Chapter – 1

Meaning of Contract

We daily enter into a number of contracts. We board a bus or train, we enter into contract. We

watch movie in multiplex, we enter into contract. But generally we are unaware of the right and

obligations arising out of the contracts. The primary objective of law of contract is to identify the

circumstances where promises made by parties to a contract become legally binding on them.

Indian Contract Act, 1872

The Indian Contract Act (ICA) came into force on the first day of September, 1872. The Act

extends to whole of India except the State of Jammu and Kashmir.

Law of Contract creates Rights in personam and not rights in Rem.

Right in Personam or Jus in Personam

It means right of a person against a specific person. The law of contract creates right in

personam. For example, A sold his car to B for Rs. 2 lakh. A has a right to claim 2 lakh from B.

On the other hand, B has a right to claim delivery of car form B. This is right against a specific

person.

Learning Objectives

After going through the chapter, the students will be able to know

What is an agreement and a contract?

What are essentials of a valid contract?

Various kinds of contracts

Right in Rem or Jus in Rem

This is a right that exists against the whole world. For example, After getting car from A or after

execution of contract. B has right to enjoy the possession of car against the whole world.

Meaning of Contract

The formation of a contract primarily begins when one person gives a proposal or offer to the

other person. Hence, when a person makes an offer to the other person, the other person may

accept it or reject it. Where the offer is rejected, it results into nothing but where the offer gets

accepted, it becomes a promise.

As per section 2 (h) of ICA, 1872,

An agreement enforceable by law is a contract.

If an agreement has legal enforceability, it becomes a contract. Legal enforceability comes if

agreement fulfills all the essentials of a valid contract given under section 10 of ICA.

Hence

+ =

Offer Acceptance

Agreement

Agreement + Legal enforceability

Contract

Agreement Legal Enforceability Contract

Essentials U/S 10 of ICA, 1872

Essentials of a valid contract (Sec 10 of ICA)

Section 10 of Indian Contract Act, 1872 reads, “All agreements are contracts if they are made by

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

object, and are not hereby expressly declared to be void”.

In simple words, all the essential elements of a valid contract must exist in an agreement so as to

create a valid contract. The essentials as explained under Section 10 are as follows:

1. Legal offer and acceptance

To create a valid contract, there should be agreement first. For forming a agreement,

there should be valid offer by one party and valid acceptance to such offer by other party.

Offer and acceptance should fulfill all the essentials of valid offer and valid acceptance as

given in SLM-2.

2. Intention to create a legal relationship

Parties must have intention to enter into a legal relationship while entering into

agreement. If there is no intention to enter into legal relationship, then there will be no

contract. For example, A asked B to come to his place for dinner. B agreed. Here parties

don’t have intention to enter into legal relationship. So it is just a social agreement.

Balfour vs. Balfour

Mr. and Mrs. Balfour were enjoying leave in England. When they were to return to

Ceylon (Where Mr. Balfour was employed) Mrs. Balfour was advised to remain in

England by reason of her ill health. Mr. Balfour returned to Ceylon and agreed to send his

wife an amount of 30 Pounds amount for her expenses. He sent the expenses for

sometime but afterwards some differences arose which resulted in their separation and he

stopped sending the allowances to her. Mrs. Balfour filed a case against her husband for

the allowances.

Held: It was that Mr. Balfour was not liable for the expense as it was just a social

agreement.

3. Lawful consideration

Consideration means something in return. In other words, price paid for the promise is

called consideration. An agreement without consideration is void. Moreover, the

consideration should be lawful.

For example: A paid B Rs. 50,000 for promotion of his son in govt. job. This is unlawful

consideration. Hence, the agreement is void.

4. Lawful object

Object means basic purpose of entering into the contract. Whenever two persons enter

into a contract there is a basis purpose of forming such a contract, which is called as the

object of the contract. The object or purpose for which the contract is to be formed must

be lawful in the eyes of law. Under Section 23 of the ICA, 1872 both the object and

consideration of the agreement, must be lawful in order to make it enforceable contract.

The agreement, the object of which is illegal or unlawful is called as an illegal agreement.

All illegal agreements are void agreement i.e. are not enforceable by law.

Section 23 provides that the object and consideration is aid to be unlawful when:

(i) It is forbidden by law ; or

(ii) It is of such a nature that, if permitted, it would defeat the provisions of any law ; or

(iii) It is fraudulent ; or

(iv) It involves injury to the person or property of another ; or

(v) The court regards it as immoral or opposed to public policy.

5. Competency of parties

The parties who want to enter into a contract should be competent to do so. Section 11

states that the person willing to enter into a contract must satisfy three conditions,

namely,

(i) He must be a major (i.e. a person equivalent to 18 years of age or more than 18 years

of age)

(ii) He must be a person of sound mind.

(iii) He must not be disqualified from contracting by any law to which he is subject.

Mohiri Bibee vs Dharmo Das Ghose

Minor mortgaged a security to obtain a loan of Rs. 20,000. Later, the minor refused to repay

the loan amount of Rs. 20,000 and demanded his mortgaged security back. It was held that

the minor was not liable to repay the loan of Rs. 20,000 because the mortgage was void.

Therefore, the minor did not repay the loan amount and took back his mortgaged security as

well.

6. Free Consent

For a valid contract, parties should have free consent. Basically these are two

requirements :

(i) There should be consent: - Law says these should be consensus ad idem. It means

parties should agree upon same thing in the same sense.

(ii) Consent should be free:- The consent of the parties should be free. It means consent is

not caused by following :-

(a) Coercion – Consent obtained by physical threat.

(b) Undue Influence – Consent obtained by mental threat.

(c) Fraud – Consent obtained by intentionally deceiving the other.

(d) Misrepresentation – Consent obtained by un-intentionally deceiving the other.

(e) Mistake – Consent obtained by committing a mistake / error.

Webster vs. Cecil

Both A and B mutually agree to sell and buy goods at Rs. 1990. By mistake B wrote to A

offering to buy the same goods at Rs 2990. A immediately accepted the offer at Rs. 2990 when

he knew the agreed price was Rs 1990. Held, the agreement was void.

7. Certainty of Meaning

If the meaning of the agreement is not clear to the parties, then the agreement is void. In

other words, when terms and conditions of the agreement are not clear, it becomes a void

agreement.

For example: A agreed to sell 100 tons of Oil to B at certain price. Here price is not

clear. Moreover the type of Oil is not specified. Hence it is a void agreement.

8. Possible to perform

The agreement should be possible to perform. If it is impossible to perform it will be void

agreement. For example, Ram asked Sham to pay him Rs. 50,000 and he will bring his

dead mother alive. Such an agreement is void.

9. Legal formalities

As such, the Indian Contract Act does not itself lay down any formal requirements for a

contract, but the Act gives a legal sanction to all those formalities which may be

prescribed by some other law. The most common formal requirements include:

• requirement of having an agreement in writing ;

• requirement of having an agreement in prescribed form ;

• requirement of having an agreement attested ;

• requirement of having an agreement registered ;

• requirement of having paid any stamp duty.

Depending upon the nature of the contract and the law to which such a contract should abide to,

the legal formalities need to be fulfilled.

10. Not declared to be void

The Indian Contract Act, 1872 has specifically declared some of the agreement to be void

agreements (i.e. agreements not enforceable by law) under Section 23 to Section 30 of the

Act namely:

(i) Unlawful agreement – Section 23 and Section 24

(ii) Agreements without consideration – Section 25

(iii) Agreements in restraint of marriage – Section 26

(iv) Agreements in restraint of trade – Section 27

(v) Agreements in restraint of legal proceedings – Section 28

(vi) Uncertain agreements – Section 29

(vii) Wagering agreements – Section 30

(viii) Agreements to do impossible acts – Section 56.

Where the parties to an agreement form any of such agreements stated above, then all such

agreements are already declared by the law to be void agreements, therefore no such agreement

can become an enforceable agreement.

Activity one – Check your progress

1. A contract with a minor is _________?

2. Any agreement which has legal enforceability is called ___________?

3. Law of contract creates rights in __________?

4. Essentials of contract are given under section ___________?

5. Can invitation for dinner create a valid contract?

(Hints : 1. Void, 2 Valid Contract, 3. Personam, 4. Section-10, 5. No.)

Kinds of Contract

The contracts can be classified on different basis as follows:

Classification of Contract

On the basis On the Basis On the Basis Printed

of Formation of Performance of Validity Contracts

- Valid Contract

Express Implied Quasi - Void Agreement

Contract Contract Contract - Void Contract

- Voidable Contract

- Unenforceable Contract

Executed Executory

Contract Contract

A. On the basis of formation

1. Express Contracts: - When the parties to the contract express their intention to enter into

the contract, then such a contract is called express contract. It can be expressed in words

spoken or written. Both written as well as oral contracts are enforceable. But for oral

contracts enforceability, there should be sufficient evidence present.

2. Implied Contracts: - A contract which is not expressed orally or in written rather is

implied from the:

(a) Circumstances of the case or

(b) Behaviour of parties or

(c) From previous dealings between the parties is known as implied contract.

For example: (a). Boarding a bus, it is implied to buy the ticket. (b). After eating food in

a restaurant, it is implied to pay the bill.

3. Quasi contracts: - As the name suggests, a quasi or a constructive contract is a contract

which is not formed by the parties to the contract but is enforced on the parties to the contract

by the court of Law. In other words, such a contract is not formed but is constructed by law,

that is why it is called as constructive contract.

Example: If some goods are delivered by mistake to a wrong person (who is not the owner

of these goods) then there forms a quasi contract between the person who is wrongfully

delivered the goods and the true owner of the goods. As per the contract, the person must

return the goods to the true owner and in return the true owner must compensate the other.

B. On the Basis of Performance

1. Executed Contracts: - The contracts in which both the parties have fulfilled their

respective obligations are called executed contracts.

For example: - A entered into contract with for sale of his car of Rs. 3 lakh. A handed

over the car to B and B paid the due amount. Hence it is an executed contract.

2. Executory Contract: - The contract in which parties have yet to fulfill their obligations

are called executory contracts.

C. Printed or Standard Form Contracts

In a standard form contracts, the terms of the contract are pre-drafted by one of the

parties and the other party has just to sign it for acceptance (without having any

opportunity or time to get the terms changed). In such a contract, the terms and

conditions of the contract are not settled by the process of negotiation between the

parties.

For example: (i) A draft prepared by Insurance Company for Insurance Policy. (ii)

Terms & conditions printed on a Railway Ticket for passengers.

D. On the basis of Validity of Contracts.

1. Valid Contracts: - U/S 2(h) of ICA, 1872 – “An agreement enforceable by law is a

valid contract.” Therefore an agreement which satisfies all the essentials (U/S 10 of

ICA, 1872) of a valid contract becomes enforceable by law and thus is called a valid

contract.

2. Void agreements:- An agreement where any of the essentials mentioned under

Section 10 of Indian Contract Act, 1872 is not fulfilled becomes a void agreement.

An agreement may become void agreement due to many reasons as explained below:

Agreements made by incompetent parties (Section 11)

Agreements made by mutual or bilateral mistake (Section 20)

Agreement where object or consideration is unlawful (Section 23)

Agreement where object or consideration is illegal in part (Section 24)

Agreements without consideration (Section 25)

Agreements in restraint of marriage (Section 26)

Agreements in restraint of trade (Section 27)

Agreements in restraint of legal proceedings (Section 28)

Agreement with uncertain meaning (Section 29)

Wagering agreements (Section 30)

Agreements which are impossible to perform (Section 56)

3. Void contracts:- U/S 2(j) of ICA, 1872 - “A contract which ceases to be enforceable

by law becomes void when it ceases to be enforceable.”

A void contract is a contract:

• Which was valid contract when formed,

• But because of the supervening impossibility of performance.

• Today it has become impossible to perform, hence void.

In simple words, if a contract becomes impossible to perform without the fault of the

promisor but because of some later event that is outside the control of the promisor, then

such a contract becomes a void contract.

The performance in a void contract may be excused due to:

(i) Performance has become impossible by any change of law.

(ii) Performance has become impossible because of destruction of subject matter.

(iii) Performance has become impossible because of death of a party.

4. Voidable Contract: - When consent of one of the parties to contract is not free, then

contract becomes voidable. As per ICA, 1872. “An agreement which is enforceable

by law at the option of one or more of the parties thereto, but not at the option of the

other or others is a voidable contract.”

Consent of Parties may not be free because of following reasons:-

Coercion as defined in Sec. 15, or

Undue influence as defined in Sec. 16, or

Fraud as defined in Sec. 17, or

Misrepresentation as defined in Sec. 18, or

Mistake, subject to the provisions of Secs, 20, 21 and 22.

5. Unenforceable Contract: An un-enforceable contract is a contract which is not

enforceable by law because of some technical defect existing in it. Once that defect is

cured, the contract becomes enforceable by law. Like, some contracts should be duly

registered as required U/S 17 of the Indian Registration Act XVI of 1908. If such a

contract is formed without registration, it would be called as un-enforceable contract

until it is registered. Once it is registered, it shall become a valid enforceable contract.

Similarly, some contracts must be duly stamped after payment of stamp duty. If such

contracts are formed without stamp duty, they will not be enforceable unless stamped.

Distinction Between Void Agreement and Illegal Agreement

Basis of Distinction Void Agreement Illegal Agreement

1. Definition U/S 2(g) of ICA, 1872, “An

agreement not enforceable by law

is void.”

An illegal agreement is an

agreement the object of

which is unlawful.

2. Reason An agreement may become void

due to many reason such as ; an

agreement with an incompetent

person, an agreement without

consideration, an agreement in

restraint of trade, etc.

An illegal agreement

becomes illegal only when

the object of the agreement

is not legal i.e. unlawful

3. Scope The scope of void agreement is

wider than illegal agreement.

Infact, illegal agreement is a kind

of void agreement

All illegal agreements are

void agreements. But all

void agreements are not

illegal agreements.

4.Punishment for

parties

A void agreement may not always

result into legal punishment for

parties to the contract.

The parties to an illegal

agreement are liable to

punishment by law.

5. Effect on collateral

Transactions

Transactions collateral to void

agreements are enforceable by

law.

Transactions collateral to

illegal agreements are also

tainted with illegality and

hence are devoid of legal

enforceability.

Distinction Between Contract and Agreement

Basis Contract Agreement

1. Meaning Contract means an agreement

which is enforceable by law

Agreement means a promise

which is created through

acceptance to an offer

2. Legal Enforceability Contract is legally enforceable Agreement is not legally

enforceable

3. Intention of Parties Parties should have intention

to enter into a legal

relationship to form a contract

Parties don’t require intention

to create a legal relationship to

form an agreement

4. Competency of Parties Parties should be competent to

enter into a contract

Competency of Parties is not

required to form an agreement

5. In case of breach In any party commits breach,

other party can sue

In case of agreement if any

party commits breach, other

party can’t sue

6. Scope Contract is a wider term as all

contracts are agreements but

all agreements are not

contracts

It is a narrow term

7. Essentials Agreement becomes a contract

if all the essentials given u/s

10 fulfilled.

If essentials are not fulfilled

agreement never becomes

contract.

Difference between Voidable contract and Void agreement

Basis Voidable contract Void agreement

1. Meaning When one party has an option

to cancel the contract the

contract is called voidable

When agreement is not

enforceable at law, it is called

void agreement

2. Reason Contract becomes voidable if Agreement becomes void due

one of the party doesn’t have

free consent

to reasons like incompetency

of parties or absence of

consideration

3. Validity Voidable contract is valid until

& unless it is cancelled.

Void agreement can’t be

converted into valid contract.

4. Remedies The party whose consent is

not free can either

(i) Cancel the contract or

(ii) affirm the contract

Here no such remedy is

available

5. Right of third party Third party can acquire right

out of voidable contract, In

such case, voidable contract

can’t be rescinded

Third party can’t acquire any

right out of void agreement

6. Legal effects Voidable contract if confirmed

becomes a valid contract and

hence legally enforceable

Void agreement is not legally

enforceable

Distinction Between Void contract and Voidable Agreement

Basis Void contract Voidable agreement

1. Meaning The contract when created was

enforceable but due to reason

like impossibility to perform

has become unenforceable is

called void contract.

The contract where consent of

one party is not free is called

voidable contract.

2. Reason Void Contract is not legally

enforceable

Voidable contract is

enforceable if it is not rescind.

3. Validity Void contract can’t be

converted into valid contract.

Voidable contract gets

converted into valid if party

whose consent is not free

affirms the contract.

4. Remedies The innocent party can bring

about the claim for “Quantum

Meruit” remedy. Quantum

meruit means to claim claim

the remuneration for the work

so done in contract which has

now become void.

The remedies available for a

voidable contract are :

(i) Recession of contract.

(ii) Restitution

5. Right of third party A third party cannot acquire

any right in a contract that has

become void.

A third party can acquire

rights in a voidable contract.

Activity Two – Check your progress

1. Contract imposed by law are called _______________?

2. If contract becomes impossible to perform, it is called ____________?

3. It three is technical defect in the contract, it is a _______________?

4. If consent of one of the parties to contract is not free, it becomes ___________?

5. Third party can acquire right out of

Voidable contract

Void agreement?

(Hints : 1. Quasi Contracts, 2. Void contract, 3. Unenforceable contract, 4. Voidable Contract, 5.

Voidable Contract.

