Legal Aspects of Business
Unit 1
Unit 1Structure: 1.1 Introduction Objectives 1.2 Meaning and
Nature of Law Characteristics of law Law and morality Ignorance of
law is no excuse 1.3 Sources of Indian Law Primary sources of
Indian law Secondary sources of Indian law 1.4 Legal Environment of
Business 1.5 Mercantile Law Meaning and nature Objectives Sources
of Indian business law 1.6 Some Basic Legal Concepts Concept of
legal entity Concept of legal rights Concept of property
Intellectual Property Rights (IPR) Concept of ownership Concept of
possession 1.7 Essentials of Law 1.8 Summary 1.9 Terminal Questions
1.10 Answers
Law
1.1 IntroductionThis unit, you begin by answering the question,
What is law? This the meaning and nature of law. The classification
of law, such as and criminal law; substantive and procedure law is
illustrated. In you also study the different sources of Indian law
such as precedents and the legislation. involves civil law this
unit custom,
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Objectives This introductory unit on law will help you get
familiar with the concept of business law and other basic legal
concepts related to law. After studying this unit, you should be
able to:
Explain the nature of law Describe sources of Indian law Define
business legal environment and mercantile law Analyze the
essentials of law
1.2 Meaning and Nature of LawThe term law is used in many
senses: you may speak of the law of physics, mathematics, science,
or the laws of the football or health. In its widest sense, law
means any rule of conduct, standard or pattern, to which actions
are required to conform; if not conformed, sanctions are imposed.
When we speak of the law of a State, we use the term law in a
special and strict sense. 1.2.1 Characteristics of law 1. Law is a
body of rules. These rules prescribe the conduct, standard or
pattern to which actions of the persons in the state are required
to conform. However, all rules of conduct do not become law in the
strict sense. We resort to various kinds of rules to guide our
lives. For example, our conduct may be guided by a rule such as do
not be arrogant or do not be disrespectful to elders or women.
These are ethical or moral rules by which our daily lives are
guided. If we do not follow them, we may lose our friends and their
respect, but no legal action can be taken against us. 2. Law is for
the guidance or conduct of persons both human and artificial. The
law is not made just for the sake of making it. The rules embodied
in the law are made, so as to ensure that actions of the persons in
the society conform to some predetermined standard or pattern. This
is necessary so as to ensure continuance of the society. No doubt,
if citizens are self-enlightened or self-controlled, disputes may
be minimized, but will not be eliminated. Rules are, therefore,
drawn up to ensure that members of the society may live and work
together in an orderly manner. Therefore, if the rules embodied in
the law are broken,Sikkim Manipal University Page No. 2
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3.
4.
5.
6.
7.
8.
compulsion is used to enforce obedience, and certain
consequences ensue. Law is imposed. Law is imposed on the members
to bring about an order in the group, enabling it to continue and
prosper. It is not something which may or may not be obeyed at the
sweet will of the members of society. If you cannot impose a rule
it is better not to have it. Thus, law is made obligatory on the
members of the society. Law is enforced by the executive.
Obviously, unless a law is enforced it ceases to be a law and those
persons subject to it will regard it as dead. For example, if A
steals Bs bicycle, he may be prosecuted by a court and may be
punished. Also, the court may order the restitution of the bicycle
to its rightful owner i.e., B. If the government passes many laws
but does not attempt to enforce them, the citizens lose their
respect for government and law, and society is greatly weakened.
The force used is known as sanction which the state administers to
secure obedience to its laws. The state. A state is a territorial
division, with people therein subject to a uniform system of law
administered by some authority of the state. Thus, law presupposes
a state. Content of law. The law is a living thing and changes
throughout the course of history. Law responds to public opinion
and changes accordingly. Law can never be static. Therefore,
amendments are made in different laws from time to time. For
example, the Monopolistic and Restrictive Trade Practices Act,
1969, has been subjected to many amendments since its inception in
1969. Two basic ideas involved in law. The two basic ideas involved
in any law are: (i) to maintain some form of social order in a
group and (ii) to compel members of the group to be within that
order. These basic ideas underlie formulation of any rules for the
members of a group. A group is created because first, there is a
social instinct in the people to live together and secondly, it
helps them in self-preservation. Rules are made by the members of
the group, so that the group doesnt whither away. Law is made to
serve some purpose which may be social, economic or political. Some
examples of law in the widest sense of the term. Law in its widest
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etiquettes, the non-observance of which may lead to public
ridicule, (ii) Law of the Land the non-observance of which may lead
to arrest, imprisonment, fines, etc., (iii) Rules of international
law, the non-observance of which may lead to social boycott,
trade-sanctions, cold war, hot war, proxy war, etc. 1.2.2 Law and
morality It was stated earlier that one of the characteristics of
law is that it is for the guidance or conduct of persons. This is
so in the case of morality also as there is a close relationship
between the two. In fact law not only has its origin in morality,
but also is easier to enforce when people yield to government for
moral reasons. However, a person may be morally bound but not
legally. Thus, if a young person does not show respect for an
elderly person on the street, the law will take no action, although
he stands condemned by the moral judgment of people on the street.
On the other hand, the law occasionally has to decide on a person
who is not morally at fault. For example, X appoints Y as his
agent. Y enters into contact with Z on behalf of X. Y commits fraud
in the transaction and thereby injures Z. X is bound to compensate
Z. Further, there are some actions in which both morality and
legality are involved.
Figure 1.1
1.2.3 Ignorance of law is no excuse This is the literal
translation of maxim ignorantia juris non excusat. Every member of
the society is expected that his actions conform to a set
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or standard as reflected in legal rules. For this purpose, he is
presumed to know the legal rules. He cannot take the plea that he
did not know them. No doubt, in practice, he cannot learn and know
all the laws of the land, but he can obtain expert guidance from
those who possess legal knowledge. Thus, he has access to books on
law and to those persons who are experts in legal matters.
Therefore, the maxim ignorantia juris non excusat places a burden
on every member of the society with the knowledge of law. In other
words, Ignorance of law is not a good excuse. Self Assessment
Questions 1. Which one of the following possess the power of
supreme legislation in India: (a) The President; (b) The Lok Sabha;
(c) The Rajya Sabha; (d) The Parliament; (e) The Supreme Court. 2.
A _______________ is a territorial division, with people therein
subject to a uniform system of law administered by some authority
of the state.
1.3 Sources of Indian LawThe main sources of modern Indian Law,
as administered by Indian courts, may be divided into two broad
categories: (i) Primary sources and, (ii) Secondary sources. 1.3.1
Primary sources of Indian law The primary sources of Indian law
are: (a) customs, (b) judicial precedents (stare decisis), (c)
statutes and (d) personal law. Customary law Customs have played an
important role in making the law and therefore is also known as
customary law. Customary Law, in the words of Keeton, may be
defined as those rules of human action, established by usage and
regarded as legally binding by those to whom the rules are
applicable, which are adopted by the courts and applied as sources
of law because they are generally followed by the political society
as a whole or by some part of it. In simple words, it is the
uniformity of conduct of all persons under likeSikkim Manipal
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circumstances. It is a generally observed course of conduct by
people on a particular matter. When a particular course of conduct
is followed again and again, it becomes a custom. Judicial
precedents are an important source of law Judicial precedents are
another important source of law. It is based on the principle that
a rule of law which has been settled by a series of decisions
generally should be binding on the court and should be followed in
similar cases. These rules of law are known as judicial precedents.
However, only such decisions which lay down some new rules or
principles are treated as judicial precedents. Thus, were there is
a settled rule of law, it is the duty of the judges to follow the
same; they cannot substitute their opinions for the established
rule of law. This is known as the doctrine of stare decisis. The
literal meaning of this phrase is stand by the decision. Statute an
important source of law The statutes or the statutory law or the
legislation is the main source of law. This law is created by
legislation such as Parliament. In India, the Constitution empowers
the Parliament and state legislatures to promulgate law for the
guidance or conduct of persons to whom the statute is, expressly or
by implication, made applicable. It is sometimes called enacted law
as it is brought into existence by getting Acts passed by the
legislative body. It is called Statute Law because it is the writ
of the state and is in written form (jus scriptum). Personal law
Many times, a point of issue between the parties to a dispute is
not covered by any statute or custom. In such cases, the courts are
required to apply the personal law of the parties. Thus in certain
matters, we follow the personal laws of Hindus, Mohammedan and
Christians. 1.3.2 Secondary sources of Indian law The secondary
sources of Indian Law are English Law and Justice, Equity and Good
Conscience. English law The chief sources of English Law are: (i)
the Common Law (ii) Equity, (iii) The law Merchant and (iv) The
Statute Law.
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Nowadays, English law is not very important source of Indian
law. The English law, in its application to India, has to conform
to the peculiar circumstances and conditions prevailing in this
country. Even though the bulk of our law is based on and follows
the English law, yet in its application our courts have to be
selective. It is only when the courts do not find a provision on a
particular problem in the primary sources of Indian Law that it my
look to subsidiary sources such as the English Law. For example,
the greater part of the Law Merchant has been codified in India.
