Unit-01-Law Structure: 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 1.1 Introduction This unit,
you begin by answering the question, What is law? This involves the
meaning and nature of law. The classification of law, such as civil
law and criminal law; substantive and procedure law is illustrated.
In this unit you also study the different sources of Indian law
such as custom, precedents and the legislation. 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 Law The 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, compulsion is used to enforce obedience, and certain
consequences ensue. 3. 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. 4. 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.
5. 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. 6. 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. 7. 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. 8. 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 sense may
include: (i) Moral rules or 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
pattern 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 Law 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. 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 like 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. 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. However, like 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.
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
law of the land. 1.4 Legal Environment of Business The 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 for 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 Law
1.5.1 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 Companies Act, 1956, 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. 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.
Self Assessment Questions 8. Statutes, common law, precedents,
etc. are ______________ of Indian business law. 9. Business law
prescribes a set of rules for the governance of transactions and
relations between ____________________. 1.6 Some Basic Legal
Concepts 1.6.1 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 means 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. 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 Law There 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 non-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 Summary
Business laws are essential for the students of management to
understand the legal rules and aspects of business. Just like any
other study even 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 Questions 1. 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? 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 Answers
Answers to Self Assessment Questions 1. (d) 2. State 3. (a) 4. (b)
5. Equity 6. Complement 7. Law 8. sources 9. business entities 10.
(c)
11. (c) 12. (b) 13. (d) 14. (d) 15. (c) 16. (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) business persons and
their customers, dealers, suppliers, etc., and (iii) business
persons and the state. 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 politically-motivated 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. Question Describe various reasons
behind the increment in cost of Enron plant in Maharashtra.
(Hint: Due to the political reasons) MB0051-Unit-02-Law of
Contract Unit-02-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? 2.11 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 2.12
Remedies for Breach of Contract 2.13 Freedom to Contract Freedom to
contract is a myth or an illusion What is a standard form contract?
2.14 Summary 2.15 Terminal Questions
2.16 Answers 2.1 Introduction In 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
2.2 Meaning and Essentials of a Valid Contract 2.2.1 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. 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 Acceptance Offer 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)). 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) As 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 Contract 2.4.1 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. 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.
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 Consent 2.5.1
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. 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. 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. 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.
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 Contracts 2.9.1
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) 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) 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 with 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 Contract When 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.
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 Contract 2.13.1 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
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)
2.14 Summary The 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 Questions 1. 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. 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 Answers
Answers to Self Assessment Questions 1. True 2. False 3. False 4.
False 5. False 6. False 7. False 8. False 9. False 10. True
11. False 12. False 13. True 14. False 15. False 16. False 17.
False 18. True 19. False 20. True 21. True 22. Novation 23. True
24. True 25. True 26. True 27. 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 users 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 to 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 balls 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.)
MB0051-Unit-03-Contracts of Guarantee and Indemnity
Unit-03-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 Introduction
In 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. 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 indemnity 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. 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) 3.3 Kinds of Guarantee 3.3.1 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. 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.
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 3.4 Rights and
Obligations of the Creditor 3.4.1 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 him
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. Subsequently, C sells
the furniture, but owing to his misconduct and willful negligence,
only a small price is realised, then A is discharged from liability
on the note. Self Assessment Questions 6. In the event of principal
debtor being a minor, creditor cannot recover his money from the
surety. (True/False) 7. The creditor does not a right of general
lien on the securities of the surety in his possession.