Activity 3 - Check your progress (Case Studies)

1. A invites B for dinner at his home on a Sunday. B hires a taxi and reaches A’s home at

the specified time, but A fails to perform his promise. Can B sue A for any damages?

(Hint: No, it was a social agreement and hence not enforceable by law.)

2. C offered to pay A, an auto mechanic, Rs. 50 for testing a used car which C was going to

purchase from D. A agreed and tested the car. C paid A Rs. 50 in cash for his service. Is

the agreement between C and A (a) express or implied, (b) executed or executory, (c)

valid, voidable or enforceable?

(Hint: The agreement is (a) express, (b) executed , and (c) valid)

Summary

An agreement enforceable by law is a contract.

If an agreement has legal enforceability, it becomes a contract. Legal

enforceability comes if agreement fulfills all the following essentials of a

valid contract given under section 10 of ICA.

1. Legal offer and acceptance

2. Intention to create a legal relationship

3. Lawful consideration

4. Lawful object

5. Competency of parties

6. Free Consent

7. Certainty of Meaning

8. Possible to perform

9. Legal formalities

10. Not declared to be void

Contracts can be classified further on various basis such as formation,

validity, performance etc.

3. A promises to pay B Rs. 500 if he beats C. B beats C, but A refuses to pay. Can B

recover the amount?

(Hint: No as the agreement is illegal)

4. A spiritual guru promised a person that he would make her dead mother alive, if the

person paid him Rs. 1 crore. Is the contract valid?

(Hint: No, the agreement is impossible to perform, hence is void agreement)

5. Mrs. & Mr. Gupta went to a restaurant and enjoyed the buffet served there. Later they

denied the payment of the food, on the plea that they never placed an order for food,

hence there was neither express nor implied contract. Discuss.

(Hint: They have to pay, eating food served in buffet is itself an implied contract.)

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. Define the term Contract.

2. Explain the following

(a) Legal enforceability (b) Free Consent

(c) Consideration (d) Capacity of Parties

(e) Social Agreement (f) Domestic Agreement

(g) Void Agreement (h) Valid Contract

3. Can all agreements become valid contract?

4. Differentiate between the following :

(a) Void Agreement and Illegal Agreement

(b) Void Contract and Voidable Contract

(c) Void Agreement and Voidable Contract

(d) Rights in Rem and Rights in Personam

5. Can a social agreement become enforceable by law?

Long Questions

1. “All contracts are agreements but all agreements are not contract.” Discuss the statement.

2. Define the term Contract. Also explain the essentials of a valid contract.

3. What tests are applied to ascertain whether an agreement is a contract or not?

4. Discuss in detail the kinds of contracts.

5. What are the essential ingredients required in the formation of a valid contract?

6. Is there a difference between contract and agreement? Explain in detail.

Chapter - 2

Offer and Acceptance

As we have read earlier that agreement which fulfills all the essentials given under Section 10 of

ICA, 1872 are valid contracts. Agreement comes into existence only after a valid offer by the

offereor and a valid acceptance by the offeree. An offer in itself doesn’t create any legal

relationship. The legal relationship comes into existence only when an offer is accepted.

I. Offer

Section 2(a) of Indian Contract Act (ICA), 1872 defines offer as:

“When one person signifies his willingness to do or abstain from doing anything, with a view to

obtain the assent of that other to such an act or abstinence, he is said to make a proposal”.

The definition quoted above has highlighted three important traits of a valid offer:

a) One person must signify,

b) His willingness to do or abstain from doing anything,

c) To obtain the assent of other

He is said to make a proposal.

Learning objectives

After going through the chapter, you will be able to learn

When an agreement comes to existence

What is valid offer and acceptance

When communication and revocation is complete?

Can silence amount to acceptance?

When an offer lapses?

For example, A wanted to sell his car. He offered it to B for Rs. five lakh. B accepted the offer.

Hence, a valid contract comes to existence.

Essentials of offer

1. Offer must be communicated to other party:

Definition of offer clarifies that offer must be signified to other party. Mere intention of doing

something which is not communicated to other party is not an offer. Until the offer is

communicated, it can’t be accepted. It is very essential that the person to whom the offer is made

has full knowledge of that offer.

Lalman Shukla vs Gauri Datt1

Lalman Shukla was an employee with Pt. Gauri Dutt. When the nephew of Pt. Gauri Dutt was

found missing, Lalman Shukla was sent for the search. It was announced later that who so ever

finds the missing nephew will be rewarded with Rs. 501. Unaware of the announcement of the

reward, Lalman Shukla located the missing nephew and brought back. It was said that Lalman

Shukla has no right to claim reward because he has no knowledge of the proposal. Hence, an

action without the knowledge of the proposal is no acceptance.

2. Offer must be made with a view to obtain the assent of the other:

The second part of the definition emphasizes the requirement that an offer must be made with a

view to obtain the consent of the offeree to the proposed act or abstinence. When the offer is not

made with the purpose of getting the assent of the offeree, such statements don’t constitute a

valid proposal.

For example, A told B that he wanted to sell his horse and he wanted to fetch a price of Rs

200000. A didn’t have intention to get B’s consent on the same. Hence, this is not a valid offer.

3. Intention to create a legal relationship:

Offer must be made with an intention to create a legal relationship. An offer that creates mere

social or moral obligation doesn’t constitute a valid agreement.

1 www.lawnotes.in/Lalman_Shukla_vs_Gauri_Dutt

For example, A invited B for dinner at his place. B accepted. When B reached A’s place his

house was locked. Here, B can’t sue A as offer just created a social obligation and not a legal

obligation.

4. Offer must be definite and clear:

The offer must be such that its terms are definite and clear to the offeree. If it is indefinite, it will

not be considered as a valid offer. The reason for the same is that when the offer is vague it

cannot be said that what exactly the parties intended to do.

For example, X offered his car to B to be sold at a price of Rs. 500 or 700. Such an offer is not a

valid offer.

5. Offer must signify the final willingness of the offeror:

The proposal or offer will be valid if it signifies the final willingness of the offeror. Sometimes, a

party does not express his final willingness but proposes certain term on which he is willing to

negotiate. In such case, he is not making a valid offer.

For example, A told B that he will not sell his car below the price of three lakh. Here the offer

doesn’t signify the final willingness of the offeror. Hence it is not a valid offer.

6. Offer must be distinguished from answer to a question:

The offer must be distinguished from an answer to a question: The terms of an offer should be

clear so that there is no confusion whether it is a valid offer or an answer to a question. An

answer to a question cannot be taken as an offer.

For example, A sent a telegram to B writing “Will you sell us Bumper hall pen (Plot of land)?

Telegraph lowest cash prize”. B replied by telegram “lowest price for Bumper Hall Pen Pound

900”. A send a telegram stating therein “I agree to purchase Bumper Hall Pen for Pound 900

Balfour vs. Balfour

Mr. Balfour had to move to Ceylon. He promised her wife to send her 30 pounds per

month while he was abroad. He failed to pay the amount. Mrs balfour filed a suit against

her husband for recovering the said amount. The court held that it was mere a domestic

agreement and the offer made by Mr. Balfour just created a social or domestic

obligation. Hence, it was not a valid contract.

asked by you. Please send us your title deeds.” B refused to sell the plot of land at that price. A

brought legal action against B. it was held that B did not make any offer to sell at that price, he

simply answered the question asked by A. The court observed that A asked the following two

questions in his first telegram.

(a) Willingness to sell, and (b) lowest price.

B only answered the second question, and reserved his answer to his willingness to sell.

Therefore, he had made no offer.

7. Offer must be distinguished from invitation to offer:

Sometimes, a person may ask for some information or may supply some information and invite

the other to make an offer. When a party does not make an offer but simply proposes certain

terms and invites the other party to make an offer on proposed terms, such statement is called

invitation to offer.

For example:

An invitation to traders to make tenders

Display of goods for sale in a showroom

An invitation by company to public to subscribe for its shares.

Advertising auction sales.

8. Offer must be distinguished from mere statement of intention:

To make an offer a valid offer, it should be made with an intention to get assent of the other

party. If it is just a statement of intention, then it will not be a valid offer. Sometimes a person

declares his intention to do something; this will not amount to offer.

For example, A told C that he wanted to sell his plot in Model town for 60 lakh. Such a

statement is mere statement of intention and hence, is not a valid offer.

9. Offer may be made to world at large:

The offer may be specific or general. If it is made to a specific person, it becomes specific offer.

When it is made to public at large, it is general offer. In case of general offer, the contract is not

made with the entire world. But it is made only with the person, who having the knowledge of

the offer, comes forward and acts according to the conditions of the offer.

Harbhajan Lal vs Harchjaran Lal2

A young boy ran away from his father's home. The father offered a reward stating that anybody

who finds trace of the boy and brings him home will get Rs. 500." A found him and took him to

the Railway Police Station where he made a report and sent a telegram to the boy's father saying

that he had found his son. In this case, it was decided that hand-bill was an offer open to the

whole world and capable of acceptance by any person who fulfilled the condition. Here A, by

tracing the missing boy had substantially performed the conditions of the offer therefore he was

entitled to receive the award.

It may be noted that where the general offer is of continuing nature as in case of Smoke Ball’s

case, it can be accepted by any number of persons until it is retracted. But where the offer needs

the finding of a missing thing as in Harbhajan Lal’s case, it is closed as soon as the first

information is received by the offeror.

10. Offer may be positive or negative:

An offer may be to do something or not to do something. An offer to do something is a positive

offer. And an offer not to do something is a negative offer.

2 www.studymode.com/subjects/harbhajan-lal-v-harcharan-lal-page1.html

Carlill vs Carbolic Smoke Ball Co.

This case is an example of a general offer. The company had advertised that if a person

took ‘smoke ball’ as per the instructions and fell a prey to influenza, he or she would be

entitled to claim 100 pounds from the company. Mr.s Carlill used the medicine as per

instructions in the advertisement, yet she fell a prey to influenza and claimed Pound 100.

The Company pleaded that since the offer was an advertisement, Mrs. Carlill should have

been in touch with company and informed it of her acceptance of the offer. The court

decreed that in such a situation, the notice of acceptance was not mandatory, and that Mrs.

Carlill had accepted the offer by using the medicine in the prescribed manner and was

therefore entitled to 100 pounds.

11. Offer may be expressed or implied:

Offer is expressed when it is communicated by words, spoken or written or by doing some

required act. But when it is shown through the conduct of the parties, then it is implied offer.

Offer may be implied or expressed. Both will be valid.

For example, A writes to B offering his horse for Rs. 30,000. It is an express offer. Consuming

food at self service restaurant is an implied offer to serve food for payment in return.

Kinds of Offer

1. Express and Implied offer

An express offer is one which is made by words spoken or written. An implied offer is

one which is made otherwise than in words. In other words, it is inferred from the

conduct of the person or the circumstance of the particular case.

For example, A offered his car to be at price of Rs. 2 lakh. This is express offer. A bid at

an auction is an implied offer to buy.

2. Specific and General offer

An offer when made to a definite person or persons is called specific offer. Such an offer

can be accepted only by the person or persons to whom it is made. Thus, where A makes

an offer to B to sell his car for Rs. 200, this is a specific offer and B alone can accept it. A

‘general offer’, on the other hand, is one which is made to the world at large or public in

general and may be accepted by any person who fulfils the required conditions. The

leading case on the subject of ‘general offer’ is that of Carlill vs Carbolic Smoke Ball

Co.

3. Standing or Open Offer.

An offer for the continuous supply of a certain article at a certain rate over a definite

period is called a standing offer. Such offers though accepted do not give rise to contract

unless an actual order is placed. The offeror can withdraw his offer at any time before an

order is placed with him.

For Example, A, by means of an offer agrees to supply coal to B at a particular rate for a

period of two years. B accepts the tender. In this case B is not bound to place an order for

all the coal which he requires nor is A bound to keep that offer alive during the course of

two years unless there is an extra-consideration.

Tender for supply of goods is a kind of standing offer. When advertisement inviting

tenders is given, it is an invitation to offer. When the tender is approved, it becomes

standing offer. As and when the order is placed that amounts to acceptance of offer and

results in a binding contract.

4. Counter offer

Whenever an offeror makes an offer to the offeree, the offeree must accept the same

unconditionally. If the offeree attaches some condition to an unconditional offer, it

amounts to counter offer. Further a counter offer has following two consequences:

(i) Counter offer leads to lapse of the original offer.

(ii) The original offer so lapsed cannot be revived again.

5. Cross Offer

Two offers which are similar in all respects made by two parties to each other, in

ignorance of each other’s offer are known as ‘cross offers’. Cross offers do not amount to

acceptance of one’s offer by the other. Hence, no contract is entered into on cross offers.

Hyde Y. Wrench

An offer was made by A to B for the sale of a farm for 1,000 pounds. B rejected this

offer and said that he will pay only pound 950 to which A did not agree. Thereupon B

said that he was willing to pay 1,000 pounds to which also A did not agree. B sued A

and contended that there was a contract by which A was bound. It was held that B had

once rejected A’s offer by his counter offer to pay 950 pounds and this made the original offer to lapse, and therefore, no contract had resulted in this case.

Tinn v. Hoffman & Co.

A wrote a letter to B, a firm of furniture dealers to supply him 5,000 chairs of a

particular type and at a certain price. The same firm on the same day posted a letter to

A offering to sell 5,000 chairs of the same quality at the same price. The letters crossed

each other in the post. Held, that the letters were cross offers, and neither was

acceptance of the other because each side was ignorant of the proposal of the other

party at the time of writing the letter.

Check Your progress (Activity One)

1. A wrote a letter to B offering him his car for Rs. 2 lakh and put that letter in his drawer.

Is it a valid offer?

2. A invited B for movie at his place. B went to A’s place by hiring a taxi. Can B Claim taxi

Charges?

3. A lost his wallet. He gave advertisement in newspaper stating that whosoever finds and

return it, will get Rs. 5,000. Is it a valid offer?

4. A made an offer to B for selling his car at Rs. 2 lakh. Is it specific or general offer?

5. Tender is an example of __________________________.

6. Advertisement inviting tender is __________________________________.

7. An offer was made by X to Z for sale of car Rs. 3 lakh. B said he will pay 2,90,000. Tell

the consequences.

8. An offer ________________ Rs. 2,90,000. A rejected B’s offer. B said that I will pay Rs.

3 lakh. Can a contract come to existence?

9. A wrote a letter to B offering his car for Rs. 2 lakh. B wrote a letter to A offering to

purchase his car for Rs. 2 lakh. Can valid contract come to existence?

10. A bid at an auction is an _______________________ offer.

(Hints : 1. No, offer should be communicated, 2. No, 3. Yes, it is a general offer. 4. Specific

offer, 5. Standing offer, 6. Invitation to offer, 7. B made a counter offer which resulted in closing

of original offer, 8. No, as counter offer by B closed the original offer, 9. No, Case of cross offer,

10. Implied offer)

Acceptance

The definition of acceptance as quoted as per section 2 (b) if ICA, 1872 reads:

When the person to whom offer is made,

Signifies his assent thereto the proposal is said to be accepted,

A proposal when accepted becomes a promise.

Effect or Importance of Acceptance

English author Anson compares an offer with a train of gun powder, and acceptance with a

lighted match. The effect of accepting an offer and its revocation is explained by Anson as

under:

‘Acceptance is to an offer what a lighted match is to a train of gun powder. It produces

something which cannot be recalled or undone.’

This means that when a lighted match is shown to a train of gun powder, it explodes and

something happens which cannot be undone. Similarly, an offer once accepted becomes a

contract and gives rise to legal obligations. An offer is like a gun powder. It can be revoked

before it is accepted or it can even lapse on account of acceptance not being given within a fixed

time or reasonable time. But once acceptance is given, the offer results into contract. Anson lays

emphasis on two points, namely

(a) Once the offer is accepted there can be no revocation of the acceptance, and

(b) There can be no acceptance after the revocation of the offer.

Acceptance may be express or implied. When acceptance is made by words, spoken or written,

it is an express acceptance. When conduct of the party shows that he has accepted the offer, it is

an implied acceptance. Thus, where a person boards a train, he impliedly accepts to pay the fare.

Similarly, when a person goes to a hotel and eats some food, he impliedly accepts to pay for it.

Essentials of Valid Acceptance

1. Acceptance must be communicated

As it is clear from the definition, the acceptance should be communicated to create a valid

contract. Mere mental acceptance is not enough. Acceptance can be express or implied to

make a valid contact. But in case of general offer, like in case of Carbolic Smoke Ball

Company vs Carlill case, communication of acceptance is not compulsory, Moreover in case

of unilateral contracts, communication of acceptance is not mandatory.

2. Acceptance must be communicated to the offeror

To reach an agreement or conclude a contract, the acceptance of the offer needs essentially to

be communicated to the person making the offer. If the acceptance of offer is not

communicated to the person making the offer, the acceptance is not valid in terms of law.

3. The acceptance must be communicated by a person who has the authority to accept

A valid contract arises only if acceptance is communicated by a person who has the authority

to accept. If it is communicated by any unauthorized person. It will not create any legal

relationship.

4. The acceptor must be aware of the offer

Acceptance follows offer. It the acceptor is not aware of the existence of the offer and

conveys his acceptance, no contract comes into being. There must be knowledge of the offer

before anyone could consent to it. The leading case is Lalman Shukla v. Gauri Dutt as

discussed above.

