed to public policy and not enforceable.

As per the Indian Contract Act, agreements entered into by way of wager are not enforceable. Wager is a contract where one person promises to pay the other money on the happening of an uncertain future event and the other person promises to pay on the non-happening of the event. There is a reciprocal promise involved in a wager. Wager is like a bet where the happening of an uncertain event is the condition on which the promise depends.

Illustration: A agrees to give Rs.1,000 to B if India wins the match on 24th August. B agrees to pay A the same amount if India does not win the match. The agreement is a wager and it is void.

Contingent Contract

Contingent contract, also called as Conditional contract, is a contract to do something or not to do something on the happening or non-happening of an event, which is collateral to the contract. Contingent contracts cannot be enforced until the uncertain future event happens. If the uncertain future event becomes impossible, contingent contracts become void.

Illustration: A agrees to sell his farm land to B if he wins the case involving his farm land. This is a case of contingent contract because the performance of the contract is based on the happening of an uncertain event. The uncertain future event is winning the case.

Unlike wager, in contingent contract, there is no reciprocal promise. Third parties may have an interest in contingent contract.

Discharge of Contract

Mutual obligations of parties are created in a contract. When the mutual obligations of the parties are fulfilled, the contract comes to an end. When the contract is ended, it is said to be discharged. In other words, Discharge means termination of the contractual relations of the parties to the contract.

Discharge of a contract may be done by the following ways:

Discharge by Performance
Discharge by Agreement or Consent
Discharge by Impossibility of Performance
Discharge by Lapse of time
Discharge by Operation of law
Discharge by Breach of contract

Discharge by Performance

When parties to a contract perform their obligations and fulfil their promises, the contract gets discharged by performance.

Illustration: An offer to sell his dining set to B for Rs.10,000, B pays Rs.10,000 to A and A delivers his dining set to B. Here the contract gets discharged by performance as both the parties fulfilled their promises.

Discharge by Agreement or Consent

(a) Novation - A new contract is substituted for an old contract.

(b) Rescission - Certain terms or all terms of a contract are cancelled.

(d) Remission - Acceptance is made to a promise but not on the complete terms of the promise but to a lesser fulfilment of the promise.

(e) Waiver - Parties to a contract abandon their mutual rights.

(f) Merger - Certain terms of a contract or all the terms of a contract are merged into another contract with the consent of the parties.

Illustration: A enters into an agreement with B for buying certain machine parts for their project. Before the agreement ends, A and B change certain terms of the agreement and include those terms in the agreement. This is a case of Discharge by agreement.

Discharge by Impossibility of Performance

Performance of a contract can become impossible with or without the knowledge of the parties to the contract. It can also become impossible subsequently after the parties have entered into a contract. It can also happen by Supervening impossibility [Section 56]. Supervening impossibility takes place by the following:

Destruction of the subject matter
Death or incapacity
Non-existence of state of things having an effect directly or indirectly on the contract
Outbreak of war
Change or amendments in law

Illustration: X agreed to sell his car to Y for Rs. 1 lakh and deliver it after two months. After a week, X met with an accident and car got completely destroyed. The contract gets discharged by impossibility of performance as the car was completely destroyed.

Discharge by Lapse of Time

Time is very significant while entering into a contract. According to the Limitation Act, a contract should be performed within a specified time called period of limitation. If the contract is not performed within the specified time and the other party does not resort to any action within the limitation period, then he is deprived of his remedy and the contract gets discharged by lapse of time.

Discharge by Operation of Law

The following are instances where a contract gets discharged by operation of law:

Death of either of the parties
Insolvency
Merger
Unauthorized alteration of the terms of the agreement

Discharge by Breach of Contract

Breach means failure to perform the obligation by a party. When a party to a contract does not perform his part of the obligation due to which the contract becomes broken, the person who suffers because of the breach is entitled to receive compensation or damages from the party who has breached the contract [Section 73].

Illustration: A agrees to supply 20 litres of oil to B on 1st June. On 1st June, A does not supply the oil. Then A has breached the contract. Suppose A has supplied the oil but B does not accept the oil, then B has breached the contract. In the first instance, B is entitled to receive compensation from A. In the latter instance, A is entitled to receive compensation from B.

Damages

Remedy is a means given by law for the enforcement of the right of a person. A common remedy for breach of contract is awarding damages to the affected party. Monetary compensation given to the affected party for the loss or injury caused to him due to the breach is called damages. The objective of awarding damages by the court is to put the injured party in the same position as he would have been if the contract had not been breached.

This, under the contract law, is called the Doctrine of Restitution. The basis of this Doctrine is awarding damages for the pecuniary loss incurred by the party to the contract.

Illustration: A agrees to deliver 40 bags of rice to B for Rs.20,000 on 5th July. On 5th July, A delivers only 20 bags of rice to B. B is entitled for damages from A for the loss that he suffered because of A (non delivery of 20 bags of rice).