The Indian Contract Act, 1872, the Indian Partnership Act, 1932,
the Scale of Goods Act 1930 and the Negotiable Instruments Act,
1882, are some of the very important Acts relating to business
transactions. Where, however, there is some doubt as to the
interpretation of any provisions of these Acts or where certain
branches of the Law Merchant have not been codified, the courts in
India look to English decisions on the point, for guidance.
Justice, equity and good conscience In India we do not have, no did
we ever had separate courts (as in England) administering equity.
But the equitable principles of law, i.e., justice, equity and good
conscience, are the guiding force behind most of the statutes in
our country and the decisions of the courts. Especially, where law
is silent on any point or there is some lacuna in a statute, the
principles of equity come handy to the judges who exercise their
discretion often on equitable considerations. The frequent use of
terms such as good faith, public interest, public policy, in
statutes and by the judges in their judgements is based on
principles of equity. Now we shall briefly describe the main
sources of English law: 1. Common law. This source consists of all
those unwritten legal doctrines embodying customs and traditions
developed over centuries by the English courts. Thus, the common
law is found in the collected cases of the various courts of law
and is sometimes known as case law. 2. Equity. The literal meaning
of the term equity is natural justice. The development of equity as
a source of law occurred due to rigours and hardships of the Common
Law. Therefore, in its technical and narrower sense, equity means a
body of legal doctrines and rules emanating from the
administrations of justice, developed to enlarge, supplement or
override a narrow rigid system of existing law of the land.
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the common law, the equity is unwritten and is a supplement to
common law as a source of law. 3. Statute law. The Statute law
consists of the law passed by the Parliament and therefore, is
written law. The authority of parliament is supreme but is subject
to natural limitations and those laid down by the Constitution. It
can pass any law it pleases and can override its own previous Acts
and the decisions of the courts. Statute law, therefore, is
superior to and can override any rule of Common Law or equity. 4.
The law merchant or lex mercatoria. It is another important source
of law and is based to a great extent on customs and usages
prevalent among merchants and traders of the middle ages. Its
evolution like that of equity can be traced to unsuitability of
Common Law so far as the commercial transactions were concerned.
The Common Law was found to be unsatisfactory in dealing with
disputes between merchants. The merchants, therefore, developed
certain rules based upon customs and usages to govern their
mercantile transactions. These rules were known as Lex Mercatoria
or the Law Merchant. Activity 1: Identify a recent change in the
law which will have a significant impact on business organizations
in general. The change in the law may be in the form of an Act of
Parliament, delegated legislation or judicial decision. Self
Assessment Questions 3. The doctrine of judicial precedent is also
known as the doctrine of: (a) Stare decisis; (b) Obiter dicta. 4.
The important sources of law are custom, precedent, and
legislation. Their appearance in the legal history has been in the
following order: (a) Legislation, custom and precedent; (b) Custom,
precedent and legislation; (c) Precedent, custom and legislation.
5. _____________ means a body of legal doctrines and rules
emanating from the administrations of justice, developed to
enlarge, supplement or override a narrow rigid system of existing
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1.4 Legal Environment of BusinessThe law is almost a universal
human need. No society can exist without a legal order. We need
institutions and a framework of rules and regulations to provide
firmness to our mutual relations. Without law, there would be
complete anarchy in society. That is why we regard rule of law as
the essence of civilised society. It provides certainty to our
relationships. It emphasizes that laws ought to be general in
character so that there is no arbitrariness in their exercise. It
also emphasizes complete equality before law and equal conformity
to law by officials and individuals. Law and business are closely
related disciplines. They complement each other. Law is a major
factor in business decision making. Almost every aspect of business
is regulated by law. Even the installation of a business unit
itself may involve observance of some legal provision or the other.
For instance, in the case of a company, the various provisions of
the Companies Act, 1956 and other allied laws are to be complied
with for incorporation and commencement of business. The contracts
entered into by business with others may be held to be void or may
be against public policy. Certain business practices may amount to
monopolistic, restrictive or unfair trade practices. Products
supplied may be defective. There may be deficiency in the service
provided by business. The agreement between a manufacturer and his
dealers may defeat the provisions of some law or the other.
Sometimes the law may require business to provide certain
facilities to its employees, even when the contract does not
provide therefore. For instance, the provisions of labour welfare
laws impose a legal obligation on employers to provide certain
benefits to their workers. Sometime ago, the Central Government
gave complete freedom to Banks to fix interest rates, which was
obviously aimed at triggering off competition in the Indian
economy. But all nationalized banks in India tried to keep the
prime lending rate artificially high by resorting to cartelisation
which is violative of the MRTP Act, 1969. The banks arrived at the
particular interest rate at the behest of the Indian Banks
Association (IBA) and not by taking into consideration the cost of
raising funds. Thus, the legal environment of business is one of
the major factors in regulating its conduct though some of the laws
may act as facilitators forSikkim Manipal University Page No. 9
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some segment of the business at some time or the other. Almost
every aspect of business is controlled by law. Sometimes even the
nature of the business organization itself imposes legal fetters
right from the time of its formation. The buying and selling,
production, marketing and other functions of the business
enterprise are to be conducted within a certain framework of legal
environment. The decision making process of business, right from
its very inception, will be guided by law. Certain conduct is
illegal, and business which commits acts or omissions declared to
be illegal is subject to sanctions. There may be fines or
imprisonment if the conduct is declared a crime. The sanctions may
include liability for damage if the conduct amounts to a breach of
contract. In addition, the law and legal sanctions may be used to
prevent certain conduct or to require that certain acts be done or
to make business to comply to some requirement. Thus, business
people must take decisions within the framework of law otherwise
sanctions will be imposed. In this way, law is the foundation for
the regulation of all business conduct and decisions. Self
Assessment Questions 6. Law and business are ______________ other.
7. Every aspect of business is controlled by _________________.
1.5 Mercantile Law1.5.1 Meaning and nature Business Law may be
defined as that branch of law which prescribes a set of rules for
the governance of certain transactions and relations between: (i)
business persons themselves, (ii) business persons and their
customers, dealers, suppliers, etc., and (iii) business persons and
the state. In the context of Indian business some of these
transactions and relations concern the following:
Regulation of restrictive and unfair business practices, Foreign
exchange management and regulation, Insolvency of business persons,
Promotion of conciliation, and arbitration for settlement of
business disputes, Regulation of companies incorporated under the
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Negotiable instruments, Patents, trade marks and copyrights,
Actionable claims, factoring and forfaiting, Import and export
regulation, Contracts, sale of goods, guarantee, indemnity,
bailment, pledge, charge, mortgage, partnerships, insurance,
carriage of goods, Prevention of food adulteration, regulation of
essential commodities, Regulation of stock exchange and financial
securities, Regulation and development of industries, Economic
offences, Conservation of foreign exchange and prevention of
smuggling activities, Regulation of foreign contributions, foreign
capital, Excise, import and export duties, tax on income, wealth,
etc.
1.5.2 Objectives From the description of the nature and meaning
of business law, it can be inferred that the subject has many
objectives to achieve. Firstly, law lays down the framework within
which business activities shall be carried out. For example, X
company issues an advertisement disparaging the products of its
rival Y company. Further X company prohibits its dealers to deal in
the products of Y company. These acts of X company are not in
conformity with some legal rules prescribed by some statute or the
other. Thus Y company can enforce its right which have been
infringed by the X company. Secondly, a businessperson can resort
to various judicial and quasi-judicial authorities against the
government in case his legal rights have been violated. Thirdly,
some laws are made to facilitate the business persons to achieve
their goals smoothly. For example, business has been extended the
facility of doing business by getting a company incorporated,
deriving all the advantages of incorporation, such as separate
legal entity, limited liability, etc.
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Fourthly, business law has social objectives too. The
anti-competition laws, the pollution control laws, etc., are some
of the examples. Further, laws concerning regulation of essential
commodities and prevention of food adulteration in the interest of
the consumers go a long way in serving social objectives. Lastly,
business laws aim to prevent concentration of economic power and
help in the adjustment of claims of individuals against each other.
1.5.3 Sources of Indian business law The sources of Indian business
law are: 1. Statutes such as the Indian Contract Act, 1872, the
Sale of Goods Act, 1930, the Partnership Act, 1932, the Negotiable
Instruments Act, 1881, the Insurance Act, 1938. 2. Common law: In
the absence of a legal provision on a subject, the Indian courts
apply English Common Law. Even in interpreting Indian law, the
Indian courts refer to English decisions. 3. Custom and usages: The
Indian business customs and trade usages, unless excluded by a
statute, are allowed to govern business transactions. The
Negotiable Instruments Act, 1881, has not excluded the trade usage
of hundis as negotiable instruments. 4. Precedents: Courts make law
too. Their main contribution comes in the form of decisions in law
suits. The cases decided by the Supreme Court and other courts have
served as precedents to follow by the lower courts. 5. Justice,
equity and good conscience: The equitable principles of law
developed by the English equity courts are the guiding force behind
most of the Indian statutes on business laws. Also as and when
necessary, the Indian courts make use of these principles of equity
in interpreting the Indian law. Activity 2: The concept of
ownership does not permit any vacuum. Whats your opinion on this?