FELTHOUSE V. BINDLEY (1862)

F offered to buy his nephew’s horse for Rs. 30,000 adding, “If I don’t hear from you, I

shall consider the horse is mine at Rs. 30,000. The nephew did not reply, but told his

auctioneer not to sell the horse, as it was sold to his uncle. But the auctioneer sold it by

mistake to a third party. F sued him for conversation of his property. It was held that

there was no communication of acceptance. Mental acceptance or uncommunicated

assent does not result in a contract.

POWELL vs. LEE (1908)

P was a candidate for the post of head master in a school. The managing committee of the

school passed a resolution for the appointment of P. A member of the committee in his

personal capacity informed P of the resolution, but P did not receive any official

intimation. Later on, the resolution was cancelled and P was not appointed to the post. P

filed a suit against the committee for breach of contract. It was held that there was no

contract as P did not receive any authorized intimation from the Committee.

5. Acceptance must be absolute & unqualified

The acceptance must be absolute and unqualified. There must be no variation in the terms of

the offer. Otherwise, acceptance would amount to a counter-offer, which may or may not be

accepted by the offeror.

6. Acceptance must be according to the mode prescribed or usual or reasonable mode

If the acceptance is not done according to the prescribed mode, the offeror may inform the

offeree within a reasonable time that the acceptance is not according to the prescribed mode

and may insist that the offer must be accepted in the prescribed mode only. If he does not

inform the offeree, he is deemed to have accepted the acceptance.

7. Acceptance must be given within a reasonable time

If any time limit is specified, the acceptance must be given within that time. If no time limit

is specified, it must be given within a reasonable time.

8. The acceptance must be given before the lapse of offer

Acceptance should be given before the lapse of the offer, only then it will be a valid

acceptance. An acceptance which is made after the withdrawal of the offer is invalid, and

does not create any legal relationship.

9. Acceptance not be presumed from silence

Mere mental acceptance which is not expressed in words or in writing is not recognized as

acceptance from the legal standpoint. Acceptance must be something more than mere mental

acceptance. In other words, there must not only be a desire to accept, but the desire must be

expressed in words – oral or written.

Exception of the rule: Silence can amount to acceptance

Acceptance can be implied from the conduct of the parties, or from the circumstance of the case

or from the previous dealings between the parties.

(i) Conduct of the parties

The manner in which the parties to the contract conduct themselves can amount to the

acceptance even if silence was observed.

For Example, On receiving a notice from the landlord, for increase of rent, the tenant

did not reply but also did not vacate the premises. Held, the tenant had given implied

acceptance by remaining silent and by continuing to take benefit of living in the

premises.

(ii) Circumstance of the Case

The acceptance can be implied from the circumstance of the case also.

Brogden v. Metropolitan Railway Co.

Mr Brogden, the chief of a partnership of three, had supplied the Metropolitan Railway Company

with coals for a number of years. Brogden then suggested that a formal contract should be

entered into between them for longer term coal supply. Each side's agents met together and

negotiated. Metropolitan's agents drew up some terms of agreement and sent them to Brogden.

Brogden wrote in some parts which had been left blank and inserted an arbitrator who would

decide upon differences which might arise. He wrote "approved" at the end and sent back the

agreement documents. Metropolitan's agent filed the documents and did nothing more. For a

while, both acted according to the agreement document's terms. But then some more serious

disagreements arose, and Brogden argued that there had been no formal contract actually

established. The court held that mere silence does not constitute acceptance but it may be implied

from the circumstances of the case. 3

3 https://en.wikipedia.org/wiki/Brogden_v_Metropolitan_Rly_Co

(iii) Previous dealings between the Parties

The Previous dealing between the parties can also lead to implied acceptance.

For Example, On the instruction of the master, a servant bought rashan on credit

from a Karyana store. Once, the servant took his personal list & bought the goods on

credit. Held, the master was liable because it was due to the previous dealings

between the master and karyana store owner, that the Karyana store owner gave

goods on credit.

Check your Progress (Activity 2)

1. A offered to B his car for Rs 2 lakh. B wrote a letter accepting A’s offer but did not post

it. It is a valid acceptance?

2. A lost his mobile phone and announced that whosoever finds & returns it will get a prize

of Rs. 2000. B was not aware of offer. He found and returned mobile to A. Can B claim

prize money?

3. X offered his goods for sale to Z for Rs. 2 lakh. B said he will pay 1,90,000. Is it a valid

acceptance?

4. Ram offered his plot for sale to sham and told him that he will have to reply in written.

Bham sent him a message through A. Is it a valid acceptance?

5. Acceptance should be given before ________________________ of offer.

6. A sent a letter to B offering to purchase B’s car for Rs. 2 lakh. He wrote if B doesn’t

reply, A will assume that B has accepted the offer. B didn’t reply. Can acceptance be

presumed from B’s silence?

7. A sent an offer to B for purchasing his plot for Rs. 30 lakh. B rejected the offer. Can B

afterwards accept the offer?

8. A sent an offer to B for sale of his horse. A dies and it came to knowledge of B. Can B

accept the offer?

9. Can acceptance be conditional?

10. Can acceptance be given by any person?

(Hints :-

1. No, acceptance must be communicated to offeror

2. No. B was not aware of offer

3. No. B put a condition on A’s offer. It is counter offer

4. No, acceptance should be through prescribed mode.

5. Lapse

6. No

7. No, the offer has been lapsed

8. No, the offer has been lapsed

9. No

10. No, acceptance can be given by the person who has authority to accept.)

Communication and Revocation of Offer and Acceptance (Section 4 &5):

Communication of offer & Acceptance (Section 4)

Communication of offer is complete when it comes to the knowledge of the person to whom it

is made.

Communication of acceptance is complete

a) for proposer: when it is put in course of transmission to him

b) for acceptor: when it comes to the knowledge of proposer.

Communication Complete

In case of offer In case of acceptance

When it comes to knowledge of offeree

For offeror For acceptor

Put in course of transmission to him

When it comes

to knowledge

of offeror

(1) Letter of offer posted (2) Letter of offer received

(4) Letter of Acceptance received (3) Letter of Acceptance posted

1. Communication of offer is complete at point (2)

2. Communication of acceptance is complete

a) For offeror: At point (3)

b) For acceptor: At point (4)

Offeree Offeror

Revocation of offer and acceptance (Section 5)

1. Revocation of offer: - Offer can be revoked at any time before letter of acceptance is

posted by acceptor ie. Before point no. (3)

2. Revocation of acceptance: - Acceptance can be revoked at any time before letter of

acceptance reaches offeror i.e. before point no. (4). If both letters such at same time, then

which one is spend first decides the case.

Modes of Lapse of an Offer

1. By communication of notice of revocation

A Proposer can revoke his proposal before the completion of the acceptance by sending a

notice of revocation. Such notice needs to be clear and unambiguous. The notice for the

revocation of an offer should be communicated by the person who has made the offer or

by his authorized representative.

2. By lapse of Time

Sometimes, the time is fixed for the acceptance of the offer, and it is not accepted within

the fixed time. In such cases, offer comes to an end automatically on the expiry of fixed

time.

3. By Non-fulfillment of condition precedent

An offer is revoked when the acceptor fails to fulfill a condition precedent to the

acceptance of the proposal which was conditional offer.

Adams v. Lindsell (1818)

In this case, D made an offer to sell wool to P by letter dated September 2, 1817. This letter

reached on September 5, 1817. P posted his letter of acceptance on the same day. i.e., on the

5th

September, which D received on September 9, 1817. But D had already sold the wool to

some other party having waited up to 8th

September. In an action brought against them by P

for the breach of contract, the Court held D liable. According to the Court, the contract was

complete when P posted the letter of acceptance.

For Example, S, a seller, agrees to sell certain goods subject to the condition that B, the

buyer, pays the agreed price before a certain date. If B fails to pay the price by that date,

the offer stands revoked.

4. By the death or insanity of the offeror

If the offeror dies or becomes insane, the offer comes to an end if the fact of his death or

insanity comes to the knowledge of the offeror. But if offeree doesn’t know about this

and accepts the offer, the acceptance is valid. This will result in a valid contract, and legal

representatives of the deceased offeror shall be bound by the contract.

5. By Counter-proposal

It is compulsory to accept the proposal in its original format. When an offer is accepted

with some modification in the terms of the offer or with some other condition not

forming a part of the offer, such qualified acceptance amounts to a counter offer. If A

offers to sell his scooter to B for Rs.5,000, and B offers to buy it for Rs. 4,500, it signifies

the end of A’s original proposal.

6. The Law Being Changed

An offer comes to an end if there is a change in law that makes the contract incapable of

performance.

7. By not Accepting in the Prescribed Mode or Usual Mode

If offer is not accepted in the specific manner (if any, prescribed in the offer) or in some

usual and reasonable manner (if no manner has been prescribed in the offer) then offer

lapses.

For example, X offered to sell his car to Y for Rs.1,00,000 and wrote to Y “Send your

acceptance by telegram.” Y sent acceptance by an ordinary letter. X can reject such

acceptance.

8. By Rejection of Offer by Offeree

An offer lapses if it is rejected by the offeree. An offer is said to be rejected if the offeree

expressly rejects it or accepts it subject to certain conditions. It may be noted that once an

offer is rejected, it cannot be revived subsequently.

Summary

One person must signify, his willingness to do or abstain from doing anything, to

obtain the assent of other, he is said to make a proposal.

When the person to whom offer is made, signifies his assent thereto the proposal

is said to be accepted.

Check Your Progress- Activity 3 (Case Studies)

1. A offers to sell his car to B for Rs. 50,000. C who is standing nearby & hearing the

conversation says “I will buy the car if B does not buy it.” B does not buy the car.

(a) Has this resulted in a contract between A & C ?

(b) Would it make any difference, if C says to A., “This is the money, take it & give me

the car”.

Hint. (a) No, offer was made by A to B & not to C. (b) A, may or may not accept the C’s

offer.

2. An article is on display in a showroom with price tag of, Rs. 100”. Mr. A offers Rs.100 to

the shopkeeper for the article, but shopkeeper refuses to sell it. Can Mr. A sue B for not

selling the article?

Hint. Mr. A Cannot force the shopkeeper to sell the article, because display of the article

is only invitation to offer & not offer.

3. An auctioneer advertised in a newspaper that a sale of office furniture will be held at

Bangalore. Ajay, of Mumbai reached Bangalore on the appointed date and time. But the

auctioneer withdrew all the office furniture form the auction sale. Ajay sued him for his

loss of time and expenses. Will he succeed?

Hint. In sale by auction goods are sold by inviting bids from the prospective buyers. The

bids are offers and invitation to people to participate in auction sale through

advertisement is not a proposal but merely an invitation to offer. Therefore, the brokers

will not succeed in claiming compensation for loss of time and expense in reaching

Bangalore for advertised auction sale cancelled later on.

4. A offers, by a letter, to sell certain article to B who receives the letter the next day B

immediately posts his letter of acceptance. The same evening A posts another letter

revoking his offer A’s letter of revocation & B’s letter of acceptance cross in the post. Is

there any contract between A & B?

Hint. Yes a contract comes in to existence between A & B as per sec 4& sec 5.

5. A offers to sell his house to B for Rs. 5 lakhs. B says, “I accept your offer. Here is Rs. 2

lakhs in cash & a 3 month promissory note for the balance”. Is there any contract

between A & B.

Hint. No, there is not contract between A & B because acceptance is conditional.

6. A reward was announced by the police, for anyone who gave information about a

convict. Ram Narayan gave the necessary information and while giving the information

Ram Narayan mentioned that he gave the information “to ease his conscience.” But later

he claimed the reward money. Can he claim the reward money?

7. A offers to sell a house in Mumbai to B for Rs. 50,000. B, at the same time, offers by a

letter to buy A’s car for Rs.15,000. The two letters cross each other in the post. Is there a

concluded contract between A and B?

[Hint : No, these are cross offers.]

8. A offers to sell a house in Mumbai to B for Rs.50,000. The offer is communicated to B in

Delhi by an express letter. The letter is delayed in the censor office. Before A’s letter

reaches B, B receives a telegram from A revoking his offer. Is there a contract between A

and B?

[Hint : No. (Sec. 5)]

9. A made an offer to sell some goods to B conditional on receiving a reply by return of

post. A gave the latter to his peon on post but the peon forgot to post it immediately and

actually posted it after seven days. One receiving A’s letter, B wrote a reply, accepting

the offer, and duly posted it by return of post. In the meantime, not having heard from B,

A sold the goods to C. Has B any legal remedy against A?

[Hint: There is contract between A and B (Sec.4). But since A has already sold the

goods, B can recover damages from A.]

P applied for the principalship of a local college, and the Governing Body passed a

resolution appointing him. After the meeting, a member of the Governing Body privately

informed him of the resolution. The resolution was subsequently rescinded. P claims

damages. Will he succeed? (Hint: No)

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Answer Questions

1. How is an offer made?

2. What is a general offer?

3. What is an invitation to offer? How it differs from offer?

4. Acceptance is to offer what a lighted match is to a train of gunpowder. Explain.

5. Who can accept an offer?

6. Can acceptance of an offer be implied from the silence of the offeree?

7. When is communication of offer complete?

8. When is communication of acceptance complete as against the acceptor?

9. When is communication of revocation complete?

10. What happens if an offer is not accepted according to the mode prescribed?

Long Answer Questions

1. Define offer. What are the essentials of a valid offer?

2. What do you understand by the term ‘acceptance’? What conditions must be fulfilled to

convert a proposal into a promise?

3. “A mere mental assent not evidenced by words or conduct does not constitute

acceptance.” Comment.

4. “An acceptance to be effective must be communicated to the offeror”. Are there any

exceptions to this rule?

5. “Acceptance is to offer what a lighted match is to a train of gun-powder. It produces

something which cannot be recalled or undone.” Comment.

6. Discuss the rules relating to offer, acceptance and revocation with proposal”. Discuss.

7. Discuss the rules relating to offer, acceptance and revocation with suitable examples.

8. Discuss law relating to communication of acceptance and its revocation.

9. Define

(i) Lapse of an offer

(ii) A counter offer

Chapter - 3

Consideration

According to section 10 of the Contract Act, consideration is one of the essentials of a valid

contract. An agreement without consideration is void. So a gratuitous act, however sacred it may

be, cannot create any legal obligations.

It is a ‘quid pro quo’ i.e., something in return. In simple words this ‘something’ is known as

consideration.

For Example: X agrees to sell his TV set to Y for Rs. 8,000. TV set is the consideration of Y

and Rs. 8,000 is the consideration of X.

The definition of consideration as mentioned under section 2(d) of ICA, 1872 states;

“When at the desire of the Promisor;

promisee or any other person;

has done or abstained from doing something;

or does or abstains from doing something.

or promises to do or abstains from doing something;

such act or abstinence or promise is called a consideration for the promise.”

After going through the chapter,

Students will be able to learn

Meaning of consideration and its essentials

Stranger to consideration and stranger to contract

Exceptions to “No consideration no contract Doctrine of Privity of contract

Exceptions to Doctrine of Privity of contract

Essentials of a Valid Consideration

1. It must move at the desire of the promisor

Consideration must move at the desire or request of the promisor. If it is done at the

request of a third party or without the desire of the promisor, it will not be a consideration

For Example, X saves Z’s goods from fire without being asked to do so. X cannot

demand payment for his services.

2. It may move from promisee or any other person

As long as there is consideration in a contract it is immaterial who has furnished it.

Section 2(d) has clearly stated that it is not necessary that consideration should be

furnished by the promisee only. What is important is that there should be the presence of

consideration in an agreement to make it a valid contract. Consideration can be given by

the promisee or if the promisor has no objection, it may move from any other person also.

The important point is that consideration should have been received, no matter from the

other party to the contract or someone else.

Dutton vs. Poole (1677)

Father wanted to fell timber to arrange for the marriage expenses of his daughter. His

son promised to bear all expenses of his sister’s marriage provided the father did not fell timber. Father agreed to this but the son later refused to bear the expenses of

marriage. The daughter could sue her brother.

Durga Prasad v. Baldeo (1880)

At the desire of the collector of the district, A built a market. F occupied a shop in the market

built by A. Because A constructed the market, therefore F agreed to pay commission to A. F

failed to pay the commission. The action brought by A to recover the commission was

dismissed on the ground that the market was built by A at the desire of the collector of the

district and not at the desire of F. Hence, F was not liable for the commission.

3. Consideration must be lawful

According to section 10 of the Act, “All agreements are contracts if they are made for a

lawful consideration”. So a consideration must be lawful without which an agreement is

void. Section 23 states that consideration is unlawful if

(a) It is forbidden by law;

(b) Or, is of such a nature that if allowed it would defeat some law of the country;

(c) It is fraudulent;

(d) It involves injury to the property or person of the other;

(e) Court regards it as immoral or opposed to the public policy.

4. The consideration must be of some value in the eyes of law

Consideration shall be something which not only the parties regard, but the law can also

regard as having some value. Thus, a worthless act will not be a sufficient consideration

even if the act is done at the desire of the promisor.

For Example, A promised to give his new car to B provided B will fetch it from the

garage. Here, B’s act of fetching the car satisfies the words of definitions as it is done as

the desire of the promisor. But it does not catch the spirit of the definition, and cannot be

regarded as valuable consideration.