(True/False) 3.5 Rights, Liabilities and Discharge of Surety Rights
of a surety may be classified under three heads: (i) rights against
the creditor, (ii) rights against the principal debtor and (iii)
rights against co-sureties. 3.5.1 Rights against the creditor In
case of fidelity guarantee, the surety can direct creditor to
dismiss the employee whose honesty he has guaranteed, in the event
of proved dishonesty of the employee. The creditors failure to do
so will exonerate the surety from his liability. 3.5.2 Rights
against the principal debtor a) Right of subrogation: Sec.140 lays
down that where a surety has paid the guaranteed debt on its
becoming due or has performed the guaranteed duty on the default of
the principal debtor, he is invested with all the rights which the
creditor has against the debtor. In other words, the surety is
subrogated to all the rights which the creditor had against the
principal debtor. So, if the creditor loses, or without the consent
of the surety parts with any securities (whether known to the
surety or not) the surety is discharged to the extent of the value
of such securities (Sec.141). Further, the creditor must hand over
to the surety, the securities in the same condition as they
formerly stood in his hands. b) Right to be indemnified: The surety
has a right to recover from the principal debtor the amounts which
he has rightfully paid under the contract of guarantee. 3.5.3
Rights against co-sureties a) Right of contribution. Where a debt
has been guaranteed by more than one person, they are called
co-sureties. Sec.146 provides for a right of contribution between
them. When a *surety has paid more than his share or a decree has
been passed against him for more than his share, he has a right of
contribution from the other sureties who are equally bound to pay
with him. Example: A, B and C are sureties to D for the sum of Rs.
3,000 lent to E. E defaults in making payment. A, B and C are
liable, as between themselves to pay Rs. 1,000 each and if any one
of them has to pay more than his share, i.e., Rs. 1,000 he can
claim contribution from the others, for the amount paid in excess
of Rs. 1,000. b) Where, the co-sureties have guaranteed different
sums, they are bound under Sec.147 to contribute equally, subject
to the limit fixed by their guarantee and not proportionately to
the liability undertaken. Examples: (i) A, B and C as sureties for
D, enter into three several bonds, each in a different penalty,
namely, A in the penalty of Rs 10,000, B in that of Rs 20,000, C in
that of Rs 40,000, conditioned for Ds duly accounting to E. E makes
default to the extent of Rs 30,000. A, B and C are each liable to
pay Rs 10,000. (ii) In the above example, if D makes default to the
extent of Rs 40,000, A is liable to pay Rs 20,000 and B and C Rs
15,000 each.
3.5.4 Liability of surety Unless the contract provides
otherwise, the liability of the surety is co-extensive with that of
the principal debtor (Sec.128). In other words, the surety is
liable for all those amounts the principal debtor is liable for.
Example: A guarantees to B the payment of a bill of exchange by C,
the acceptor. The bill is dishonoured by C. A is liable not only
for the amount of the bill but also for any interest and charges
which may have become due on it. The liability of a surety is
called as secondary or contingent, as his liability arises only on
default by the principal debtor. But as soon as the principal
debtor defaults, the liability of the surety begins and runs
co-extensive with the liability of the principal debtor, in the
sense that the surety will be liable for all those sums for which
the principal debtor is liable. The creditor may file a suit
against the surety without suing the principal debtor. Further,
where the creditor holds securities from the principal debtor for
his debt, the creditor need not first exhaust his remedies against
the securities before suing the surety, unless the contract
specifically so provides. The creditor is even not bound to give
notice of the default to the surety, unless it is expressly
provided for. Position of surety in case of a minor principal
debtor. According to the decision of the Bombay High Court in
Kashiba v. Shripat I.L.R. 10 Bom. 1927 the surety can be held
liable, though a minor debtor is not liable. But the later
decisions of the Bombay High Court have taken a contrary view. In
Manju Mahadeo v. Shivappa Manju and in Pestonji Mody v. Meherbai it
was held that as under Sec.128, the liability of the surety is
coextensive with that of the principal debtor, it can be no more
than that of the principal debtor and that the surety therefore
cannot be held liable on a guarantee given for default by a minor.
If a minor could not default, the liability of the guarantor being
secondary liability does not arise at all. The same view has been
endorsed by the Madras High Court in the case of Edavan Nambiar v.
Moolaki Raman (A.I.R. 1957 Mad. 164). It was held that unless the
contract otherwise provides, a guarantor for a minor cannot be held
liable. 3.5.5 Discharge of surety The liability of