Self Assessment Questions 8. Statutes, common law, precedents, etc.
are ______________ of Indian business law.Sikkim Manipal University
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9. Business law prescribes a set of rules for the governance of
transactions and relations between ____________________.
1.6 Some Basic Legal Concepts1.6.1 Concept of legal entity Law
applies only to persons. Thus, persons are the subjects of law. A
person is an entity which is clothed with rights and duties. There
are two kinds of persons. A person may be a natural or an
artificial person. All human beings are natural persons. They are
tangible and visible. On the other hand, an artificial person is a
metaphysical body, intangible and invisible. An artificial person
is brought into existence by following a procedure given in some
law. For example, a public company is an artificial person and is
brought into existence by following the procedure given in the
Companies Act, 1956. Thus there must be at least seven persons for
bringing a public company into existence. In this way, an
artificial person comes into existence when law confers such a
status upon a group of persons or any object or institution. An
artificial person is also known as a legal entity when it comes
into existence. It has one corpus or body in law, distinct from the
members who constitute it. In addition to Companies Act, 1956,
there are some other laws under which artificial persons can be
brought into existence. Some such laws are: Societies Registration
Act, 1860; Co-operative Societies Act, 1912. 1.6.2 Concept of legal
rights We have mentioned earlier that a person is an entity clothed
with certain rights and duties. The sources of different rights may
be customary, statutory, contractual, personal laws, etc. Some of
the rights, which a person has, are interest in life, or liberty or
property or extending over domestic relations and even to
contractual relations. Some of these interests are not recognised
or protected by law. The rights recognised or protected by law
alone are enforceable. These rights have their origin in some
source or the other, such as custom, statutes, personal law, law of
tort. 1.6.3 Concept of property There could be no such thing as
business law, or even business, if there were no such thing as
property. Thus the concept of property is very important in
business law. In a laymans restricted sense property meansSikkim
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movable (personal property such as furniture) or immovable
assets (real property such as land and buildings.) This is what is
known as tangible property. Legally, however, the term property
refers neither to objects nor to land alone. In its legal sense,
property refers to legally protected rights to use, possess, enjoy
and dispose of a thing. Land and other physical objects can exist
where there is no law, for example, rocks on the moon. However,
property rights can exist only where there is some law to define
and enforce them. Law protects people in the exercise of property
rights. In this way, the law contributes to the value of things.
1.6.4 Intellectual Property Rights (IPR) A trademark, a copyright,
or a patent right are incorporeal assets. These are known as IPR.
For instance, musical copyright in respect of songs, tunes and
literary and artistic copyright belong to the author as his
property. Thus, in this case of IPR, the subject matter of
proprietary interest is not the product (such as a book, a
cassette), but the exclusive right of the author or singer or
inventor to publish a book, record music, or manufacture a
particular thing or allow others to do so only at his behest. 1.6.5
Concept of ownership The term ownership may be described as a
bundle of rights in rem (against the whole world), having certain
characteristics namely the right of unspecified duration, and use,
and generally being inheritable and transferable. 1.6.6 Concept of
possession It is said that law attaches great importance to mere
possession even without ownership. Even a wrongful possession is
protected. For example, an owner of property (say X) dispossess an
occupant (say Y) without Ys consent. X is liable to restore
possession even though the occupant is unable to show any right to
be in possession. Thus, even a trespasser, if allowed to be in
occupation by negligence, cannot be disturbed even by the true
owner. This is so as the trespasser is treated as a person having
settled position. A wrong possession of property for a period of 12
years is known as adverse possession. It destroys the right of the
owner vis--vis the occupant. A person acquires title to anything
which is previously unowned. It is known as res-nullius.
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Self Assessment Questions 10. Custom is: (a) Neither written nor
unwritten law; (b) Both written and unwritten law; (c) Unwritten
law (d) Written law. 11. The rights which pertain to the realm of
status which indicates the proposition of person in the eye of law
in the society is known as. (a) Property rights (b) Information
rights (c) Personal rights (d) None 12. Out of the following, which
one is not the source of English law? (a) Common law (b) Business
law (c) Equity (d) Statute law
1.7 Essentials of LawThere are certain essentials which must be
present in law in order to make it effective. These are: (i)
Predictability, (ii) Flexibility and (iii) Reasonable application
and coverage. Law must be such that one is enabled to predict with
some accuracy the legal consequences of an action. For example,
business people enter into contracts on the premise that if the
other party fails to keep its promise, they would have certain
remedies under the law. Law must be flexible in the sense that it
must not be so rigid and unchanging as to be impossible to mould to
the present. The world is changing. New inventions are being made.
Law must be flexible enough to meet changing conditions. And, if at
a later stage, it is found that the existing law is incapable of
tackling certain changes, then it must accommodate them by
amendments thereto. Law must be reasonable both in its application
and coverage. Wide publicity should be given to the law enacted so
as to give an opportunity to those affected by it to know its
requirements, and consequences for nonSikkim Manipal University
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compliance of those requirements. However, the old doctrine of
ignorance of law is no excuse stands on its own feet. As regards
reasonableness of laws coverage, the subject matter thereof must be
considered reasonable by the people at large. Therefore, a law that
a large number of persons consider to be unreasonable will soon
become ineffective. Activity 3: Suggest your overview on The right
has a source either in a contract, or in a customs, or in natural
law. Self Assessment Questions 13. The Indian Legal System handles
cases in two separate ways _______________ and criminal. (a)
Business law (b) Personal law (c) Substantive law (d) Civil law 14.
Private law include (a) Family laws (b) Law of property (c) Law of
contract (d) All of the above 15. All the following laws include in
public law EXCEPT a) Criminal law b) Constitutional law c) Law of
tort d) Municipal law 16. IPR stands for (a) Intellectual Promising
Rights (b) Intellectual Property Rights (c) Indian Property Rights
(d) International Property Rights
1.8 SummaryBusiness laws are essential for the students of
management to understand the legal rules and aspects of business.
Just like any other study evenSikkim Manipal University Page No.
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business management is incomplete without a proper study of its
laws. Any form of business needs legal sanction. Therefore, it is
imperative that a manager understands the various ways in which
businesses can be organized. This subject introduces some of the
common forms of business organizations, including some forms unique
to India like the Joint Hindu Undivided Family firm. Different
types of organizations like Sole Ownership, Partnership, Private
Limited Company, Public Limited Company, Joint Stock Company along
with the rationale for adopting these forms are explored. What form
of business organization is the best under a particular set of
conditions? What advantage or disadvantage does it have over other
forms of business? Glossary English Common Law: English common law
is a system of law based upon English customs, usages and
traditions which were developed over centuries by the English
Courts. Equity: It refers to that branch of the English law which
developed separately from the common law. Law: Law is a body of
principles recognized and applied by the state in the
administration of justice. Statute Law: The statute law refers to
the law laid down in the Acts of Parliament. State: A state is a
territorial division, with people therein subject to a uniform
system of law administered by some authority of the state.
1.9 Terminal Questions1. The legal constraints tend to control
or limit the discretion of the business on the grounds that.
Absolute rights cannot be conferred in the modern society. Comment.
2. You must have come across some law or the other which has either
been amended or enacted recently. Describe its (i) Objectives (ii)
Legal provisions (iii) Impact on business and society. 3. What are
the sources of Indian law? Discuss any one important source of law
and justify why it is important. 4. What are the nature and
significance of business law?Sikkim Manipal University Page No.
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5. Possession, right or wrong, is protected by law. Explain 6.
The study of law is not limited to learning legal rules, knowledge
of the legal environment of business is very necessary.
Comment.
1.10 AnswersAnswers to Self Assessment Questions 1. 2. 3. 4. 5.
6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. (d) State (a) (b) Equity
Complement Law sources business entities (c) (c) (b) (d) (d) (c)
(b)
Answers to Terminal Questions 1. Refer 1.4 Explain the various
legal constraints of business in todays scenario. 2. Refer 1.2 How
legal provisions affect the business what are their objectives. 3.