5. It must be real

Thought the consideration need not be adequate, but it must be competent and real, not

illusory, it must have some value in the eyes of law. It should not be physically or legally

impossible, uncertain and illusory.

For Example:

(a) Physically Impossible: X promises to Y to make his dead mother alive if he pays him

Rs.1000. It is not a good consideration as it is physically impossible to perform.

(b) Legally impossible: X files a suit against Y for non-payment of a promise. Y asked Z

to withdraw the suit for a consideration of Rs. 500. Here what Z is promising is

legally impossible, because suit can be withdrawn only by X and not by Z.

(c) Uncertain Consideration: X agrees to pay Y an adequate amount for a certain work.

Here the consideration “adequate amount” is uncertain and hence the agreement is

unenforceable.

6. Consideration may be past, present or future

The words, “has done of abstained from doing; or does or abstains from doing; or

promises to do or to abstain from doing” used in the definition of consideration clearly

indicate that the consideration may consist of either something done or not done in the

part, or done or not done in the present, or promised to de done or not done in the future.

To put it briefly, consideration may consist of a past, present or a future act or abstinence.

7. Something other than the promisor’s existing obligations

The act constituting consideration must be something which the promisor is not already

bound to do because a promise to do what a promisor is already bound to do adds nothing

to the existing obligation.

8. Consideration can be forbearance to sue: If a person who could sue another for the

enforcement of a right agrees not to pursue his claim, this constitutes a good

consideration for a promise by the other person. This results in a benefit to the person not

sued and a detriment to the person who could sue.

For Example, A borrows from B Rs.100 at 20 per cent p.a. but fails to pay the amount.

When B is about to file a suit, A agrees to pay a higher rate of interest. B, as a result, does

not file the suit. This forbearance on the part of B to file a suit is a sufficient

consideration and B can enforce the promise by A to pay the higher rate of interest.

Ramchandra Chintaman v. Kalu Raju

X promises Y, his advocate, to pay an additional sum if the suit was successful. The

suit was declared in favour of X but X refused to pay additional sum. It was held that

Y could not recover additional sum because the promise to pay additional sum was

void for want of consideration as Y was already bound to render his best services

.under the original agreement.

9. The consideration may be either positive or negative

According to Section 2(d) of the Indian Contract Act, the consideration may be a promise

to do something or abstain from doing something. Thus, a consideration may be an act ‘to

do’ or ‘not to do’ something i.e. it may be positive or negative.

No Consideration, No Contract: Section 25, ICA, 1872

According to Section 25, ICA, 1872:

“An agreement without consideration is a void agreement.”

“Absence of consideration makes an agreement void”

“Gratuitous promises are enforceable by law”

“Ex Nudo Pacto Non Oritur Actio”

All the statements given above highlight the Importance of Consideration in an agreement. A

promise for free is called as Gratuitous Promise. The agreement where there is no

consideration for the promisor in return is called as gratuitous promise.

Exceptions to the General Rule of Section 25

1. Agreement made on account of natural love and affection (Sec.25 (1))

An agreement made without consideration is enforceable if, it is

(i) expressed in writing, and

(ii) registered under the law for the time being in force for the registration of

documents, and is

(iii) made on account of natural love and affection,

(iv) between parties standing in a near relation to each other.

For Example, (a) Ram Promises, for no consideration, to give to Sham Rs.1,000. This is

a void agreement.

(b) Mohan for natural love and affection, promises to give his son Sham, Rs. 1,000.

Mohan puts his promise to Sham into writing and registers it. This is a contract.

2. Promise to compensate voluntary services (Sec.25 (2))

A promise to compensate a person, who has already done something voluntarily for the

promisor, is enforceable. Promise to pay for voluntary services will be binding if

following conditions are fulfilled:

i) The services should be rendered voluntarily.

ii) The service must have been rendered for the promisor.

iii) The promise must be made voluntarily.

It should be noted that a promise to compensate voluntary services need not be in writing

or registered. It means that such a promise may be even oral.

For Example, A finds B’s purse and returns it to him. B promises to give A Rs.500. This

is a binding promise.

3. Promise to pay a time-barred debt [Sec. 25(3)]

A time barred debt is a debt which is not recoverable because of lapse of specified time

(presently 3 years) under the Limitation Act. In the normal course, once a debt becomes

time barred, the lender is left with no remedy to get his money back. Therefore a debtor is

not legally bound to pay the debt if it becomes time-barred.

In such a case, if the debtor subsequently promises to pay the time barred debt,

apparently there is no consideration moving from the other party but the contract is still

enforceable. This is because, under section 25(3) of the Act, a promise by a debtor to pay

a time-barred debt is enforceable provided:

(i) It is made in writing,

Raj Lukhy Dabee v. Bhootnath Mukherjee

A Promised to pay his wife, B a fixed sum of money every month for her separate

residence and maintenance. This agreement was written and registered one. In this

agreement, certain quarrels and disagreements were also mentioned between A and his

wife B. It was held that agreement was not enforceable because it was not made on

account of natural love and affection. The court could find no trace of love and

affection between the parties whose quarrels had compelled them to separate.

(ii) Is signed by the debtor or by his agent generally or specially authorized in that

behalf, and

(iii) The debt is a time barred debt.

The promise may be to pay the whole or any part of the debt.

For Example, D owes C Rs. 1,000 but the debt is barred by the Limitation Act. D signs a

written promise to pay C Rs.1,000 on account of the debt. This is a valid contract.

4. Completed gift

A gift (which is not an agreement) does not require consideration in order to be valid.

“As between the donor and the done, any gift actually made will be valid and binding

even though without consideration” [Explanation 1, to Section25]. In order to attract this

exception, there need not be natural love and affection or nearness of relationship

between the donor and done. The gift must, however, be complete.

5. No Consideration necessary for creation of agency

Under section 185 of the Indian Contract Act, no consideration in necessary to create an

agency. For giving a person authority to act as agent, consideration is not necessary.

For example, A authorizes B to act on his behalf (act as an agent) in front of C and B

agrees to do so. The contract is enforceable at the court to law although no consideration

is moving from A to B. A will be bound by the act done by B on his behalf as against C.

6. No Consideration necessary for guarantee

Anything done or any promise made for the benefit of the debtor may be a sufficient

consideration for the guarantor.

For Example, B requests A to sell and deliver goods to him on credit. A agrees to do so

on the guarantee so given by C. C gives the guarantee to A for selling goods on credit to

B. This is a sufficient consideration for C (the guarantor) that the goods were sold and

delivered on credit to B. it is a valid contract of guarantee.

7. Charitable subscriptions

A promise to donate to a charitable organization whereby the organization incurred some

further liability on the promise so made, will amount to a valid and enforceable contract

although no consideration exists for the promisor in return.

For Example: Ram promised to donate Rs 1 lakh for repairs of temple. Relying on

Ram’s promise, the temple authorities entered into another contract for repair of temple.

Held, even though there is no consideration for Ram in return but the contract between

Ram & Temple Authorities is a valid and enforceable contract.

8. Remission[Sec 63]

No consideration is required for an agreement to receive less than what is due. This is

called remission in the law.

Stranger to Consideration

Under the Indian Contract Act, 1872, consideration for a contract may move from the promisee

or any other person. In case the consideration moves from a person other than the promisee, the

promisee can be categorized as a stranger to the consideration. Such a person can also enforce

the contract.

Stranger to Contract

The general law of contract that a person who is not a party to a contract cannot sue is the same

in English Law as well as in the Indian Law. A person who is not a party to a contract, cannot

Chinnayya V. Ramayya (1882)

An old lady made a gift of her property to her daughter with a direction to pay a certain sum

of money to the maternal uncle by way of annuity. On the same day, the daughter executed a

contract in writing in favour of the brother agreeing to pay the annuity. The daughter did

not, however, pay the annuity and the uncle sued to recover it. It was held that there was

sufficient consideration for the uncle to recover the money from the daughter.

sue on the contract even though the contract is for his benefit, such a person is called Stranger to

Contract. It implies that only parties to a contract can sue to each other.

Activity One: - Check your Progress.

1. A was out of town. His house caught fire B incurred some expenses for the same. When

A came. B asked A to pay him 20,000. Can B Claim Money?

2. A gave Rs. 20,000 to B to kill C. Is it a valid consideration?

3. A was in need of money. He sold his Activa for 20,000 whose original worth was 40,000.

Is it a valid contract?

4. A’s scooter was stolen. He gave Rs. 20,000 to Inspector for filing FIR. Is it a valid

consideration?

5. A gave B Rs. 20,000 and asked him to supply goods to C. Can C enforce B?

6. Father transferred his property on son’s name and got this deed registered. Did valid

contract come to existence?

7. A was drowning and B saved him. A promised him to pay Rs. 2,000. Can B claim

money?

8. A had to give 20,000 to B. B remitted Rs. 5,000 and asked A to pay Rs. 15,000. Is it a

valid contract?

9. A and B entered into contract for supply of goods from A to B. Can C sue?

10. A gave cheque of Rs. 2,000 to B. B Endorsed the cheque to C. Is Bank liable to make

payment to C?

Hints:

1. No, as consideration should move at desire of promisor

2. No, Not lawful.

3. Yes as consideration need not be adequate.

4. No, it is for performing existing obligation.

5. Yes, he is stranger to consideration and can sue.

6. Yes, as per section 25(1)

7. Yes, it is a promise to pay for past voluntary services.

8. Yes

9. No, He is stranger to contract.

10. Yes, he is holder in due course of negotiable instrument.

Privity of contract

A person, who is not a party to contract, cannot sue on the contract even though the contract is

for his benefit such a person is known as stranger to contract. It means only parties to a contract

can sue each other. This rule is known as the ‘doctrine of privity of contract’. Privity of contract

means the relationship subsisting between the parties who have entered into contract with each

other.

Exceptions to the doctrine of Privity of Contract

A stranger to a contract cannot sue except in the following cases:

1. Beneficiary under trust or a charge

When a trust is created, the beneficiary can enforce the rights given to him under the trust, even

though he was not a party to the contract between the settler and the trustees.

For example, A transfers some property in favour of B to be held by him in trust for the benefit

of X. X can enforce the agreement even though he is a stranger to the contract.

Dunlop Pneumatic Tyre Co. V. Selfridge & Co. (1915)

A sold a large quantity of tyres to B at a certain price on entering into a covenant not to sell

the tyres below the price mentioned in price list supplied by A. B sold the tyres to C a retail

dealer under a contract stipulating the same covenant as between A and B. C sold the tyres at

less than the list price. A sued C for the breach. It was held that A could not sue C as A was

not a party to the contract between B and C.

Bakhsh Singh vs. jang Bahadur (1938)

A father appointed his son U as the successor of his property and in consideration thereof U

agreed with his father to pay the illegitimate son of the father J a certain sum of money and to

give a village to j as well on J’s attaining majority. Later U denied the money and village to J. Held, J could file a case against U (although no privity of contract existed between U and J),

because a trust was created in his favour.

2. Marriage settlement, partition or other family arrangements: Sometimes, an agreement is

made in connection with marriage, partition or other family arrangements, and provision is made

for the benefit of some person. In such cases, person, for whose benefit the provision is made in

such family arrangement, can enforce the agreement even if he is not a party to it.

3. Acknowledgement of Payment

Where according to the terms of contract, a party is required to make payment to the third party

and he acknowledges the payment to him (third party). Thus the third party may sue the party

acknowledge the payment, although there is no privity of contract between them.

4. Covenants running with land

In cases of transfer of immovable property, the purchaser of land with notice that the owner of

the land is bound by certain conditions or covenants created by an agreement affecting the land

shall be bound by them although he was not party to the original agreement which contained the

conditions or covenants .

For example, A sold a piece of land to B. The land so sold, was attached to another contract

whereby A and other neighboring land owners shall pay to Government an annual payment for

Shuppuammal V. Subramanyan

Two brothers in a partition deed agreed to pay Rs. 300 in equal shares to their mother for

maintenance. The brothers subsequently refused to pay the amount. On a suit it was held

that the mother could enforce the promise even though she was stranger to the contract.

Shiro Datta vs. Panda

A tenant and a sub-tenant agreed between themselves that the sub tenant would pay his and

the tenant’s rend directly to the landlord. On nonpayment of tenant’s rent, the landlord sued the sub-tenant. Held, the landlord could sue the sub-tenant, because the sub-tenant by his

conduct had represented himself as an agent of the tenant and therefore he could not deny

the payment of tenant’s rent to the landlord, no matter no privity of contract existed between the landlord and sub-tenant.

the repairs of the canal running along their lands. Held, B could not deny that annual payment on

the plea that he had not been the party to the contract between land owners and the government.

5. Contracts through an agent

A principal can enforce the contracts which are entered into by his agent though he was not a

party to the contract. It may, however, be noted that the agent must act within the scope of his

authority, and also in the name of his principal.

6. Assignment of a Contract

Where a benefit under a contract has been assigned, the assignee can enforce the contract subject

to all equities between the original parties to the contract e.g. the assignee of an insurance policy.

7. Holder in due course of negotiable instruments

Holder in due course of negotiable instruments is a holder who has obtained the negotiable

instrument in good faith and for valuable consideration. He may sue the prior parties although he

was not a party to contract.

Example: A has an account in Central Bank. A draws a cheque of Rs.1,000/- in favour of B. B

goes to bank to encash the cheque. Although there is no contract between the Bank and B, yet the

bank will be liable to pay Rs.1,000/- to B. B may also endorse the cheque to C and then C Will

be entitled to receive Rs. 1,000/- from the bank although there is no privity between Bank and C.

Summary

Consideration is the price for which the promise of other is bought.

Legal rules for consideration are:

It must move at the desire of the promisor

It may move from promisee or any other person

Consideration must be lawful

The consideration must be of some value in the eyes of law

It must be real

Consideration may be past, present or future

Something other than the promisor’s existing obligations

Consideration can be forbearance to sue

The consideration may be either positive or negative

An agreement without consideration is a void agreement

Exceptions to the Rule “No consideration no contract”:

Agreement made on account of natural love and affection

Promise to compensate voluntary services

Promise to pay a time-barred debt

Completed gift

No Consideration necessary for creation of agency

No Consideration necessary for guarantee

Charitable subscriptions

Remission

A person, who is not a party to contract, cannot sue on the contract even though the

contract is for his benefit such a person is known as stranger to contract. On the other

hand the consideration moves from a person other than the promisee, the promisee can

be categorized as a stranger to the consideration.

Only parties to a contract can sue to each other. This rule is known as the ‘doctrine of

privity of contract’.

Check your progress- Case Studies (Activity 2)

1. When A is out of station on holiday, a storm damages the roof of his house. B, his neighbor &

friend carry out the necessary repairs. On coming back, A Promises to pay Rs. 10,000 for the

expenses incurred & time spent by B. Can B recover the amount if A does not pay it later on?

Hint: Yes B can recover the amount from A as per conditions being fulfilled of Sec 25 (2).

2. A and B are friends. B treats A during A’s illness. B does not accept payment from A for the

treatment and A Promises B’s son X to pay him Rs. 1,000. A being in poor circumstances is

unable to pay. X sues A for money. Can X recover?

Hint: X cannot recover amount from A because agreement was between A and B.

3. A promises to give Mr. B Rs 500 as birthday present on B’s birthday. A fails to fulfill this

promise. Mr. B wants to file a suit against A for the realization of amount. Advise Mr. B.

Hint: B is not advised to file the suit because there is no consideration in this agreement. An

agreement without consideration is null and void.

4. A, a Muslim lady sues her father in law for the arrears of allowance payable to her by him, under

an agreement between him & her own father, in consideration of marriage. Will she succeed?

Hint: Yes, because although she is a stranger to contract, but she can sue as contract was made

for her benefit.

5. A promise B his nephew, a reward of Rs 500 if he refrained from smoking for two years. B does

so. Is he entitled to the reward?

Hint: Yes, B is entitled to reward because he has at the desire of uncle refrained from smoking

for 2 years. This is a valid consideration as per definition in Section 2(d) in the form of

abstinence.

6. A husband executed a registered document in favour of his wife. After referring to quarrels and

disagreement between them, he promised to pay for her separate maintenance and residence. On

his failure to pay, the wife seeks your advice. Advice her.

Hint : She cannot recover as there is natural love and affection between them (Sec.25(1))

7. A promise to make a gift of Rs. 3,000 towards the repairs of a temple. The trustee of the temple

on the faith of his promise incurs liabilities. A does not pay. Can the trustee recover the promised

amount from A?

Hint : The trustee can recover to the extent of liabilities incurred.

8. A and B, two Hindu brothers, divided the family property between them and agreed at the time

of partition that they should contribute a sum of Rs. 10,000 in equal shares and invest it in the

security of immovable property and pay the interest towards the maintenance of their mother.

Can the mother compel her sons to have the amount invested as settled in her favour?

Hint : Yes, Mother is beneficiary

9. A, being in dire need of money, sells his new car purchased two months ago at a cost of Rs.

1,72,000 for Rs. 11,000. Afterwards A seeks to set aside the contract on the ground of

inadequacy of consideration. Will he succeed?

Hint : No, because the consent was free.

10. A owes B Rs. 1,000 but the debt is barred y limitation. A gives a letter to B agreeing to pay him

Rs. 500 on account of the debt. Is this is valid agreement?