Refer 1.3 The main sources of modern Indian Law, as administered by
Indian courts, may be divided into two broad categories: (i)
Primary sources and, (ii) Secondary sources. 4. Refer 1.2 Business
Law may be defined as that branch of law which prescribes a set of
rules for the governance of certain transactions and relations
between: (i) business persons themselves, (ii) businessSikkim
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persons and their customers, (iii) business persons and the
state.
dealers,
suppliers,
etc.,
and
5. Refer 1.6 Effect of possession in the business. 6. Refer 1.4
The legal environment of business is one of the major factors in
regulating its conduct though some of the laws may act as
facilitators for some segment of the business at some time or the
other. Mini-case The Enron Development Corporation of USA, which is
one of the largest integrated natural gas companies in the world,
started construction in Maharashtra, in April 1995, on the 695, MW
gas fired plant. But the new government of Maharashtra-the Shiv
Sena - BJP combine ordered a review of the project. The BJP had
opposed the deal on various counts when it was being struck between
Enron and then the government of Maharashtra headed by Congress
party. Some of the counts on which the project was criticised were:
(i) the social and environmental aspects of the project, (ii) the
alleged bribes paid by Enron, (iii) the high cost of the project,
(iv) the lack of transparency, and (v) the absence of competitive
bidding. The Congress leaders alleged that cancelling the project
was a politicallymotivated decision. Also, it is pertinent to refer
to the ruling by the Bombay High Court in 1994, when it threw out a
petition filed against the project by one of the leaders of BJP. In
a strongly worded verdict the court had said, The proposal was
deliberated at length for two and a half years, draft agreements
were prepared from time to time, and it was ultimately the eighth
or ninth draft which was finalised. Nothing was done secretly.
There was total transparency at every stage of negotiation. There
is nothing to show that anybody was being favoured for any specific
reason. Also the Government of India had taken a series of
decisions concerning inviting private sector participation in the
power sector and announcing a list of incentives. Firstly, the
first few private sector projects were to be given the status of
pioneer projects what later came to be known as fast track ones,
and were to be given every facility by the government. Secondly,
for the first few projects, the government would not go in for
public tendering. Naturally, Enron cannot be blamed for government
policies.
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Question Describe various reasons behind the increment in cost
of Enron plant in Maharashtra. (Hint: Due to the political
reasons)
Sikkim Manipal University
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Unit 2
Law of Contract
Structure: 2.1 Introduction Objectives 2.2 Meaning and
Essentials of a Valid Contract Contract Agreement Essentials of a
contract Classification of contracts 2.3 Proposal (or Offer) and
Acceptance Modes of making an offer Acceptance of an offer
Completion of communication of offer and acceptance (Sec.4) 2.4
Capacity to Contract Persons who are competent to contract Capacity
of a minor to enter into a contract Mental incompetence prohibits a
valid contract 2.5 Consent and Free Consent Meaning of consent Free
consent 2.6 Consideration (Secs.2(d), 23-25 and 185) Meaning of
consideration No consideration, no contract (Secs.10 and 25) 2.7
Agreements Declared Void (Secs.26-30) Agreements against public
policy (Secs.26-28) Agreement in restraint of trade 2.8 Contingent
Contract (Secs.31-36) Contingent contract defined (Sec.31)
Essential characteristics of a contingent contract 2.9 Quasi
Contracts Meaning of quasi contracts Cases which are treated as
quasi contracts 2.10 Performance of Contracts (Secs.37-67) Meaning
of performance of contract Meaning of offer to perform Who must
perform the promise under a contract?Sikkim Manipal University Page
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2.11
2.12 2.13
2.14 2.15 2.16
Different Modes of Discharge of Contracts (Secs.73-75) Discharge
of contracts by performance or tender Meaning of mutual consent
(Sec.62) Discharge of contracts by impossibility of performance
Discharge of a contract by operation of law Discharge of contracts
by breach Remedies for Breach of Contract Freedom to Contract
Freedom to contract is a myth or an illusion What is a standard
form contract? Summary Terminal Questions Answers
2.1 IntroductionIn the previous unit, you came to know about the
law and basic concepts of law. In this unit you will study about
the contract of law. In this unit you will study how to enter into
the contracts. Some of these are made consciously, for example,
purchase or sale of a share of a company or a plot of land.
Sometimes we do not even realize that we are making a contract,
e.g., hiring a taxi, buying a book, etc. In any case, contracts,
howsoever made, confer legal rights on one party and subjects the
other party to some legal obligation. In the case of people engaged
in business, they carry on business by entering into contracts.
Thus, the business executives, corporate counsels, entrepreneurs,
and professionals in different fields deal frequently with
contracts. Objectives After studying this unit, you should be able
to:
Describe the essentials of a valid contract Enumerate the
capacity of contract Define acceptance Define consent
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2.2 Meaning and Essentials of a Valid Contract2.2.1 Contract A
contract is an agreement, enforceable by law, made between at least
two parties by which rights are acquired by one and obligations are
created on the part of another. If the party, which had agreed to
do something, fails to do that, then the other party has a remedy.
Example: D Airlines sells a ticket on 1 January to X for the
journey from Mumbai to Bangalore on 10 January. The Airlines is
under an obligation to take X from Mumbai to Bangalore on 10
January. In case the Airlines fails to fulfil its promise, X has a
remedy against it. Thus, X has a right against the Airlines to be
taken from Mumbai to Bangalore on 10 January. A corresponding duty
is imposed on the Airlines. As there is a breach of promise by the
promisor (the Airlines), the other party to the contract (i.e., X)
has a legal remedy. 2.2.2 Agreement Sec.2(e) defines an agreement
as every promise and every set of promises forming consideration
for each other. In this context, the word promise is defined by
Sec.2(b). In a contract there are at least two parties. One of them
makes a proposal (or an offer) to the other, to do something, with
a view to obtaining the assent of that other to such act. When the
person to whom the proposal is made signifies his assent thereto,
the proposal is said to be accepted. A proposal, when accepted
becomes a promise (Sec.2(b)). Enforceability by law: The agreement
must be such which is enforceable by law so as to become a
contract. Thus, there are certain agreements which do not become
contracts as this element of enforceability by law is absent. 2.2.3
Essentials of a contract Sec.10 provides that all agreements are
contracts, if they are made by free consent of parties, competent
to contract, for a lawful consideration, and with a lawful object,
and are not expressly declared by law to be void. To constitute a
contract, there must be an agreement between two or more than two
parties. No one can enter into a contract with himself. An
agreement is composed of two elements offer or proposal by one
party and acceptance thereof by the other party.Sikkim Manipal
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Effect of absence of one or more essential elements of a valid
contract: If one or more essentials of a valid contract are
missing, then the contract may be either voidable, void, illegal or
unenforceable. 2.2.4 Classification of contracts Contracts may be
classified as follows: Classification of contracts according to
formation: A contract may be (a) Made in writing (b) By words
spoken and (c) Inferred from the conduct of the parties or the
circumstances of the case. Formal and informal contracts: This is
another way of classifying contracts on the basis of their
formation. A formal contract is one to which the law gives special
effect because of the formalities or the special language used in
creating it. The best example of formal contracts is negotiable
instruments, such as cheques. Informal contracts are those for
which the law does not require a particular set of formalities or
special language. Classification according to validity: Contracts
may be classified according to their validity as (i) Valid, (ii)
Voidable, (iii) Void, (iv) Unenforceable. A contract to constitute
a valid contract must have all the essential elements discussed
earlier. If one or more of these elements are missing, the contract
is either voidable, void, illegal or unenforceable. As per Sec.2(i)
A voidable contract is one which may be repudiated (i.e., avoided)
at the will of one or more of the parties, but not by others. Self
Assessment Questions 1. A promise for a promise is a good
consideration. (True/False) 2. A stranger to consideration cannot
maintain a suit. (True/False) 3. An agreement, the meaning of which
is not certain or capable of being made certain, is valid.
(True/False)
2.3 Proposal (or Offer) and AcceptanceOffer is not only one of
the essential elements of a contract but it is the basic building
block also. An offer is synonymous with proposal. The offerer or
proposer expresses his willingness to do or not to do (i.e.,
abstain from doing) something with a view to obtain acceptance of
the other party to such act or abstinence (Sec.2(a)).Sikkim Manipal
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2.3.1 Modes of making an offer An offer can be made by any act
or omission of party proposing by which he intends to communicate
such proposal or which has the effect of communicating it to the
other (Sec.3). An offer can be either express or implied, and
specific or general. Express offer: It means an offer made by words
(whether written or oral). The written offer can be made by
letters, telegrams, telex messages, advertisements, etc. The oral
offer can be made either in person or over telephone. Implied
offer: It is an offer made by conduct. It is made by positive acts
or signs so that the person acting or making signs means to say or
convey something. However, silence of a party can, in no case,
amounts to offer by conduct. Offer by abstinence: An offer can also
be made by a party by omission to do something. This includes such
conduct or forbearance on ones part that the other person takes it
as his willingness or assent. 2.3.2 Acceptance of an offer When the
person to whom the offer is made signifies his assent thereto, the
offer is said to be accepted (Sec.2(b)). Thus, acceptance is the
act of giving consent to the proposal. The offeree is deemed to
have given his acceptance when he gives his assent to the proposal.
The acceptance of an offer may be express or implied. It is express
when the acceptance has been signified either in writing or by
words of mouth or by performance of some required act of the
offeree. Implied acceptance: Acceptance is implied when it is said
to be gathered from the surrounding circumstances or the conduct of
the parties. 2.3.3 Completion of communication of offer and
acceptance (Sec.4) It is necessary to communicate offer to the
offeree and the acceptance to the offeror. When is it that the
communication is considered to be completed? The communication of
an offer is complete when it comes to the knowledge of the person
to whom it is made. Where A proposes by a letter to sell his car to
B at a certain price, the communication of the offer is complete
when B receives the letter. The completion of communication of
acceptance has two aspects, viz.; (i) As against the offer or and
(ii) AsSikkim Manipal University Page No. 25
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against the acceptor. The communication of acceptance is
complete (i) As against the offer or when it is put into a course
of transmission to him so as to be out of the power of the
acceptor; (ii) As against the acceptor, when it comes to the
knowledge of the offer or. Self Assessment Questions 4.
Communication of offer is complete when the letter of offer is
posted. (True/False) 5. A proposal when accepted becomes a valid
contract even though acceptance is not in the prescribed mode.
(True/False) 6. The communication of acceptance is complete, as
against the person to whom its made, when it comes to his
knowledge. (True/False)
2.4 Capacity to Contract2.4.1 Persons who are competent to
contract Any one cannot enter into a contract; he must be competent
to contract according to the law. 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 (Sec.11). 2.4.2 Capacity of a minor to enter
into a contract Age of a person determines enough maturity to make
a contract. The contract law defines maturity as the age of
majority. That usually is 18 years. Does this mean that a minor is
not competent to contract? No, a minor may make a contract, but he
is not bound by the contract; however the minor can make the other
party bound by the contract. 2.4.3 Mental incompetence prohibits a
valid contract A person who is not of sound mind may not enter into
a contract; he must be of sound mind so as to be competent to
contract. A test of soundness of mind has been laid down by law. A
person is said to be of unsound mind for the purpose of making a
contract if at the time he makes it he is incapable of
understanding it and of forming a rational judgement as to its
effect upon his interests. The liability for necessaries of life
supplied to persons of unsound mind is the same as for
minors.Sikkim Manipal University Page No. 26
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A lunatic is a person who is mentally deranged due to some
mental strain or other personal experience. An idiot is a person
who is of permanently unsound mind. He does not have lucid
intervals. He is incapable of entering into a contract and
therefore a contract with an idiot is void. A person who is drunk,
intoxicated or delirious from fever so as to be incapable of
understanding the nature and effect of an agreement or form a
rational judgement as to its effect on his interests cannot enter
into valid contracts whilst such drunkenness or delirium lasts.
Activity 1: A company issues a prospectus giving false information
about the unbounded wealth of Nevada. A shareholder buys shares on
the faith of such information. He wants to avoid the contract. Can
he do so? Self Assessment Questions 7. A married woman cannot enter
into a contract. (True/False) 8. When the promisee does not accept
the offer of performance, the promisor is not responsible for
non-performance. (True/False)
2.5 Consent and Free Consent2.5.1 Meaning of consent Offer by
one party is accepted by the other party. The consent of the
offeree to the offer by the offer or is necessary. It is essential
to the creation of a contract that both parties agree to the same
thing in the same sense. When two or more persons agree upon the
same thing in the same sense they are said to consent. 2.5.2 Free
consent For a contract to be valid it is not only necessary that
the parties consent but also that they consent freely. Where there
is a consent but no free consent the contract is voidable at the
option of the party whose consent was not free. Thus, free consent
is one of the essentials of a valid contract. A consent is said to
be free when it is not caused by: (i) coercion, (ii) undue
influence, (iii) fraud, (iv) misrepresentation or (v)
mistake.Sikkim Manipal University Page No. 27
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Meaning of coercion (Secs.15 and 72) Coercion is (i) the
committing or threatening to commit any act forbidden by the Indian
Penal Code or (ii) 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.
(Sec.15). Meaning of fraud (Secs.17 and 19) Fraud means and
includes any of the following acts committed by a party to a
contract with an intent to deceive the other party thereto or to
induce him to enter into a contract: (i) the suggestion as a fact
of that which is not true by one who does not believe it to be
true; (ii) active concealment of a fact by one having knowledge or
belief of the fact; (iii) promise made without any intention of
performing it; (iv) any other act fitted to deceive; (v) any such
act or omission as the law specifically declares to be fraudulent.
Meaning of misrepresentation (Secs.18-19) Misrepresentation is also
known as simple misrepresentation whereas fraud is known as
fraudulent misrepresentation. Like fraud, misrepresentation is an
incorrect or false statement but the falsity or inaccuracy is not
due to any desire to deceive or defraud the other party. Such a
statement is made innocently. The party making it believes it to be
true. In this way, fraud is different from misrepresentation.
Meaning of mistake (Secs.20-21) Mistake may be defined as an
erroneous belief on the part of the parties to the contract
concerning something pertaining to the contract. Self Assessment
Questions 9. Consent obtained by fraud makes the agreement void.
(True/False) 10. An attempt to deceive which does not deceive is
not fraud. (True/False) 11. Cancellation of a contract by mutual
consent of the parties is called waiver. (True/False)
2.6 Consideration (Secs.2(d), 23-25 and 185)2.6.1 Meaning of
consideration One of the essential elements of a valid contract is
that it must be supported by consideration.Sikkim Manipal
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In simple terms consideration is what a promisor demands as the
price for his promise. The term consideration is used in the sense
of quid pro que, i.e., something in return. This something or
consideration need not be in terms of money. This something may
even be some benefit, right, interest or profit accruing to one
party, or some forbearance, detriment, loss or responsibility
given, suffered or undertaken by the other party. Also a promise by
one party may be consideration for the promise of other party.
2.6.2 No consideration, no contract (Secs.10 and 25) A promise
without consideration cannot create a legal obligation. A person
who makes a promise to do or abstain from doing something usually
does so as a return of equivalent of some loss, damage, or
inconvenience that may have or may have been occasioned to the
other party in respect of the promise. Self Assessment Questions
12. Past consideration is no consideration. (True/False) 13. If the
offeree does not accept the offer according to the mode prescribed
by the offeror, the offer does not lapse automatically.
(True/False)
2.7 Agreements Declared Void (Secs.26-30)The Act declares
certain agreements to be void. Some of them (such as the following)
have already been explained: (i) agreements entered into through a
mutual mistake of fact between the parties (Sec.20); (ii)
agreements, the object or consideration of which is unlawful
(Sec.23); (iii) agreements, part of consideration of which is
unlawful (Sec.24); (iv) agreements made without consideration
(Sec.25). Some other agreements which are declared to be void are
explained below. 2.7.1 Agreements against public policy
(Secs.26-28) An agreement which conflicts with morals of the time
and contravenes any established interest of society is void as
being against public policy. Some of the agreements which are
against public policy and have been declared to be void by law.
These are as follows: (i) Trading with enemy: (ii) Agreements for
stifling prosecution. (iii) Contracts in the nature of champerty
and maintenance. (iv) Agreement for the sale of public offices and
titles are void. (v) Agreements in restraint of parental rights are
void. (vi) Agreements in restraint of marriage of any person other
than a minor is void.Sikkim Manipal University Page No. 29
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2.7.2 Agreement in restraint of trade Sec.27 provides that every
agreement by which any one is restrained from exercising a lawful
profession, trade or business of any kind is, to that extent, void.
All agreements in restraint of trade, whether general or partial,
qualified or unqualified, are void. It is, therefore, not open to
the courts to enter into any question of reasonableness or
otherwise of the restraint [Khemchand v. Dayaldas, (1942) Sind,
114]. Self Assessment Questions 14. An agreement to agree is a
valid contract. (True/False) 15. Social agreements are enforceable
in courts. (True/False)
2.8 Contingent Contract (Secs.31-36)2.8.1 Contingent contract
defined (Sec.31) A contingent contract is a contract to do or not
to do something, if some event, collateral to such contract does or
does not happen. Example: A contracts to pay B Rs 10,000 if Bs
house is burnt. This is a contingent contract. 2.8.2 Essential
characteristics of a contingent contract There are three essential
characteristics of a contingent contract: (i) The performance of a
contingent contract depends upon happening or nonhappening of some
future event. (ii) The event must be uncertain. If the event is
bound to happen and the contract has got to be performed in any
case, it is not a contingent contract. (iii) The event must be
collateral, i.e., incidental to the contract. Activity 2: X an old
lady, by a deed of gift, made over certain property to her daughter
D, with the specific directions that she should pay P, who is the
sister of the old lady, a sum of Rs 100 per month. The same day D
entered into an agreement with P to pay her the agreed amount. D,
now refuses to pay her aunt P, the above amount on the plea that no
consideration had move from P to D, P, therefore, sues D. is the
suit maintainable and can D be held liable to pay the amount?