Hint : Yes (Sec. 25.(3))

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. Distinguish between stranger to contract and stranger to consideration.

2. “Adequacy of consideration does not affect the contra t.” Comment.

3. Who is a stranger to contract? Define with an example.

4. What do you mean by Quid-Pro-Quo?

5. Can a stranger to a contract sue?

6. Is a promise to pay a time barred debt enforceable?

7. What is privity of contract?

8. Discuss the effect of doctrine of privity of contract.

Long Questions

1. Define consideration. Why is it essential in a contract? What are the legal rules regarding

consideration?

2. Define consideration and point out the salient features of the term ‘consideration’ as

defined in the Indian Contract Act.

3. “Insufficiency of consideration is immaterial; but an agreement without consideration is

void.” Comment.

4. “A contract without consideration is void.” Comment

5. A man cannot acquire rights under a contract to which he is not a party.’ Comment.

6. ‘A stranger to consideration can sue, but a stranger to contract cannot sue.’ Comment.

7. “No consideration, No Contract.” Explain.

8. “Inadequacy of consideration is of itself no ground for avoiding a contract, but it may be

evidence of undue influence.” Explain this statement.

9. “A stranger to a contract cannot sue.” Are there any exceptions to this rule?

10. Consider the doctrine of privity of contract and give an account of the exceptions to the

doctrine.

Chapter - 4

Free Consent and Capacity of Parties

According to section 10 of the Contract Act consent of all the parties must be free at the time of

entering into a contract. There are two requirements of ‘free consent’ viz.

1. There should be consent and

2. The consent must be free

Meaning of “Consent” and the “Free consent” (Sec. 13 and 14)

Consent: It means act of assenting to an offer. “Two or more persons are said to consent when

they agree upon the same thing in the same sense”. (Sec. 13)

Free consent: Consent is aid to be free when it is not caused by

1. Coercion as defined in Sec. 15, or

2. Undue influence as defined in Sec. 16, or

3. Fraud as defined in Sec. 17, or

4. Misrepresentation as defined in Sec. 18, or

5. Mistake, subject to the provisions of Secs, 20, 21 and 22.

When there is no consent, there is no contract. Salmond describes it as error in consensus. If

there is no consensus ad idem, there is not contract.

Learning Objectives:

After going through the chapter, students will be able to learn

What is consent and free consent

When Consent is not free

What are the consequences when consent is not free

Who is incompetent to enter into contract

I. Coercion

Coercion means compelling a person to enter into a contract under a pressure or threat.

According to Section 15, a contract is said to be caused by coercion when consent is

obtained by –

(a) Committing any act which is forbidden by the Indian Penal Code : or

(b) Threatening to commit any act which is forbidden by the Indian Penal code; or

(c) Unlawful detaining of any property ; or

(d) Threatening to detain any property.

For example, X beats Y and compels him to sell his car for Rs. 50,000. Here, Y’s consent

has been obtained by coercion because beating someone is an offence under the Indian Penal

code.

Characteristics of Coercion

(a) There must be a THREAT / FORCE

(b) Threat must be to commit an ACT FORBIDDEN by law i.e. Indian penal code

(c) Threat may be to unlawfully detain the property of other.

(d) The objective is force the other party to enter into the contract.

(e) Coercion may move from a stranger and coercion may be directed toward stranger as

well

Essentials of Coercion

1. The coercion must be the committing of any act forbidden by the Indian Penal Code.

2. The coercion must be the threatening to commit any act forbidden by the Indian Penal

Code.

3. The coercion must be the unlawful detaining or threatening to detain any property.

4. The acts of coercion must be done with the intention of causing the other party to enter

into a contract.

5. The Indian Penal Code may or may not be in force where the coercion is committed.

6. The acts of coercion may be initiated by any person even by stranger.

7. The coercion may be by way of threat to commit suicide.

8. The coercion may not be by way of threat to file a suit. However, threat to file a suit on

false charge amounts to coercion, since an act is forbidden by the India Penal Code.

Consequence of Coercion

The aggrieved party (the innocent party whose consent was not free) can have the following

remedies when the consent is obtained by coercion:

1. Rescission of the contract: Only the aggrieved party can rescind the contract i.e. avoid

the contract. The contract becomes VOIDABLE CONTRACT at the option of the

aggrieved party.

2. Restitution: Restitution means to put the parties in the same position as they were before

entering into the contract. Therefore, the term restitution implies:

(i) To restore the benefits: If the aggrieved party had obtained some benefits in the

contract (so caused by coercion) then all such benefits must be restored/returned

back.

(ii) To compensate the losses: Where the aggrieved party suffered some losses, those

should be compensated.

II. Undue Influence

The term ‘undue influence’ means dominating the will of the other person to obtain an

unfair advantage over the other.

According to Section 16(1), a contract is said to be induced by undue influence –

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

position to dominate the will of the other, and

The dominant party uses that position to obtain an unfair advantage over the other.

For example,

1. A devotee gifted her property to her spiritual guru to secure benefits to her soul in next

world. It was held that spiritual guru was in position to dominate the will of devotee.

(Mannu Singh V. Umadat Pandey)

2. X, an illiterate old man of about 90 years, physically weak and mentally in distress,

executed a gift deed of his properties in favour of Y his nearest relative who was looking

after his daily needs and managing his cultivation. It was held that Y was in a position to

dominate the will of X. (Sher singh V. Prithi Singh)

Presumption of Domination of Will

According to Section 16(2), a person is deemed to be in a position to dominate the will of

another in the following three circumstances:

(a) Where he holds a real or apparent authority over the other

Example: Master and servant, parent and child, Income Tax officer and assessee,

Principal and a temporary teacher

(b) Where he stands in a fiduciary relation to the other

Example: Trustee and beneficiary, spiritual adviser (Guru and his disciples, solicitors and

client, guardian and ward

(c) Where he makes a contract with a person whose mental capacity is temporarily or

permanently affected by reason of age, illness or mental or bodily distress.

Example: Medical attendant and patient.

Effects of Undue Influence

The effect of undue influence is that it makes the contract voidable at the option of the party

whose consent is obtained by undue influence, i.e. such party can put an end to the contract if he

so chooses.

Burden of Proof of Undue Influence

Sometimes a contract is challenged in a Court of Law on the ground of undue influence. Then it

is the duty of the weaker party to prove that his consent was obtained by undue influence. He has

to establish the following two points;

1. The superior party was in a position to dominate his will, and

2. The superior party actually used his influence to obtain his consent to the contract.

Comparison between Coercion and Undue Influence

Basis of distinction Coercion Undue influence

1. Relationship Parties to a contract may or may not

be related to each other.

Parties to a contract are related

to each other under some sort

of relationship

2. Consent Consent is obtained by giving a

threat of an offence or committing

an offence

Consent is obtained by

dominating the will

3. Nature of pressure It involves physical pressure. It involves moral pressure.

4. Who can exercise It can be exercised even by a

stranger to the contract.

It can be exercised only by a

party to a contract and not by

a stranger.

5. Restoration of benefit The aggrieved party has to restore

the benefits received under Sec.64.

The party avoiding the

contract may or may not

return the benefit under

Sec.19A

6. Presumption Coercion has to be proved by the

party alleging it. In no case it is

presumed by the law.

It may be presumed by the law

under certain circumstances.

The party against whom such

presumption lies must

disprove it.

7. Nature of liability The party committing the crime may

be punishable under Indian Penal

Code

It doesn’t involve any criminal

liability.

III. Fraud

According to Section 17, fraud means and includes any of the following acts committed by a

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

person to enter into a contract:

(i) The suggestion that a fact is true when it is not true and the person making the

suggestion does not believe it to be true

(ii) The active concealment of a fact by a person having knowledge or belief of the fact

(iii) A promise made without any intention of performing it

(iv) Any other act meant to deceive

(v) Any such act or omission which the law specially declares to be fraudulent.

Essentials of Fraud:

1. False Representation: To constitute fraud, one party should have made a false statement

of fact to the other party, when he actually knew well that the statement was completely

false.

Example: - A 58 year old lady intentionally makes a false statement to health to the

insurance company that she is 45 year old. Held, the lady commits fraud.

2. About Material Facts: Material facts mean the facts relating to the subject matter of the

contract. In other words, material facts mean the most important facts relating to the

existence of contract. Say in the above given example, the lady hides the material fact as

to her age which is the most important fact when taking an insurance policy for health.

3. The other party enters into the contract on the basis of such false statement: The

other party must have relied on the false statement made by the first party and enters into

the contract on the basis of such false statement only.

Example: A sells his horse to B Saying that “the horse is sound and not sick.” The horse

suffered from a disease and died within a week of its buying. Held, A committed fraud.

4. The object of the fraudulent act must be to deceive the other party: The intention

must be to deceive the other party. If the object is not to deceive the other party, but the

party is deceived for whatever reason, the act is not deemed to be fraudulent.

5. Fraud by a party or his agent: The fraud must have been committed by a party to the

contract. It may be committed by agent while acting on behalf of his principal is the fraud

by his principal. If a fraud is committed by stranger it does not affect the validity of

contract.

6. The Fraudulent act must be committed with knowledge of its falsity: It is also an

essential element of fraud that the party committing the fraudulent act must be aware that

his act is false. In other words, the fraudulent act must have been made with the

knowledge of its falsity. A person making a false statement is not guilty of fraud if he

honestly believes in its truthfulness.

7. The fraudulent act must have been committed upon the party to the contract or his

agent: It is also an essential element of fraud, that it must have been committed upon the

party to the contract. If it is committed on a stranger, then it will not amount to fraud, and

a contract shall not be voidable on account of fraud.

8. Mere Silence is not Fraud: Mere silence does not constitute fraud. As regards

nondisclosure of material facts, the general rule is Caveat Emptor, i.e. let the buyers

beware. This implies that a person before entering into an agreement need not disclose to

the other party all material facts which he knows. Silence on the part of party is not a

fraud.

When does silence amount to fraud

Ordinarily, mere silence does not amount to fraud. A contracting party is under no obligation to

disclose to the other what he knows about the material facts relating to the transaction.

Exceptions (when silence amounts to fraud)

1. Where it is duty of a party to speak but he does not speak

In certain cases, a party to contract is under a duty or obligation to speak but he does not

speak, it amounts to fraud. Here ‘duty’ means a legal duty or legal obligation. Duty to speak

arises where the parties stand in fiduciary relation to each other i.e. where one of them reposes

Shri Krishan V. Kurukshetra university

A candidate of the university examination did not mention the fact of his attendance

shortage in the application form, although he knew that he was short of attendance.

The university was stopped from cancelling his examination on the ground that there

is not fraud and it was the duty of the university to verify the facts with reference to

relevant records.

trust and confidence in the other. In all contracts of uberrimae fidei (of utmost good faith), it

is the duty of the parties to disclose all the material facts. All contracts of insurance are the

contracts of utmost good faith. It is therefore, necessary for the person taking out a policy to

disclose all material facts about his health which are known to him and are likely to affect the

willingness of the insurer. Failure on the part of insured to fulfill this obligation renders the

contract voidable at the option of the insurer.

2. Where silence is equivalent to speech

In cases, where silence of a party is itself equivalent to speech, then silence amounts to fraud.

For example, A says to B, “If you do not deny it, I shall assume that the horse is sound.” B

says nothing. Here B’s silence is equivalent to speech.

3. Half Truth

When a person is under no obligation to disclose certain facts about the transaction, but he

disclose some part of it voluntarily and stops half way, he may become guilty of fraud. A

person may remain silent, when he is under no duty to speak. But if he speaks, he is bound to

disclose the whole truth.

For example: The prospectus of a company contained the statements that the company had

paid dividends every year between 1921 and 1927. These statements were true. But the fact

was that in each of these years, the company had incurred substantial losses and the dividends

were paid only out of the secret reserves. No disclosure was made of these losses. It was held

that the prospectus was false and the director who knew that it was false was held guilty of

fraud.

4. Change of Circumstances or Constructive fraud

Sometimes a statement is true when made but it may on account of a change of circumstances

become false when contract is to be executed. In such circumstances, it is the duty of the

person who made the statement to communicate the change of circumstances.

5. Contract of sale

If the seller fails to inform the buyer about the latent defect i.e. a defect which is known to the

seller but not visible on ordinary inspection by the buyer. The seller’s silence amounts to

fraud.

IV. Misrepresentation

The term ‘misrepresentation’ may be defined as an innocent misstatement of facts which are

material for the contract. Section 18 of the Indian Contract Act, which reads as under:

Misrepresentation means and includes:-

1. The positive assertion; in a manner not warranted by the information of person making it,

of that which is not true, though he believes it to be true.

2. Any breach of duty which without an intent to deceive, gains an advantage to the person

committing it, or anyone claiming under him, by misleading another to his prejudice or to

the prejudice of anyone claiming under him.

3. Causing however innocently, a party to an agreement to make a mistake as to the

substance of the thing which is the subject of the agreement.

As per definition following acts are covered under misrepresentation:

1. Making a false statements

When a person makes a false statement but he himself believes it to be true then it is a

case of misrepresentation.

For example, A on the strength of hearsay information (without having reasonable

grounds to believe it) positively asserted to B that certain third party is going to be

director of the company to be incorporated. B bought the shares on faith of such a

statement. This is a case of misrepresentation by A(Mohanlal v Gungaji cotton mills co.)

2. Breach of duty

If a person commits a breach of duty without any intention to deceive the other thereby

gains an advantage to himself of other party. A person committing such a breach of duty

is guilty of misrepresentative.

For example, In a contract of sale of land, the seller did not disclose the latent defects

existing in the title (ownership). Latent defects are those which cannot be identified upon

ordinary inspection. Held, misrepresentation was obtained.

3. Inducing mistake about subject matter

If one of the parties induces the other, though innocently, to commit a mistake as to the

quality or nature of the thing bargained, there is misrepresentation.

For example, In a contract of sale of 500 bags of wheat, the seller made a representation

that no sulphur has been used in the cultivation of wheat. Sulphur, however, had been

used in 5 out of 200 acres of land. The buyer would not have purchased the wheat if it

was known to him. There is a misrepresentation.

Consequences of Fraud and Misrepresentation

When the consent of the party to a contract has been caused by fraud or misrepresentation, then

such a contract in voidable at the option of the party whose consent has been so caused. The

aggrieved party has the following remedies.

(i) He may avoid or rescind the contract, or

(ii) He may claim damages or restitution

Difference between Misrepresentation and Fraud

Basis of Difference Misrepresentation Fraud

1. Intention A misstatement is made but not

with intention to deceive the

other party. So, it is termed as

‘innocent misrepresentation’.

A misrepresentation is made

with an intention to deceive

the other party. It is known as

‘fraudulent misrepresentation’.

2. Belief The person making an untrue

statement believes it to be true.

The person making untrue

statement knows that it is not

true.

3. Rescission and damages The aggrieved party can rescind

the contract or sue for restitution

and there can be no suit for

damages.

The aggrieved party can

rescind and can also claim the

damages

4. Discovery of truth The aggrieved party may lose the

right to rescind the contract, if it

could discover truth with

ordinary diligence.

The aggrieved party does not

lose the right to rescind the

contract in case of active fraud

even if he has the means to

discover the truth with

ordinary diligence.

5. Nature of act. It is not a criminal act. It is a criminal act.

Activity One – Check your progress

1. Threat to detain other’s property is called ________?

2. If there is no free consent, contract becomes ___________?

3. Mental coercion is called ________________?

4. False representation about material facts made intentionally is _____________?

5. False statement made unintentionally is _______________?

(Hints : 1. Coercion, 2. Voidable, 3. Undue influence, 4. Fraud, 5. Misrepresentation.

V. Mistake

Mistake is a wrong belief about something. Mistake is ‘error in consensus’. It implies that there

is no ‘consensus ad idem’. In other words, when the parties do not agree on the same thing in the

same sense because of some misunderstanding, it is known as Mistake.

Kinds of Mistake:

Mistake may be classified as follows:

i. Mistake of fact

ii. Mistake of law

A. Mistake of facts

Mistake of fact may be (i) Bilateral Mistake. Or (ii) Unilateral Mistake.

I. Bilateral mistake: Where both the parties to an agreement are under a mistake as to a

matter of fact essential to the agreement, there is a bilateral mistake. In such a case, the

agreement is void.

The various cases which fall under bilateral mistake are as follows:-

Mistake (Wrong belief about something)

Mistake of fact Mistake of Law

Bilateral Unilateral Indian Law Foreign Law

(Void agreement) (Valid Contract except

(i) Mistake about

Identity of parties

(ii) Mistake about Valid contract Void agreement

nature of agreement)

Mistake about subject matter Mistake about Possibility of Performance

• Existence

• Quality

• Quantity Physical Impossibility Legal Impossibility

• Title

• Price

(i) Mistake as to the subject-matter

When both the parties make a mistake relating to the subject-matter, the agreement is

void. Mistake as to the subject-matter covers the following cases:

Mistake as to the existence of the subject-matter

If both the parties believe that the subject-matter of the contract is existing which in fact

at the time of the contract is non-existent, the contract is void.

For example: Mr. X has 2 cars Honda City and Verna. He offered to sell his car to B

(having intention to sell Verna) where as B perceived as Honda City. Here the contract is

void because of mistake as to identity of subject matter.

Mistake as to the quantity of subject – matter

Where both the parties are under mistake as to the quantity of subject-matter, the

agreement is void.