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Self Assessment Questions 16. A person who is usually of unsound
mind cannot enter into a contract even when he is of sound mind.
(True/False) 17. Payments made by a debtor are always appropriated
in chronological order. (True/False)
2.9 Quasi Contracts2.9.1 Meaning of quasi contracts Quasi
Contracts are so-called because the obligations associated with
such transactions could neither be referred as tortious nor
contractual, but are still recognised as enforceable like
contracts, in courts. According to Dr Jenks, quasi contract is a
situation in which law imposes upon one person, on grounds of
natural justice, an obligation similar to that which arises from a
true contract, although no contract, express or implied, has in
fact been entered into by them. 2.9.2 Cases which are treated as
quasi contracts Following are the cases which are to be deemed
quasi contracts: 1. Claim for necessaries supplied to a person
incapable of contracting or on his account. If a person, incapable
of entering into a contract, or any one whom he is legally bound to
support is supplied by another person with necessaries suited to
his condition in life, the person who furnished such supplies is
entitled to be reimbursed from the property of such incapable
person (Sec.68). 2. Reimbursement to a person paying money due by
another in payment of which he is interested. A person who is
interested in the payment of money which another is bound by law to
pay, and who, therefore, pays it, is entitled to be reimbursed by
the other. (Sec.69). Self Assessment Questions 18. Commercial
impossibility does not make the contract void. (True/False) 19. A
threat to commit suicide does not amount to coercion.
(True/False)
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2.10 Performance of Contracts (Secs.37-67)2.10.1 Meaning of
performance of contract A contract creates obligations. Performance
of contract means the carrying out of obligations under it. The
parties to contract must either perform or offer to perform their
respective promises unless such performance is dispensed with or
excused under the provisions of the Indian Contract Act, or some
law (Sec.37). 2.10.2 Meaning of offer to perform It may happen that
the promisor offers performance of his obligation under the
contract at the proper time and place but the promisee refuses to
accept the performance. This is called as Tender or Attempted
Performance. If a valid tender is made and is not accepted by the
promisee, the promisor shall not be responsible for non-performance
nor shall he lose his rights under the contract. 2.10.3 Who must
perform the promise under a contract? The promise may be performed
by promisor himself or his agent or by his legal representative.
(i) In case, there was an intention of the parties that the promise
must be performed by the promisor himself, such promise is to be
performed by him only. Thus, where A promises to paint a picture
for B, then A must perform this promise personally. (ii) If there
is no such intention of the parties, then the promisor may employ a
competent person to perform the promise. If A has promised to
deliver some items of grocery to B, A may perform this promise
either personally delivering the items to B or causing it to be
delivered to B through someone. (iii) In case of death of the
promisor, the legal representative must perform the promise unless
a contrary intention appears from the contract. A promises to
deliver goods to B on a certain day on payment of Rs 1,000. A dies
before that day. As legal representatives are bound to deliver the
goods to B, and B is bound to pay Rs 1,000 to As representatives.
Self Assessment Questions 20. The liability of joint promisors is
joint and several. (True/False) 21. If there is no such intention
of the parties, then the promisor may employ a competent person to
perform the promise. (True/False)
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2.11 Different Modes of Discharge of Contracts (Secs.73-75)A
contract may be discharged by (i) performance, (ii) tender; (iii)
mutual consent; (iv) subsequent impossibility; (v) operation of
law; (vi) breach. 2.11.1 Discharge of contracts by performance or
tender The obvious mode of discharge of a contract is by
performances that is where the parties have done whatever was
contemplated under the contract, the contract comes to an end.
Thus, where A contracts to sell his car to B for Rs 1,85,000, as
soon as the car is delivered to B and B pays the agreed price for
it, the contract comes to an end by performance. The tender or
offer of performance has the same effect as performance. If a
promisor tenders performance of his promise but the other party
refuses to accept, the promisor stands discharged of his
obligations. 2.11.2 Meaning of mutual consent (Sec.62) If the
parties to a contract agree to substitute a new contract for it, or
to rescind it or alter it, the original contract is discharged. A
contract may terminate by mutual consent in any of the six ways
viz. novation, rescission, alteration and remission, waiver and
merger. Novation means substitution of a new contract for the
original one. 2.11.3 Discharge of contracts by impossibility of
performance A contract may be discharged because of impossibility
of performance. There are two types of impossibility: (i)
Impossibility may be inherent in the transaction (i.e., the
contract), (ii) Impossibility may emerge later by the change of
certain circumstances material to the contract. 2.11.4 Discharge of
a contract by operation of law Discharge by operation of law may
take place in four ways: (i) By death. Death of the promisor
results in termination of the contract in cases involving personal
skill or ability. (ii) By insolvency. The insolvency law provides
for discharge of contracts under certain circumstances so where an
order of discharge is passed by an insolvency court the insolvent
stands discharged of all debts incurred previous to his
adjudication. (iii) By merger. 2.11.5 Discharge of contracts by
breach A breach of contract is one partys failure, without a legal
excuse, to live up to any of its promises under a contract. A
contract terminates by breach of contract. If the promisor has not
performed his promise in accordance withSikkim Manipal University
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the terms of the contract or where the performance is not
excused by tender, mutual consent or impossibility or operation of
law, then this amounts to a breach of contract on the part of the
promisor. The consequence of this is that the promisee becomes
entitled to certain remedies. The breach of contract may arise in
two ways: (i) anticipatory and (ii) actual. Anticipatory breach of
contracts: The anticipatory breach of contract occurs when a party
repudiates it before the time fixed for performance has arrived or
when a party by his own act disables himself from performing the
contract. Actual breach of contracts: The actual breach can occur
by (i) failure to perform as promised, (ii) making it impossible
for the other party to perform. The failure to perform means that
one party must not have performed a material part of the contract
by a stated deadline. The actual breach by failure to perform may
take place (a) at the time when performance is due, or (b) during
the performance of the contract. Thus, if a person does not perform
his part of the contract at the stipulated time, he will be liable
for its breach. Self Assessment Questions 22. ____________ means
substitution of a new contract for the original one. 23. A contract
terminates by breach of contract. (True/False)
2.12 Remedies for Breach of ContractWhen someone breaches a
contract, the other party is no longer obligated to keep its end of
the bargain. From there, that party may proceed in several ways:
(i) the other party may urge the breaching party to reconsider the
breach; (ii) if it is a contract with a merchant, the other party
may get help from consumers associations; (iii) the other party may
bring the breaching party to an agency for alternative dispute
resolution; (iv) the other party may sue for damages; or (v) the
other party may sue for other remedies. Rescission of the contract:
When a breach of contract is committed by one party, the other
party may treat the contract as rescinded. In such a case the
aggrieved party is freed from all his obligations under the
contract.Sikkim Manipal University Page No. 34
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Damages (Sec.75): Another relief or remedy available to the
promisee in the event of a breach of promise by the promisor is to
claim damages or loss arising to him therefrom. Damages under
Sec.75 are awarded according to certain rules as laid down in
Secs.73-74. Sec.73 contains three important rules: (i) Compensation
as general damages will be awarded only for those losses that
directly and naturally result from the breach of the contract. (ii)
Compensation for losses indirectly caused by breach may be paid as
special damages if the party in breach had knowledge that such
losses would also follow from such act of breach. (iii) The
aggrieved party is required to take reasonable steps to keep his
losses to the minimum. What is the most common remedy for breach of
contracts: The usual remedy for breach of contracts is suit for
damages. The main kind of damages awarded in a contract suit are
ordinary damages. This is the amount of money it would take to put
the aggrieved party in as good a position as if there had not been
a breach of contract. The idea is to compensate the aggrieved party
for the loss he has suffered as a result of the breach of the
contract. Self Assessment Questions 24. There are three remedies
under the Specific Relief Act, 1963. (True/False) 25. Damages under
Sec.75 are awarded according to certain rules as laid down in
Sec.73-74. (True/False)
2.13 Freedom to Contract2.13.1 Freedom to contract is a myth or
an illusion The freedom of the parties is limited by two factors.
There are certain laws for the protection of the employees, and an
employer cannot, therefore, induce his employees to enter into any
contract favourable to the employer. 2.13.2 What is a standard form
contract? A standard form contract is a document which is generally
printed, containing terms and conditions, with certain blanks to be
filled in. It is prepared by the business people. The customer has
only to sign it. Therefore, from his standpoint, the freedom to
contract is restricted. Many of
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the contracts now being entered into by consumers are not the
result of individual negotiations; rather they are one-sided
contracts. Self Assessment Questions 26. A contract is imposed by a
party having a strong bargaining power on a party having a weak
bargaining power. (True/False) 27. The freedom of the parties is
limited by four factors. (True/False) Activity 3: Discuss the
statement 'Freedom to contract is a myth or an illusion' in the
light of day-to-day transactions in the market & the essentials
of the law.