Mistake as to the quality of subject matter

If the subject matter is something essentially different from that which the parties thought

it to be, the agreement is void.

Mistake regarding price

Sometimes both parties are mistaken about the price of the subject matter of the contract.

The contract is void in this case.

Webster vs. Cecil

The buyer and seller had agreed about a property deal, but while making the offer, the

seller had written the amount Rs. 1200 instead of Pound 2100. The buyer accepted the

offer, knowing that the amount was wrongly quoted. The court held the contract void.

Mistake as to title of subject matter

If a seller is selling anything which he is not entitled to sell and both parties are acting

under the same mistake, the agreement is void.

Example: A person took a lease of a fishery which, unknown to either party, already

belonged to him. Held, the lease was void (Cooper V. Phibbs)

(ii) Mistake about possibility of performance

Sometimes, both the parties believe that the agreement is capable of being performed, but

in fact it is not possible to perform. In such cases, the agreement is void as both the parties

are mistaken about the possibility of performance of the agreement.

(a) Physical Impossibility: In case of an accident or a happening beyond the control of the

contract which makes the performance of the contract impossible, the contract is void. In

the case of Griffith vs. Brymer, a contract for the hire of a room for witnessing the

coronation procession of Edward VII was held to be void because, unknown to the

parties, the procession had already been cancelled.

(b) Legal Impossibility: A contract is void if it provides that something shall be done which,

by law, cannot be done. For example, a person might contract to supply rice from Delhi

to Kanpur, but it may not be possible because of the state government’s ban on the entry

of rice into the state.

II. Unilateral Mistake

Section 22 provides that if one party alone is under a mistake of fact, the contract is not

rendered voidable. When the contract is clear, mistake of one of the parties cannot affect it.

If a man due to his own negligence or lack of reasonable care does not ascertain what he is

contracting about, he must face the consequences.

But when mistake is regarding identity of parties or about nature of agreement then

agreement becomes void.

Cundy vs. Lindsay

A person named Blenkarn by forging the signature of a reputed firm called Blenkam,

induced Lindsey to supply him goods on credit. Lindsay supplied the goods which Blenkarn

sold to Cundy, an innocent buyer. In a suit by Lindsay against Cundy for the recovery of

goods, it was held that there was no contract between the Lindsay and Blenkarn as Lindsay

never intended to make a contract with him. The innocent buyer did not get a good title from

Blenkarn, and therefore had to return them or pay their price.

B. Mistake of Law

(i) Mistake as to the law of the country:- Every person is expected to know the law of

the country. As the saying goes, ignorance of law is no excuse. A party cannot be

allowed any relief on the ground that he has done or not done an act in ignorance of

law. For Example:- if a person commits a theft and says that he was not aware that

thieving was an illegal offence and may therefore be excused, cannot be exempted

from punishment.

(ii) Mistake as to foreign law:- A citizen of a country is expected to know the law of his

own country, but he is not supposed to know the law of a country other than his own.

If a person commits a mistake about the law of a foreign land, such a mistake may be

excusable. Such a mistake is deemed to be a mistake as to a fact.

Activity Two – Check your progress

1. In case of bilateral mistake, agreement becomes _____________?

2. If there is a mistake of Indian Law, Contract remains _____________?

3. If contract is impossible to perform, it becomes _________________

4. Mistake of foreign Law leads to ____________

5. If there is error in causa, then agreement becomes _______________

(Hints :- 1. Void, 2. Valid Contract, 3. Void Contract, 4 Void agreement 5. Voidable Contract.

Capacity of Parties

According to section 10 of the Indian contract Act, the parties to a contract should be competent,

that is, they should have the capacity to enter into a contract.

Section 11

The parties to contract shall be said to be competent or qualified to enter into a contract when

(i) They are not disqualified by infancy

(ii) They are not disqualified by insanity

(iii) They are not disqualified by any other law.

In other words, these parties are NOT competent to contract:

1. One who is minor,

2. One who is of unsound mind

3. One who is disqualified by law

I. Minor

According to section 3 of the Indian Majority Act, 1875

“A major is a person who is of eighteen years”.

That is, minor is a person who is below 18 years.

But in the following two cases minor attains majority at 21 years of age which are :-

1. Where a guardian to the minor is appointed under Guardian and Wards Act, 1890

2. Where Superintendence of minor’s property is assumed by court of wards

Effects of entering into an agreement with minor

Following are the effects of the agreements with a minor:

1. Agreement is Void ab initio

An agreement with a minor is void ab inito that is void from the beginning. All the

agreements entered into with minor are void & can’t be enforced at law.

Mohiribibi v/s Dharmo Das Ghose (1903)

A, a minor mortgaged his property to B, for a loan of Rs. 20,000 out of which Rs. 10,500 was

advanced by B to A. Later A sued B, saying agreement was void as A is a minor. Court

declared the agreement was void. Further B claimed his money back but court held the

agreement void so B can’t claim his money.

2. No estoppel against minor

It means no one can prevent a minor to plead his minority in court of law. A minor can save

himself from his obligations by pleading his minority.

Example : - A lend some money to B, a minor. When A asked for repayment B refused. A

sued B for refusal of repayment. Here B can plead his minority & A can’t stop him from

doing so.

3. Liable for torts

Tort means committing a civil wrong. If a minor indulges in a tort then he could be held

liable for that. Although an agreement with a minor is void ab initio but if he commits some

tort he will held liable for that.

Burnard vs Haggis

A lent his mare to B, a minor for riding & gave clear instruction of not jumping with mare. B

further gave the mare to C who caused mare’s death by making her jumping a fence. Here B

is liable for damages as it is a tort. Unauthorized lending of mare to C was not right.

4. No Ratification:

A minor cannot ratify an agreement entered into by him during minority after he attains

majority. A minor would have to enter into a fresh contract with fresh consideration to

continue & perform the agreement.

Example: - A, a minor purchased some goods from B. He drew a promissory note for

payment. Agreement is void. A when become major drew another promissory note but again

it is void as there is no fresh consideration.

5. Minor’s Property liable for necessaries :

If a person supplies some necessaries to a minor, then the supplier could be reimbursed from

minor’s property. Here, necessaries mean goods inadequate in supply & a proper necessity

for minor at the time of sale & delivery.

Example: - A supplied necessaries to B, a minor. Here A would be reimbursed from B’s

property.

6. Minor can be a beneficiary. An agreement with a minor can be enforced at his option but

not at the option of the other party i.e. the minority of a minor makes a minor incapable of

entering into a contract and therefore cannot bind a minor. But it does not mean that the other

party can avoid the agreement taking the plea of his minority.

7. No Specific Performance against a minor: An agreement cannot be specifically enforced

against the minor except when the contract is being entered into by the guardian/parent of the

minor.

8. Cannot be partner in partnership firm: A minor cannot become a partner in a partnership

firm but can be admitted to the benefits of the partnership only with the consent of all

partners.

9. Cannot be declared insolvent: A minor is incapable of contracting debts therefore there arise

no question of declaring a minor an insolvent.

10. Can be an agent: A minor can work as agent on behalf of a principal. He can bind the

principal for his acts but shall never be personally liable.

11. Cannot bind his Parents/Guardian, not even for his necessaries: A minor cannot bind his

parents or guardian for his acts, not even for the supply of necessaries.

12. Cannot be a shareholder: Minor cannot become a shareholder of a company. If by mistake

his name appears on the list of shareholders, then the company has the right to strike off his

name from such list of shareholders.

13. Guarantee/surety for a minor: A guarantee given for a minor is a valid guarantee and in no

case the guarantor or surety can escape from his liability.

II. People of Unsound Mind

A person is of unsound mind if he can’t understand the terms of contract & is unable to form

a rational judgment of its consequences.

Persons of unsound Mind:-

1. Idiots: - Those who have permanently lost their mental abilities of thinking.

2. Lunatics:- Those are occasionally of unsound mind & usually of sound mind or

occasionally of sound mind & usually unsound mind. That is they are temporary idiots.

3. Drunkards or intoxicated:- Those who are so drunk or intoxicated that can’t understand

terms & conditions of agreements.

4. Hypnotised person

All agreements with people of unsound mind all void.

III. Persons Disqualified by Law

Following persons are disqualified by law & any agreement with them is void :

1. Convicts: - Any agreement with convicts at the time of their imprisonment is void. But

they can enter into contract at the time of parole or after the finish of their sentence period.

2. Insolvents:- Insolvents are those whose property is with official assignee. Any agreement

with insolvent is void.

3. Foreign Sovereigns: Such persons can enter into contracts and enforce those contracts in

our courts. But an Indian citizen has to obtain a prior sanction from the central Govt. in order

to sue them in our court of laws.

4. Alien Enemy: Contracts with alien enemy (whose state is at war with republic of India) is

void.

Activity Three – Check your progress.

1. An agreement with minor is _______________

2. Can minor ratify the contract after majority?

3. Can minor be adjudged as insolvent?

4. Can minor be an agent.

5. Can insolvent person enter into contract?

(Hints : 1. Void, 2. No, 3. No, 4. Yes, 5. No.)

Summary

For a valid contract, there should be free consent of the parties. Consent is

said to be free when it is not caused by

1. Coercion

2. Undue influence

3. Fraud

4. Misrepresentation

5. Mistake

If consent is not free, the contract will be voidable at the option of that party

whose consent is not free. He can either cancel the contract or affirm the

contract. If he cancels the contract, then doctrine of restitution applies.

Parties should be competent to enter into contract. Parties will not be

competent if

1. Party is minor or

2. Of unsound mind or

3. Disqualified by law

If parties are not competent then agreement becomes void.

Check your progress- Case Studies

1. C. with the intention of inducing D to enter into a contract with him, makes a statement to

D, which is in fact untrue and thereby induces D to enter into the contract. What are D’s

rights, if the statement is made by C – (i) knowing that it was untrue, (ii) in good faith,

but negligently, (iii) in good faith and without negligence?

(Hint: In case (i) there is fraud, and in cases (ii) and (iii) there is misrepresentation on the

part of C. In all the three cases the contract is voidable at the option of D. In the first case,

D can also recover damages (Secs. 17 and 18).

2. A tells his wife that he would commit suicide, if she did not transfer her personal assets to

him. She does so under this threat. Can the wife avoid the contract?

(Hint: Yes, it is coercion)

3. A is weakened by age and illness. B his medical attendant, uses his personal influence

over him and induces him to pay an unreasonable fee for his professional services. (a)

Can A avoid the contract? (b) if so, on what plea?

(Hint: Yes, A can avoid the contract on the plea of undue influence; Sec. 16(2))

4. A fraudulently informs B that his house is free from encumbrances. B thereupon buys the

house. The house is subject to a mortgage. What are the rights of B?

(Hint: The contract is voidable at the option of B. He may avoid the contract and get

back his money)

5. A, agrees to buy certain horse from B for Rs. 10,000 & pays Rs. 5,000 as advance. It

turns out that the horse was dead at the time of bargain, though neither party knew this

fact. Can A recover the advance money given?

(Hint: Yes, A can get the money paid in advance because in this case there is bilateral

mistake as to the subject matter.)

6. A, purchased a machine from a dealer, replying on the dealer’s representation that it was

a new model. After paying the purchase price. A came to know that the machine was not

new but an old one. What are the legal rights of A?

(Hint: A can avoid the contract on the ground of fraud & get the damages from the

dealer)

7. A advances money to his son B during his minority. Upon B’s coming of age. A obtains

by misuse of parental influence, a bond from B for a greater amount that the sum due in

respect of the advance. Is B bound by the bond?

(Hint: No, the contract is voidable at the option of B as it is induced by undue influence

(Sec. 16(2))

8. A knows that the car he was buying from B was ten years old although B has represented

that he had purchased it new only four years ago. Can A avoid the contract on the ground

of fraud?

(Hint: No, as he knew that the car was ten years old and as such he could not have relied

upon the false statement made by B.)

9. A young widow was forced to adopt a boy under the threat of preventing the body of her

husband, who had just died, from being removed for cremation. Is this adoption valid

under law?

(Hint: No. The adoption is voidable at the option of the widow as it is induced by

coercion)

10. Moti, a minor aged 15, broke her right arm in a game. She engaged a physician to set it.

Does the physician have a valid claim for his services?

(Hint : Yes, but it is only Moti’s estate which will be liable)

11. Suraj supplies some articles of food to Rani, the wife of Chander who is a lunatic.

Chander has assets worth Rs. 5,000. (a) On non-payment, can Suraj proceed against the

assets of Chander? (b) Would your answer be the same if Chander instead of being a

lunatic is a minor?

(Hint : (a) Yes (b) Yes)

12. Nupur renders some services to Mahesh during his minority at the request of Mahesh.

Mahesh, on attaining majority, enters into an agreement with Nupur to compensate her

(Nuper) for services rendered during Mahesh’s minority. Is the agreement valid?

(Hint : No, because an agreement with minor cannot be ratified.)

13. X who is a major, performs some services for B, a minor at B’s request. B on attaining

the age of majority, promised to compensate X by giving him a promissory note. Is the

promissory note valid?

[Hint : No, because a minor can’t ratify an act done during minority, even on attaining

the age of majority.]

14. A, aged 16, agreed to purchase a second hand motorcycle from B for 12,000. He paid

2000 as advanced and agreed to pay the balance the next day and collect the motorcycle.

When A came with the money the next day. B says that he has changed his mind and

offered to return the advance. Can B do so?

[Hint : No, B can’t avoid the agreement simply because A is a minor and an agreement

with minor is void. Although A is a minor but law does not prevent him from becoming a

promise or beneficiary.]

15. A, a minor who wished to become a professional billiards player, entered in to a contract

with B, a noted billiard player, to pay him (B) a certain sum of money to learn the game

& play matches with him during his world tour. B spent time & money in making

arrangements for billiards matches. Is “A” liable to pay?

(Hint : Yes, as the agreement was for necessaries. Necessaries include education,

training for trade, medical service etc.)

16. M, a guardian, on behalf of a minor, L entered into a contract with S for purchase of

certain property for the benefit of L. Is the contract valid?

(Hint : Yes, provided it is within the scope of guardian’s authority.

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. Define consent. When is consent said to be free?

2. What is coercion?

3. Differentiate between coercion and undue influence.

4. Explain briefly the reason for flaw in consent.

5. Explain the principle of restitution.

6. Is fraud an intentional misrepresentation?

7. “Mere silence in not fraud”. Comment.

8. Differentiate between fraud and misrepresentation.

9. What is effect of mistake on the validity of an agreement?

10. Who is a minor?

11. Who are the persons incompetent to contract U/S 11 of ICA, 1872?

12. What is doctrine of restitution?

13. Does the law of estoppel apply to a minor?

14. Who is a person of unsound mind?

15. Is a minor liable for necessaries supplied to him?

Long Questions

1. What is misrepresentation? Distinguish it from fraud.

2. “A mere silence as to facts in not fraud.” Discuss

3. “Two or more persons are said to consent when they agree upon the same thing in the

same sense.” Explain this statement and give illustrations.

4. When is a contract said to be induced by “undue influence”? When is a party deemed to

be in a position to dominate to will of another? What is the effect of undue influence on a

contract?

5. When is consent said to be given under “coercion”? What is its effect on the contract?

Also discuss the position of the parties to a contract entered into under coercion?

6. “An agreement requires a meeting of the minds.” Comment.

7. Explain and illustrate the effect of mistake of fact on contracts.

8. What remedies are available to a person induced to enter into a contract by (a)

misrepresentation, (b) fraud?

9. A claim for necessaries supplied to a minor is enforceable by law.” Comment.

10. Who is competent to enter into a contract? Discuss the position of minor in this regard.

11. “Parties to a contract must be competent to contract.” Explain.

12. Discuss the provisions of law relating to contracts by minors.

13. Is the minor’s contract void or voidable? Can the guardian of a minor make a contract for

the minor?

14. Comment on, “An agreement entered into by minor cannot be enforced at law.”

Chapter - 5

Legality of Object and Consideration

As per section 10 of Indian Contract Act, 1872, object or consideration of the agreement should

be lawful so as to make it a valid contract. If object or consideration of the contract is not lawful,

it will be a void agreement or void ab initio.

For example, A and B made an agreement to do a bank robbery and share the proceeds equally.

This is void agreement as the object of the agreement is unlawful.

The words ‘object’ and ‘consideration’ are not synonymous. The word object means purpose of

the contract. For example, a person, while in insolvent circumstances, transferred his property to

one of his creditors with the object of defrauding his other creditors, it was held that the

agreement was void and the transfer was inoperative (Jaffar Meher Ali vs Budge Jute Mills

Co.). The court observed that although the consideration of the contract was lawful but object of

the agreement was unlawful because the purpose of the parties was to defeat the provisions of

Insolvency Law.

Learning Objectives

After going through the chapter, the students will be able to know

Difference between object and consideration

When object or consideration is not lawful

What is doctrine of public policy

What are void agreements

Reasons of void agreements

Section 23 of Indian Contract Act, 1872 declares what kinds of considerations and object are

unlawful. According to Section 23, the object or consideration of an agreement is unlawful in the

following cases:

a) Act forbidden by law:

The agreement will be void ab initio if the object of the agreement is to do any act which

is forbidden by law. An act is said to be forbidden by law when it is punishable either by

the criminal law or by special legislation.

For example, X agreed to pay Rs 1500 to Z if he steals R’s car. The agreement is void as

the consideration is unlawful. The theft is forbidden by law.

b) If it defeats provisions of any law:

Sometimes, the object or consideration is not directly forbidden by law, but if the contract

is executed it defeats the provision of any law. In such cases, the object or consideration

of the agreement is unlawful making it a void agreement.

For example, X, a Hindu already who is already married and his wife is alive, entered

into a marriage agreement with Y, an unmarried girl. The agreement is void because

second marriage is forbidden by Hindu law.

c) If it is fraudulent:

If the object of the agreement is to defraud others, then the agreement will be void ab

initio.

For example, A, B, C entered into a agreement to defraud X and divide the proceeds

equally. Hence the agreement is void.

d) Where it is injurious to a person or his property:

If the object of the agreement is to injure any person or his property, then the agreement

is considered as void ab initio. Hence, the agreement to commit any crime for which a

civil suit can be brought is unlawful and void.

For example, Ram agrees to pay Rs 18000 to Sham to kill Rex. The agreement is void.

e) Where it is immoral:

If the object or consideration of an agreement is immoral, then the agreement is

considered as void. The term ‘immoral’ depends upon the standard of morality prevailing

at a particular place and time.

For example, A gave money to B for divorcing her husband and marrying A. B agreed to

marry A as soon as she got divorce. Here, the object of the agreement is immoral. It was

held that A can’t recover the amount form B as the agreement was void. (Baivijli vs

Hamda Nagar)

f) Where it is against the doctrine of public policy:

If any agreement is against the public policy, the agreement is declared as void. Public

policy is that principle of law which holds that no person can lawfully act in such a way

which has a tendency to be injurious to the public or which is against the public good or

public welfare. It is known as doctrine of public policy. An agreement which is against

the general public is said to be an agreement opposed to public policy. Such an agreement

is unlawful and void.

For example, A and B agreed to start a business which will pollute the drinking water of

the town. Such an agreement between them is void as the object of the agreement is

against public policy.

Doctrine of Public Policy

Public policy is an elastic term and its connotation may vary with the social structure of the state.

Public policy is that principle of law which holds that no citizen can lawfully do that act which is

injurious to the public or is against the interests of the society or the state. On the basis of

decided cases on the subject, the following agreements have been held to be against public

policy:

1) Trading with an alien enemy:

Alien is a citizen of other country. If with that other country war has been declared then

that citizen of that country become alien enemies. Trading agreements with such alien

enemies are against public policy and hence void. But if there is no war declared with

that country, then these agreements result in valid contracts.

2) Trafficking in public offices:

If there is an agreement which results in disturbing normal functioning of Govt. or public

offices, such agreements are considered as against doctrine of public policy and hence

declared as void.

For example, A promised to obtain an employment to B in a public office and B

promised to pay Rs 2,00,000. Held, the agreement was against public policy and void.

3) Agreements tending to create interest opposed to duty:

If the objective of agreement is to do any act which is not in line with the duty of one of

the party, such an agreement will be a void agreement.

For example, A paid Rs 2,00,000 to B, a Govt. employee to take retirement from his

present job so that A’s son can be promoted on B’s designation. Such agreement is void.

4) Agreements interfering with administration of justice:

a) Interference with court of justice: An agreement which interferes normal course of

obtaining justice is a void agreement.

For example, A paid B some money to induce that person to give false evidence. As

the agreement interferes with court of justice, hence, it is a void agreement.

b) Stifling prosecution: It is in the public interest that if a person has committed a

crime, he must be prosecuted. An agreement that prevents an offender to be

prosecuted is an agreement that stifles prosecution is unlawful.

For example, A has filed a suit against B. B pays money to A to drop the suit against

B. Such an agreement is illegal.

c) Maintenance and champerty: Maintenance is an agreement to give assistance

financial or otherwise to another to enable him to bring or defend legal proceedings

when the person giving assistance has got no legal interest of his own in the subject

matter.

For example, A offers to pay B Rs 1 lakh if B will sue C. A’s purpose is to annoy C.

the agreement between A and B is a maintenance agreement.

Champerty is an agreement whereby one party is to assist another to bring an action

for recovering money or property and is to share the proceeds of the action.

For example, A owes B Rs. 3,00,000 as debt. B agrees to pay C the official charges

of litigation and also 50% of proceeds (to be received by B from A), if C files a case

against A. such an agreement is champerty.

5) Agreement to commit crime:

An agreement to commit crime is against the doctrine of public policy and hence a void

agreement.

For example, A paid Rs 20000 to B for killing C. Such an agreement is against public

policy hence, void agreement.

6) Agreements in restraint of parental rights:

An agreement which deprives anybody from his parental rights is against the doctrine of

public policy and hence is a void agreement. Parents are natural guardian of their

children. Anything can deprive them of their guardianship. Hence, if any agreement is

made which restrain their parental rights, such agreement will be void.

For example, A paid Rs 40,000 to B and in return B placed his daughter at disposal of A

giving away all his parental rights. This agreement is void as it is against public policy.

(Atmaram vs Bankumal)

7) Agreements restricting personal liberty:

Agreements which restrict the personal liberty of a person are void agreements as these

are against public policy.

For example, Tom paid Rex Rs one million for making him slave for life time. It

restricts the personal liberty of a person. So it is void agreement.

8) Marriage brokerage agreements:

Agreements to procure marriage of a person on payment of sum money or brokerage are

called marriage brokerage contracts. An agreement to sell a girl also comes under this

category. These types of agreements are against public policy and are declared as void

agreements.

For example, A, father of a girl, promised to give a certain sum of money to B, father of

a minor boy. A and B agreed for the marriage of minor son with A’s daughter. In this

case, agreement is void as it is against the doctrine of public policy. (Kalavanguta vs

Laxmi Narain)

9) Agreements in restraint of marriage:

Any agreement which puts a restriction on marriage of a person is against public policy

and hence, void. The restraint put on a person can be general or partial such as:

a) Can’t marry a specific person

b) Can’t marry for a specific time period

c) Can’t marry at all

For example, A gave Rs. 2,00,000 to B for not marrying B is a void agreement.

But an agreement restraining a minor to marry is a valid contract.

10) Agreements in restraint of trade:

An agreement which restricts any person to carry on a lawful business, trade or

profession is a void agreement.

For example, An agreement between A and B where A pays Rs 5 lakh to B to shut down

his business is a void agreement.

There are some exceptions to this rule. For example, if a person is selling his goodwill,

buyer can restrict seller to carry on the same business for a specified time period. But

such restrictions should be reasonable.

For example, A manufacturer sold his business to a company in consideration of some

amount of goodwill and put a condition that he would not carry on a similar business for

a certain time anywhere in the world. It was held that covenant is not binding upon him

because the restriction was unreasonable.

Check your progress (Activity 1)

1. A of India enters into B of Pakistan to supply products when war has been declared

between the two countries such an agreement is _______________________________

2. A put restriction on B that he can’t marry his daughter to anybody and in return A will

give B some money. Such an agreement is _____________________________________

3. A gave some money to police inspector for not filing FIR of C against A. This agreement

is ______________________________________________

4. A sold goodwill to B for Rs 2 lakh. B asked him to not pursue same business for three

years in specified locality. This agreement is a __________________________________

5. A and B planned to do a robbery and share proceeds equally. Agreement between A and

B is ________________________________________

6. A asked B to divorce her husband and marry him and gave her some money. The

agreement between A and B is _____________________________________________

7. X, a Hindu already married promised to B to marry her. Is it valid agreement? If No,

Why?_________________________________________________________________

8. Ram gave Sham Rs. 50000 for filing case against him. Agreement is

a__________________________________

9. Rex gave Rs 20000 to B for killing Z. Agreement is ______________________________

10. A gave Rs. 50,000 to B for acting as false witness. Such an agreement

is____________________________________________

(Hints: 1. Void agreement, 2. Void agreement, 3. Void agreement, 4. Valid contract, 5. Void

agreement, 6. Void agreement, 7. Void agreement as it defeats provision of Hindu Law, 8. Void

agreement, 9. Void agreement (illegal), 10. Void agreement)

Void agreements

An agreement where any of the essentials mentioned under Section 10 of Indian Contract Act,

1872 is not fulfilled becomes a void agreement. An agreement may become void agreement due

to many reasons as explained below:

1) Agreements made by incompetent parties (Section 11)

As explained in earlier lesson plans, parties should be competent to enter into contract to

make the agreement a valid contract. As per Section 11 of Indian Contract Act, the

following persons are not competent to contract:

a) Minor who has not attained the age of majority

b) Persons of unsound mind

c) Persons disqualified by law

2) Agreements made by mutual or bilateral mistake (Section 20)

As discussed in earlier lesson plan, in case of a mutual mistake by both the parties, the

agreement is declared as void agreement.

For example, A has two cars, Verna and Honda City. He offers B to sell his car at Rs

650000 (having intention to sell Verna). B accepts the offer (having intention to purchase

Honda City). As there is a mutual mistake at the end of both parties, hence, agreement is

void.

3) Agreement where object or consideration is unlawful (Section 23)

If object or consideration is unlawful, the agreement is declared as void. Section 23 of

Indian Contract Act, 1872 declares what kinds of considerations and object are unlawful.

According to Section 23, the object or consideration of an agreement is unlawful in the

following cases:

a) Act forbidden by law

b) If it defeats provisions of any law

c) If it is fraudulent

d) Where it is injurious to a person or his property

e) Where it is immoral

f) Where it is against the doctrine of public policy

4) Agreement where object or consideration is illegal in part (Section 24)

If the object or consideration of an agreement is illegal in part, then we need to check out

a) If illegal part is severable, then legal part results in a valid contract.

b) If illegal part is not severable, then whole agreement is treated as void agreement.

For example, A paid Rs 2,00,000 to B for purchasing products worth Rs 1,60,000 and

rest 40,000 for beating A’s competitor. Here illegal part of consideration is severable.

Hence, part of the agreement having legal consideration will be a valid contract where as

rest will be void agreement.

5) Agreements without consideration (Section 25)

Section 25 says that any agreement without consideration is void. So if consideration is

missing in any agreement, it will result in void agreement.

6) Agreements in restraint of marriage (Section 26)

This has been explained earlier in the lesson plan. If agreement puts restriction on

marriage of a person be it general or partial, it will be declared as void agreement.

7) Agreements in restraint of trade (Section 27)

Agreements putting restriction on carrying of a lawful trade or business or profession by

a person, it will be a void agreement.

8) Agreements in restraint of legal proceedings (Section 28)

Where the objective of the agreement is to deprive anyone of his legal rights or

interference of legal proceedings, then such agreements are void.

9) Agreement with uncertain meaning (Section 29)

If the meaning of subject matter is not certain, the agreement will be considered as void.

For example, A agreed to sell 100 tonnes of oil to B. The agreement is not certain as price

of the deal has not been decided. Hence it is a void agreement.

10) Wagering agreements (Section 30)

Wagering agreements are those agreements involving

a) Promise to pay money or money’s worth

b) On happening or non happening of

c) A specified future uncertain event.

In wagering agreements, there is a mutual chance of profit or loss. In other words, profit

of one party is loss for other party and vice versa.

For example, A and B agreed that if it would rain, A would pay Rs 500. Otherwise, B

would pay Rs 500 to A. Such types of agreements are void as these are of wagering

nature.

11) Agreements which are impossible to perform (Section 56)

Agreement to perform an impossible act is a void agreement under section 56.

For example, A promised to pay B a sum of Rs. 10,000 if get a autograph of Jagjit Singh.

As he is not alive, so the act is impossible to perform. Hence it is a void agreement.

Check your progress (Activity 2)

1. A entered into an agreement with B, who is a minor. The agreement was to provide B

with a loan of Rs 10,000. Such agreement is_______________________________

2. Agreement with a person of sound mind is ___________________________________

3. A, an insolvent entered into contract with B to purchase his car for Rs. Two lakh. This is

a _______________________________________________

4. A and B entered into agreement to defraud C and share the proceeds equally. Such an

agreement is ________________________________

5. A has two horses a race horse and cart horse. A offered to sell horse to B (having

intention to sell cart horse) where as B understood as offer to purchase race horse and

accepted the offer. This is ____________________________________________because

of ___________________________

6. A offered to B to sell his car at Rs 5 lakhs. B accepted the offer. This is

_____________________________

7. A offered to B to bring stars form the sky and in return he will pay two lakh to him. This

is ______________________due to _____________________________

8. A bet with B that India will win the match. If India wins, B will give him 20000. But if

India loses, A will pay him same money. This is a _______________________________

9. A offered B his car to be sold at a certain price, this agreement is

________________________________

10. B gave Rs. 5000 to C to produce false evidence. This is a _______________________

because of ___________________________

(Hints: 1. Void agreement, 2. Void agreement, 3. Void agreement, 4. Void agreement, 5. Void

agreement due to uncertainty of meaning, 6. Valid contract, 7. Void agreement as it is impossible

to perform, 8. Void agreement, 9. Void agreement , 10. Void agreement because of restrain on

legal proceedings)

Check your Progress-Case Studies (Activity 3)

1. Ram sells goodwill of his business to Sham and agrees with him to refrain from carrying

on a similar business within specified local limits. Is the agreement valid?

(Hint: The agreement is valid as in case of sale of goodwill, the buyer of goodwill can put

reasonable restriction on carrying on same trade on seller)

2. A promises B, in consideration of Rs 10000 that he will never marry throughout his life.

Is the agreement valid?

(Hint: No the agreement is void)

3. A promised to pay Rs 20000 per month to his wife so long she remained away from him

and didn’t object to his living in adultery. Is the agreement valid?

(Hint: No, the agreement is void because it defeats the provision of Hindu law.)

4. A promises to B, in consideration of Rs 2 lakh, that he will never marry to particular

individual. Is the agreement valid?

(Hint: No, An agreement restraining a person from marrying anybody or from marrying

anybody except a particular person is void.)

5. A agrees to sell to B 100 tons of oil. A deals in variety of oils and there is nothing to

show what kind of oil was intended. Is it contract?

(Hint: No, because agreement is not certain)

6. Is an agreement to commit a crime or tort or an agreement to assault someone

enforceable?

(Hint: No, the agreement is illegal)

7. A firm of coach builders hired out a carriage to a prostitute, knowing that it was to be

used by the prostitute to attract men. Can coach builders recover the amount?

(Hint: No, the agreement was illegal.)

8. A, tailor, employs B as his assistant under an agreement by which B agrees not to carry

on the same business within six kms of his shop, on the termination of his employment. Is

the contract valid?

(Hint: As the agreement is of restraint of trade hence not valid)

9. X, father of a minor son, agrees to transfer the guardianship of his son in favour of Y and

also agrees that he will never revoke the transfer. But after few days, X wants to get back

the guardianship of his son and files a suit for the same. What will be the legal position in

this case?

(Hint: The agreement is void because it is in restraint of parental rights)

10. A instructs B to enter on his behalf into a wagering transaction. B loses in the transaction

and pays from his pocket. He thereafter sues A for reimbursement. Can A raise the plea

of wager?

(Hint: No, A can’t raise the plea of wager. Wagering agreements are void but transactions

collateral to void agreements are valid)

11. A, promises B to drop a prosecution which he has filed against B for theft and in returns

B shall restore the goods to A. Can A enforce this promise?

(Hint: No, A can’t enforce the promise because its object that is dropping a prosecution

already instituted for theft is forbidden by law.)

12. X promises to pay Rs five lakhs to Y if Y secures for X an employment in a public office.

Is the agreement valid?

(Hint: No, it is opposed to public policy)

13. A borrows Rs two lakh from B for doing gambling. A subsequently does not return the

money. What can B do?

(Hint: B can’t do anything because B knew the purpose for which A took the money)

14. Is an agreement by a newspaper proprietor not to comment on the conduct of a particular

person is unlawful?

(Hint: Yes, as it is against public policy)

15. A agrees to sell a horse to B for Rs 10,000 if it wins a race and Rs 100 if it does not. The

horse wins the race but B refuses to pay Rs 10,000 and buy the horse. Can A compel B to

buy the horse?

(Hint: No, because agreement between A and B is a wagering agreement)

Summary

The agreement becomes void ab initio if object or consideration is not lawful

Object or consideration is not lawful in following cases

It is forbidden by law

It defeats provision of any law.

It is fraudulent

Where it is injurious to a person or his property

If it is immoral

When it is against the doctrine of public policy

Doctrine of public policy is that principle of law which holds that no citizen can

lawfully do that act which is injurious to the public or is against the interests of the

society or the state. Following agreements are against the doctrine of public policy

Trading with an alien enemy

Trafficking in public offices

Agreements tending to create interest opposed to duty

Agreements interfering with administration of justice

Agreement to commit crime

Agreements in restraint of parental rights

Agreements restricting personal liberty

Marriage brokerage agreements

Agreements in restraint of marriage

Agreements in restraint of trade

Void agreements are those where any of the essentials mentioned under Section 10 of

Indian Contract Act, 1872 is not fulfilled. Following agreements are void

agreements:

Agreements made by incompetent parties (Section 11)

Agreements made by mutual or bilateral mistake (Section 20)

Agreement where object or consideration is unlawful (Section 23)

Agreement where object or consideration is illegal in part (Section 24)

Agreements without consideration (Section 25)

Agreements in restraint of marriage (Section 26)

Agreements in restraint of trade (Section 27)

Agreements in restraint of legal proceedings (Section 28)

Agreement with uncertain meaning (Section 29)

Wagering agreements (Section 30)

Agreements which are impossible to perform (Section 56)

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. When is object of an agreement illegal?