2.14 SummaryThe law of contract in India is contained in the
Indian Contract Act, 1872. This Act is based mainly on English
common law, which is to a large extent made up of judicial
precedents. (there being a separate contract act in England). It
extends to the whole of India except the state of Jammu and Kashmir
and came into force on the first day of September 1872 (Sec.1
Indian Contract Act, 1872). The act is not exhaustive. Glossary
Contract: An agreement enforceable by law is a contract. Agreement:
Every promise and every set of promises forming the consideration
for each other is an agreement. Valid Contract: Contracts which
satisfy all the essential elements of a valid contract are
enforceable in a court of law. Void Contract: A contract which
ceases to be enforceable by law becomes void when it ceases to be
enforceable.
2.15 Terminal Questions1. What do you mean by contract? What
test would you apply to ascertain whether an agreement is a
contract? 2. All agreement are not contracts but all contacts are
agreements. Comment.Sikkim Manipal University Page No. 36
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3. Enumerate some of the contracts which are expressly declared
to be void by the Indian Contract Act, 1872. 4. When is an offer to
be accepted? 5. Describe the rules regarding communication of offer
and acceptance. 6. Distinguish between a wagering agreement and a
contingent contract. 7. What are the different modes of discharge
of contracts? Explain the discharge of contract by performance or
tender. 8. Give some example of ordinary damages. Can ordinary
damages be claimed for any remote or indirect loss or damages by
reason of the breach? 9. Freedom to contract is a myth or an
illusion. Discuss.
2.16 AnswersAnswers to Self Assessment Questions 1. 2. 3. 4. 5.
6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. True
False False False False False False False False True False False
True False False False False True False True TruePage No. 37
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22. 23. 24. 25. 26. 27.
Novation True True True True False
Answers to Terminal Questions 1. Refer 2.2 A contract is an
agreement, enforceable by law, made between at least two parties.
2. Refer 2.2 The agreement must be such which is enforceable by law
so as to become a contract. 3. Refer 2.2 Avoidable contract is one
which may be repudiated at the will of one or more of the parties.
4. Refer 2.3 Offer is not only one of the essential elements of a
contract but it is the basic building block also. 5. Refer 2.3 It
is necessary to communicate offer to the offeree and the acceptance
to the offeror. 6. Refer 2.8 A contingent contract is a contract to
do or not to do something.. 7. Refer 2.11 A contract may be
discharged by (i) performance, (ii) tender 8. Refer 2.12 Damages
under Sec.75 are awarded according to certain rules as laid down in
Secs.73-74. 9. Refer 2.13 The freedom of the parties is limited by
two factors. Mini-case The Carbolic Smoke Ball Company made a
product called the "smoke ball". It claimed to be a cure for
influenza and a number of other diseases. The smoke ball was a
rubber ball with a tube attached. It was filled with carbolic acid
(phenol). The tube was then inserted into the user's nose. It was
squeezed at the bottom to release the vapours into the nose of the
user. This would cause the nose to run, and hopefully flush out the
cold. In fact the inflammation caused by the device would have
probably increased susceptibility to catching influenza. The
Company published advertisements in the Pall Mall Gazette and other
newspapers on November 13, 1891, claiming that it would pay 100
toSikkim Manipal University Page No. 38
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anyone who got sick with influenza after using its product
according to the instructions set out in the advertisement. 100
reward will be paid by the Carbolic Smoke Ball Company to any
person who contracts the increasing epidemic influenza colds, or
any disease caused by taking cold, after having used the ball three
times daily for two weeks, according to the printed directions
supplied with each ball. 1000 is deposited with the Alliance Bank,
Regent Street, shewing our sincerity in the matter. During the last
epidemic of influenza many thousand carbolic smoke balls were sold
as preventives against this disease, and in no ascertained case was
the disease contracted by those using the carbolic smoke ball. One
carbolic smoke ball will last a family several months, making it
the cheapest remedy in the world at the price, 10s. post free. The
ball can be refilled at a cost of 5s. Address: "Carbolic Smoke Ball
Company, "27, Princes Street, Hanover Square, London." Mrs. Louisa
Elizabeth Carlill saw the advertisement, bought one of the balls
and used three times daily for nearly two months until she
contracted the flu on January 17, 1892. She claimed 100 from the
Carbolic Smoke Ball Company. They ignored two letters from her
husband, who had trained as a solicitor. On a third request for her
reward, they replied with an anonymous letter that if it is used
properly the company had complete confidence in the smoke ball's
efficacy, but "to protect themselves against all fraudulent claims"
they would need her to come to their office to use the ball each
day and checked by the secretary. Mrs. Carlill brought a claim to
court. The barristers representing her argued that the
advertisement and her reliance on it was a contract between her and
the company, and so they ought to pay. The company argued it was
not a serious contract. Question Do you agree to what the company
says? Justify. (Hint: summarize this case in your word.)
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Unit 3
Contracts of Guarantee and Indemnity
Structure: 3.1 Introduction Objectives 3.2 Purpose and Meaning
of the Contract of Guarantee Purpose of guarantee Definition and
nature of the contract of guarantee (Sec.126) Fiduciary
relationship 3.3 Kinds of Guarantee Oral or written guarantee
Specific and continuing guarantee A guarantee may either be for the
whole debt or a part of the debt 3.4 Rights and Obligations of the
Creditor Rights of a creditor Obligations imposed on a creditor in
a contract of guarantee 3.5 Rights, Liabilities and Discharge of
Surety Rights against the creditor Rights against the principal
debtor Rights against co-sureties Liability of surety Discharge of
surety 3.6 Contract of Indemnity Meaning of indemnity Rights of the
indemnified (i.e., the indemnity holder) Rights of the indemnifier
Commencement of indemnifiers liability 3.7 Summary 3.8 Terminal
Questions 3.9 Answers
3.1 IntroductionIn the previous units, you came to know about
the law and the contract of law. In this unit you will study about
the guarantee and indemnity of contracts.
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In this unit you come to know when a company needs some money
for its business it approaches a bank. The bank requires that the
managing director M promises to repay the loan personally should
the company default. When the directors of the company including M
execute the promissory note on behalf of the company, they sign as
companys officials. M, the managing director signs again as an
individual. The relationship between M and the bank is called a
guarantee or suretyship. It is a contractual relationship resulting
from the unconditional promise of M (known as the surety or
guarantor) to repay the loan to the creditor (the bank) for the
obligation of the principal debtor (the company) should it default.
If the company fails to repay the loan, the bank can approach M for
the payment. Sometimes the banks (lenders) ask for more security
for the loans in addition to the personal guarantee of an official
of the borrowing company. The company may agree that a particular
machinery in its factory would serve as collateral security for the
loan. If the company defaults, the bank now has three options: to
compel the principal debtor to pay, demand payment from the surety,
or obtain a court order to either claim or sell the collateral. The
bank need not look to the collateral first. But if M pays the money
to the bank, then the right of the bank on the collateral gets
transferred to him. The bank has yet another alternative for
securing its loan to the company. It could ask that all the three
directors (including M) sign the promissory note as co-sureties. If
they do so and the company defaults, the bank may seek payment from
any one or any two of them or all of them. The law relating to the
contracts of guarantee is given in the Indian Contract Act, 1872
(Secs.126-147). The sections quoted in this chapter refer to the
Act unless otherwise stated. Objectives After studying this unit,
you should be able to: Explain the contract of guarantee Describe
the types of guarantee Explain the rights and obligations of
creditor Enumerate the contract of indemnitySikkim Manipal
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3.2
Purpose and Meaning of the Contract of Guarantee
3.2.1 Purpose of guarantee The contracts of guarantee are among
the most common business contracts and are used for a number of
purposes. These are: i) The guarantee is generally made use of to
secure loans. Thus, a contract of guarantee is for the security of
the creditor. ii) The contracts of guarantee are sometimes called
performance bonds. For example, in the case of a construction
project, the builder may have to find a surety to stand behind his
promise to perform the construction contract. Also employers often
demand a type of performance bond known as a fidelity bond from
employees who handle cash, etc., for the good conduct of the
latter. If an employee misappropriates then the surety will have to
reimburse the employer. iii) Bail bonds, used in criminal law, are
a form of contract of guarantee. A bail bond is a device which
ensures, that a criminal defendant will appear for trial. In this
way a prisoner is released on bail pending his trial. If the
prisoner does not appear in the court as desired then the bond is
forfeited. In this unit our primary concern is with the contracts
of guarantee which are used for securing loan. 3.2.2 Definition and
nature of the contract of guarantee (Sec.126) A contract of
guarantee is defined as a contract to perform the promise, or
discharge the liability, of a third person in case of his default.
The person who gives the guarantee is called surety; the person for
whom the guarantee is given is called the principal debtor, and the
person to whom the guarantee is given is called the creditor. A
contract of guarantee may be either oral or in writing. From the
above discussion, it is clear that in a contract of guarantee there
must, in effect, be two contracts, a principal contract between the
principal debtor and creditor, and a secondary contract between the
creditor and the surety. In a contract of guarantee there are three
parties, viz., the creditor, the principal debtor and the surety.
Therefore, there is an implied contract also between the principal
debtor and the surety.Sikkim Manipal University Page No. 42
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Example: When A requests B to lend Rs10,000 to C and guarantees
that C will repay the amount within the agreed time and that on C
failing to do so, he will himself pay to B, there is a contract of
guarantee. The contract of surety is not a contract collateral to
the contract of the principal debtor, but is an independent
contract. There must be a distinct promise on the party of the
surety to be assumable for the debt. It is not necessary that the
principal contract, between the debtor and the creditor, must exist
at the time the contract of guarantee is made; the original
contract between the debtor and creditor may be about to come into
existence. Similarly, under certain circumstances, a surety may be
called upon to pay though principal debtor is not liable at all.
Also, where a person gives a guarantee upon a contract that the
creditor shall not act upon it until another person has joined in
it as co-surety, the guarantee is not valid if that other person
does not join (Sec.144). 3.2.3 Fiduciary relationship A contract of
guarantee is not a contract uberrimae fidei (requiring utmost good
faith). Nevertheless, the suretyship relation is one of trust and
confidence and the validity of the contract depends upon good faith
on the part of the creditor. A creditor must disclose all those
facts which, under the circumstances, the surety would expect not
to exist. So where guarantee is given for good conduct of an
employee, the employers failure to inform the surety of any breach
on the part of employee, will discharge the surety. Similarly,
where X guarantees the existing and future liabilities of A to B
upto a certain amount which limit has already been exceeded, the
contract of guarantee can be avoided on the ground of concealment
of a materiel fact. However, it should be noted that it is no part
of the creditors duty to inform the surety about all his previous
dealings with the debtor. Self Assessment Questions 1. As per the
Indian law, a contract of guarantee must be in writing.
(True/False) 2. Specific guarantee is different from continuing
guarantee. (True/False) 3. For a contract of guarantee, the primary
liability is of the surety. (True/False)
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3.3 Kinds of Guarantee3.3.1 Oral or written guarantee A contract
of guarantee may either be oral or in writing (Sec.126), though a
creditor should always prefer to put it in writing to avoid any
dispute regarding the terms, etc. In case of an oral agreement the
existence of the agreement itself is very difficult to prove. 3.3.2
Specific and continuing guarantee From the point of view of the
scope of guarantee a contract of guarantee may either by specific
or continuing. A guarantee is a specific guarantee, if it is
intended to be applicable to a particular debt and thus comes to
end on its repayment. A specific guarantee once given is
irrevocable. Example: A guarantees the repayment of a loan of Rs.
10,000 to B by C (a banker). The guarantee in this case is a
specific guarantee. A guarantee which extends to a series of
transactions is called a continuing guarantee (Sec.129) Example: A
guarantees payment to B, a tea-dealer, to the amount of Rs. 10,000
for any tea he may from time to time supply to C. B supplies C with
tea of the value above Rs. 10,000 and C pays B for it. Afterwards B
supplies C with tea to the value of Rs. 15,000. C fails to pay. The
guarantee given by A was a continuing guarantee and he is
accordingly liable to B to the extent of Rs. 10,000. A guarantee
regarding the conduct of another person is a continuing guarantee.
Unlike a specific guarantee which is irrevocable, a continuing
guarantee can be revoked regarding further transactions (Sec.130).
However, continuing guarantee cannot be revoked regarding
transactions that have ready taken place. The death of the surety
operates, in the absence of any contract to the contrary, as a
revocation of a continuing guarantee, so far as regards future
transactions. (Sec.131). 3.3.3 A guarantee may either be for the
whole debt or a part of the debt Difficult questions arise in case
of guarantee for a limited amount because there is an important
distinction between a guarantee for only a part of the whole debt
and a guarantee for the whole debt subject to a limit.Sikkim
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For instance, where X owes Y Rs 50,000 and A has stood as surety
for Rs. 30,000, the question may arise whether A has guaranteed Rs.
30,000 out of Rs. 50,000 or whether he has guaranteed the full
amount of Rs. 50,000 subject to a limit of Rs. 30,000. This matter
becomes important if X is adjudged insolvent and Y wants to prove
in Xs insolvency and also enforce his remedy against A. If A stood
surety only for a part of the debt and if Xs estate can pay only 25
paisa dividend in the rupee, then Y can get Rs. 30,000 the full
amount of guarantee from A and Rs. 5,000 from Xs estate, being of
the balance, i.e., Rs. 50,000 Rs. 30,000 = Rs. 20,000 which was not
guaranteed. Since after paying Rs. 30,000 to Y, A can claim from Xs
estate, he will get Rs. 7,500 being of Rs. 30,000 paid by A to Y.
If on the other hand, A had stood surety for the whole debt of Rs
50,000 subject to a limit of Rs. 30,000 then Y can recover from A
Rs. 30,000 and from Xs estate Rs. 12,500, i.e., of Rs. 50,000. A
will not get any dividend unless Y has been fully paid. This can
happen only if Xs estate declares a higher dividend. Activity 1:
Provide guarantee against anything from the owner it would be
sufficient to buyer? Give suggestion. Self Assessment Questions 4.
A contract of guarantee is for the security of the (a) Buyer (b)
Seller (c) Debtor (d) Creditor 5. Continuing guarantee is a: (a)
Guarantee which extends to a series of transactions (b) Guarantee
which limited access of transactions (c) Guarantee not related to
transactions (d) None of the above
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3.4 Rights and Obligations of the Creditor3.4.1 Rights of a
creditor 1. The creditor is entitled to demand payment from the
surety as soon as the principal debtor refuses to pay or makes
default in payment. The liability of the surety cannot be postponed
till all other remedies against the principal debtor have been
exhausted. In other words, the creditor cannot be asked to exhaust
all other remedies against principal debtor before proceeding
against surety. The creditor also has a right of general lien on
the securities of the surety in his possession. This right,
however, arises only when the principal debtor has made default and
not before that. 2. Where surety is insolvent, the creditor is
entitled to proceed in the suretys insolvency and claim the pro
rata dividend. 3.4.2 Obligations imposed on a creditor in a
contract of guarantee 1. Not to change any terms of the original
contract. The creditor should not change any terms of the original
contract without seeking the consent of the surety. Sec.133
provides. any variance made, without the suretys consent, in the
terms of the contract between the principal debtor and the
creditor, discharges the surety as to the transactions subsequent
to the variance. Example: A banker contracts to lend X Rs. 5,000 on
March 4. A guarantees repayment. The banker pays X Rs. 5,000 on
January 1. A in this case is discharged from his liability as the
contract has been varied as much as the banker might sue X before
March 4, but it cannot sue A as the guarantee is from March 4. 2.
Not to release or discharge the principal debtor. The creditor is
under an obligation not to release or discharge the principal
debtor. Sec.134 states: The surety is discharged by a contract
between the creditor and principal debtor, by which the principal
debtor is released, or by any act or omission of the creditor, the
legal consequence of which is the discharge of the principal
debtor. Example: A gives a guarantee to banker C for repayment of
the debt granted to B. B later contracts with his creditors
(including C, the banker) to assign to them his property in
consideration of their releasing himSikkim Manipal University Page
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from their demands. Here B is released from his debt by the
contract with C and A is discharged from his suretyship. 3. Not to
compound, or give time to, or agree not to sue the principal
debtor. Sec.135 provides, A contract between the creditor and the
principal debtor, by which the creditor makes a composition with or
promises to give time to, or not to use the principal debtor,
discharges the surety, unless the surety assents to such contract.
If the time for repayment is extended, the debtor may die or become
insane or insolvent or his financial position may become weaker in
the meanwhile, with one effect that the suretys remedy to recover
the money in case the principal debtor defaults, may be impaired.
However, there are certain exceptions. These are: a) Sec.136 states
that if the creditor makes an agreement with a third party, but not
with the principal debtor, to give extension of time to the
principal debtor, surety is not discharged even if his consent has
not been sought. b) Mere forbearance on the part of creditor to sue
the principal debtor, or to enforce any other remedy against him,
does not, in the absence of a provision to the contrary, discharge
the surety (Sec.137). c) If the creditor releases one of the
co-sureties, the other co-surety (or co-sureties) thereby is not
discharged. The co-surety released by the creditor is also not
released from his liability to the other sureties (Sec.138). 4. Not
to do any act inconsistent with the rights of the surety (Sec.139).
Where C lends money to B on the security of a joint and several
promissory note made in Cs favour by B and by A as surety for B,
together with a bill of sale of Bs furniture, which gives power to
C to sell the furniture and apply the proceeds in discharge of the
note