2. What is object opposed to public policy?

3. Differentiate between illegal and void agreements.

4. Define uncertain agreements.

5. What is a wagering agreement?

Long Questions

1. “All illegal agreements are void but all void agreements are not illegal”. Comment.

2. Under what circumstances is the object or consideration of a contract id unlawful?

Explain with examples.

3. Discuss the doctrine of public policy. Give examples of agreements contrary to public

policy.

4. Explain several types of agreements which are illegal because they are contrary to public

policy

5. What are wagering agreements? What are the legal effects of such agreements? Is a

contract of insurance a wagering agreement?

Chapter - 6

Performance and Discharge of Contract

Performance of contract

Section 37 of the Indian Contract Act, 1872, provides that, “The parties to a contract must

either perform, or offer to perform their respective promises unless such performance is

dispensed with or excused under the provisions of this Act or of any other law.”

Thus a contract is said to be performed, when parties make:

1. Actual performance, or

2. Attempted performance (i.e., ‘offer to perform’ or ‘tender to perform’)

Actual performance

A party to a contract is said to have actually performed his promise when he has fulfilled all

his obligations under the contract. Actual performance brings the contract to an end.

For example, A enters into a contract to sell his car to B. A delivers his car to B and B pays

promised money to A. Here actual performance has taken place.

Learning objectives

After going through the chapter students will be able to learn:

How can a contract be performed

Actual performance

Attempted performance or tender

Essentials of valid tender

Different modes of discharge of contract

Attempted performance

Sometimes it happens that the promisor is ready and willing to perform his promise, and

offers to perform the same, but promisee refuses to accept it. The motive of the party

‘offering to perform’ or tendering to perform’ is to perform the promise. Thus a valid tender

of performance is equivalent to the performance of promise, and it discharges a party from

his obligations under a contract.

Effect of refusal to tender

If the party to whom tender is made refuses to accept the tender, then party making tender is

discharged from his obligations. But this rule is not applicable in case of payment of a debt.

Essentials of a valid tender

Offer to perform will be valid if it fulfills all the below mentioned essentials:

1. Tender should be unconditional

Offer to perform should be unconditional; it means it should be according to terms of the

contract. If any condition is imposed on the tender, it makes it an incomplete tender and

the other party has a right to reject it.

2. It should be made at proper time and place

A tender should be made at a particular place and time as prescribed in the contract. In

the absence of any stipulation regarding place and time, the rule is that the offer should

Navain Chandra v. Yogendra Nath

The tenant sent two cheques in payment of rent to the landloard. The landloard

returned these cheques and insisted on the payment of rent in cash. The tenant did not

pay cash and the landlord sued him. The tenant contended that since he had tendered

payment (by cheques), it was a valid tender of payment of rent, and the landlord could

not sue him. In this case, the parties not being businessmen, nor did the debt arise out

a business transaction, and there being no agreement or custom permitting payment by

cheque, the landlord was held to be justified in refusing payment by cheque on the

ground that it was not a valid tender.

be made at proper place and time, what is proper time and place depends upon the

circumstances of the each case. However, the general rule is that the tender should be

made at the place of business during business hours if time and place of tender has not

been fixed.

3. The tender must be in the proper form:

Tender of money should be in the domestic currency. A person is not bound to accept a

cheque or foreign currency. A tender by cheque is valid when the person to whom it is

tendered is willing to accept such payment.

4. Reasonable opportunity of inspection:

The person, to whom the tender is made, must be given a reasonable opportunity of

inspection of goods. It means the promisee should be given an opportunity to inspect the

goods as to their quality and quantity. The tender of goods is not valid when the goods

are packed or locked in a box and the other party is not allowed to open the packet or

box. Similarly, if a tender is made at late hours on the due date and the buyer has no time

to inspect the goods, the tender is not valid.

For example, A contracts to deliver B 100 bales of cotton of a particular quality at his

warehouse on 1st March 1988. In order to make a valid tender, A will have to deliver

goods before 1st March so that B may have a reasonable opportunity of satisfying himself

that the thing offered is the cotton of the quality promised and that there are 100 bales.

5. It must be entire and not of a part only

The offer of performance must be of a whole payment or performance that is due. Thus

by rejecting a part payment, the offeree does not lose his right to demand performance.

However, he has an option to accept part payment without prejudice to claim his

remaining balance.

For example, A owed Rs. 5000 to B. He offered Rs. 3000 to B to set off a part of the

debt. This is not a valid tender of performance. By refusing to receive this, B does not

lose his right to claim Rs. 5000 from A.

6. Performance should be by promisor or authorised person (Section 40 and 41)

A valid tender must be performed accordingly:

a) Contracts of personal nature: Where a contract is based on personal skill of the

promisor, then those contracts can be performed only be promisor.

For example, A contract with a painter can be performed by painter only.

b) Contracts of non-personal nature: Where the contract does not involve any

exercise of personal skill of the promisor to perform the contract, then such

contracts can also be performed by the agent or representative of the promisor.

Hence the contracts of non personal nature need not be performed by the promisor

himself.

c) Effect of accepting performance from a third party: The promisee can also accept

the performance from a third party. When the promisee accepts the performance

from a third party, then he cannot again enforce the contract as against the

promisor. Once the promisee accepts the performance from a third party, he

actually waives off his right of performance from the promisor personally.

7. The tender must be made to the proper person: - It must be made to the promisee or

his duly authorized agent. Tender made to a stranger is invalid.

For example, A owed Rs. 5,000 to B. He offered Rs. 5,000 to C, a close friend of B.

Here the tender is not valid, because although C is a friend of B, but B has not authorized

him to collect his payment from A.

8. Devolution of joint rights and liabilities

i) Devolution of joint liabilities:

Devolution of joint liabilities arises when there are joint promisors. When two or

more persons have made a joint promise, all of them are called as joint promisors.

These are some rules regarding performance of joint promises.

a. Joint promisors must jointly perform the promise

b. Promisee may compel any joint promisor to perform. In that case, after

performing, he can ask other joint promisors to fulfill their obligations.

c. Joint promisors contribute equally as well as share deficiency equally if there

is any.

d. Promisee may release any of the joint promisor. But joint promisor is liable to

rest of the joint promisors

ii) Devolution of Joint Rights:

Devolution of joint rights arises when there are joint promisees. When one person

makes a promise to several persons, then all those to whom the promise is made are

called as joint promisees. For example, A makes a promise to X, Y and Z. In this

A is a promisor and all X, Y and Z are joint promisees. The rights of the joint

promisees are governed by section 45 that states:

1. All the joint promisees can claim or demand performance from the promisor, when

there is no express agreement to the contrary.

2. If any of the joint promisees dies, then his legal representative along with the

surviving promisees can demand performance from promisor.

3. If all of the joint promisees die, then the legal representative of all of them can

demand performance from the promisor.

Activity One – Check your progress

1. Offer to perform is called __________ ?

2. If contract is of personal nature, then can agent perform?

3. Attempted performance is called _______ ?

4. If other party refuses to accept tender, then____________?

(Hints : 1. Tender, 2 No, 3 Tender, 4 Contract is discharged.

Discharge of Contract

Discharge of a contract means termination of the contractual relations between the parties to the

contract. A contract is discharged when rights and obligations created by it come to an end. That

is contracting parties no more owe any responsibility or liability to each other.

The contract may be discharged by any of the following six modes as per Indian Contract Act,

1872 as shown below:

I. DISCHARGE BY PERFORMANCE:

The contract can be discharged by performance of respective obligations by parties to the

contract. Performance can be

a) Actual performance

b) Attempted performance or Tender

This has already been discussed in the SLM.

II. DISCHARGE BY IMPOSSIBILITY TO PERFORM

Sometimes, the performance of a contract is impossible. In such a case, the contract will get

discharged. This is based on the principle that law does not recognize what is impossible.

Para 2 of Section 56 of ICA, 1872 provides, “A contract to do an act which after the contract is

made, becomes impossible or by reason of some event which the promisor couldn’t prevent,

becomes void when the act becomes impossible or unlawful.”

An agreement which is impossible to perform is void ab initio. This doctrine is based on the

following MAXIMS:

‘Lex Non Cogit Ad Impossibilia’ that says- ‘Law doesn’t compel the impossible. *

‘Impossibiliumnullaobligatoest’ that says ‘What is impossible doesn’t create any

obligation’*

Initial Impossibility

Impossibility to perform

Subsequent Impossibility

A. Initial Impossibility or Pre contractual Impossibility

It means impossibility exists at the time of making a contract. The initial impossibility

may be (i) known or (ii) unknown to the parties at the time of making the agreement.

i) Known Impossibility

If an agreement is entered into between the parties which cannot be performed and

this fact is known to the parties, then such an agreement is VOID-AB-INITIO.

For example, A agrees with B to bring a dead man to life. It is known to the parties

at the time of making the agreement that the performance is impossible. The

agreement is void ab initio.

ii) Unknown Impossibility

Where the impossibility of performance is unknown to the parties and both of them

are mutually mistaken as to the subject matter of the agreement, such an agreement is

a VOID AGREEMENT on account of MUTUAL MISTAKE AS TO FACT.

For example, A agrees to sell certain goods to B, supposed to be on their way from

Mumbai to Kolkata in a certain ship. Unknown to both the parties, the ship had

already sunk in the deep sea, and the goods ceased to exist at the time of contract. The

contract becomes void when the impossibility of performance is discovered.

B. SUPERVENING IMPOSSIBILITY OR POST CONTRACTUAL IMPOSSIBILITY

Impossibility which arises subsequent to the formation of a contract (which could be

performed at the time when the contract was entered into) is called post-contractual or

supervening impossibility. A contract is capable of being performed at the time it is

made, however it may become impossible to perform or unlawful due to change in

circumstances which are beyond the control of the parties. In such a case, the contract

becomes void and parties are discharged from performing their obligations arising out of

the contract. This is known as ‘doctrine of supervening impossibility’. This doctrine will

be applicable if following conditions are satisfied:-

(i) The act must have become impossible.

(ii) The impossibility should be by reason of some event which the promisor could not

prevent.

(iii) The impossibility should not be self induced by the promisor.

In English Law, the doctrine of supervening impossibility is recognized as Doctrine of

Frustration.

Reasons/ Grounds for subsequent impossibility

1. Destruction of Subject–Matter

Where the subject matter of the contract is destroyed without any fault of the parties, the

contract is discharged by impossibility.

Taylor Vs Caldwell

In this case, the defendant agreed to let out a music hall for a series of concerts on

certain days. But the hall was burnt by fire before the stipulated date. The contract was

held to have become void and the defendant (the owner of the hall) was freed of the

liability to let out the hall as he had promised.

2. Personal Incapacity or Death of the Promisor:- When the performance of a contract

depends on the personal skill or qualification of a person, the contract is discharged on

the illness or incapacity or death of that person.

3. Change in law or government policy rendering further performance

If a person makes a contract to perform an act which is within the law when the contract

is made but later becomes unlawful because of a change in law or a new law, the contract

is discharged.

4. Declaration/Outbreak of War

All contracts made with an alien enemy during war time are void. Even when the parties

make the contract at the time when the relations between the countries are friendly, the

outbreak of war makes the performance of the contract impossible. In such cases, either

the contract is deemed to be discharged or is suspended till the war is over.

For example, A contracts to take in a cargo for B at a foreign port. A's government,

afterwards, declares a war against the country in which the port is situated. The contract

becomes void when war is declared.

Robinson vs Davison

An artist undertook to perform at a concert for a certain price. Before she could do so,

she was taken seriously ill. Held, she was discharged due to illness.

Shyam Sundar vs Durga

The vendor of a land could not execute the sale because the same land was

acquired by the government under statutory powers. Held, the contract had become

impossible of performance.

5. Non-existence or Non-occurrence of a Particular State of Things Necessary for

Performance or Failure of Purpose

Where the ultimate purpose for which the contract was entered into fails, the contract is

discharged, although there is no destruction of any property affected by the contract and

the performance of the contract remains possible in literal sense.

Krell vs Henry

H hired a room from K for two days to view the coronation procession of King Edward VII.

Although the contract did not contain any reference to the coronation, both the parties knew it.

Owing to the king’s illness, the procession was abandoned. Held that H was not liable to pay the

rent for the room as the existence of the procession was the basis of the contract and its

cancellation discharged the contract.

Exceptions to Doctrine of Supervening Impossibility

It means that when a person has promised to do something, he must perform his promise unless

the performance becomes absolutely impossible.

“IMPOSSIBILITY OF PERFORMANCE IS, AS A RULE, NOT AN EXCUSE FOR NON- PERFORMANCE.”

A contract is not discharged by the supervening impossibility in the following cases:

1. Difficulty in Performance

Sometimes, the performance of the contract does not become impossible, but becomes difficult

only due to some subsequent event. In such cases, the parties remain bound to perform the

contract. In other words, the parties are not discharged from their liability. In other words, the

parties are not discharged from their liability as the performance is difficult only and not

impossible. A contact is not discharged simply on the ground that its performance has become

more difficult, risky, burdensome and unprofitable.

Black Burn Bobbin Co. vs Allen & Sons

The defendant agreed to supply a certain quantity of Finland timber to be delivered between July

and September 1914. Till August, no delivery was made. Then the war broke out and transport

was disorganized and defendant could not bring timber from Finland. Held, the difficulty in

getting the timber from Finland did not excuse the performance.

2. Commercial Hardships/ Impossibility

A Contract is not discharged merely because expectation of higher profits is not realized, or the

necessary raw material is available at a higher price because of the outbreak of war, or there is a

sudden depreciation of currency.

For example, X, a furniture manufacturer agreed to supply certain furniture to Y at an agreed

rate. Afterwards, there was a sharp increase in the rates of the timber and rates of wages. Since, it

was no longer profitable to supply at the agreed rate, X did not supply. X will not be discharged

on the ground of commercial impossibility.

3. Impossibility Due to the Conduct of Third Party

In contracts where the promisor is dependent on a third party for his performance, and cannot

perform because of the non-performance of the third party, such non-performance is not deemed

to be because of impossibility.

For example, A promises to deliver 500 blankets to B, and has to purchase the same from the

manufacturer. If A cannot procure these blankets from the manufacturer, he still can perform

what he has promised by purchasing the blankets from the open market. In such a case, A cannot

be absolved of performance and is liable to be sued for damages.

4. Strikes, Riots or Civil Disturbances

A contract is not discharged on the grounds of strikes, lockouts and civil disturbance unless

otherwise agreed by the parties to the contract.

For example, X agreed to supply to Y certain goods to be imported from Algeria. The goods

could not be imported due to riots in that country. It was held that this was no excuse for non-

performance of the contract [Jacobs v. Credit Lyonnais]

5. Self-induced Impossibility

Doctrine of frustration holds good only if the impossibility is not self induced.

For example, A contract cannot be discharged if the promisor is convicted of a crime.

6. Failure of One of the Objects

When a contract is entered into for several objects, the failure of one of them does not discharge

the contract.

For example, A company agreed to let out a boat to H, (a) for viewing a naval review on the

occasion of the coronation of King Edward VII, and (b) to sail round the fleet. Due to Illness of

the King, the naval review was later cancelled but the fleet was assembled. Held, the contract

was not discharged because the holding of the review was not the sole basis of the contract. To

sail round the fleet, which formed an equally basis object of the contract was still capable of

attainment (H.B steamboat Co. vs. Hutton)

Effects of Supervening impossibility

Contract becomes void due to supervening impossibility. In such cases, doctrine of restitution

applies. Parties have to restore the benefits they have taken from other party.

III. DISCHARGE OF CONTRACT BY MUTUAL AGREEMENT

A contract can be discharged by mutual agreement in any of the following ways:

a. Novation

Where a new contract is formed to replace an existing one, the contract so replaced is said to be

discharged by novation. Novation means substituting a new contract for the existing one. The

new contract is entered into between the same parties or the new parties. The novation is valid

when all the parties consent it. The new contract must be valid and enforceable, otherwise the old

contract will continue valid.

For example, A owed 100 to B, under contract. B owed 100 to C. It was agreed among A, B

and C that A would pay 100 to C.

b. Alteration

An alteration of a contract means a change in one or more terms of the contract with the mutual

consent of the parties. The alteration discharges the original contract and creates a new contract.

However, the parties to the new contract remain the same. In case of alteration of the contract,

the old terms and conditions need not to be performed while the new terms and conditions must

be performed.

For example, A agreed with B to supply 100 TV sets at a certain price by the end of October.

Subsequently, A and B mutually agree that the supply to be made by the end of November. This

is an alteration in the terms of the contract by consent of both the parties.

c. Rescission

Where the parties agree, before the due date of performance, mutually decide not to perform

their respective obligations, the contract is discharged by rescission. Thus, rescission means

cancellation of the contract by mutual consent of the parties.

For example, A agrees to supply certain goods to B at a certain date. Before the date of

delivery, A and B agree not to perform the contract. The contract is discharged by rescission.

d. Remission

The remission means the acceptance of a lesser consideration than what is agreed under the

contract. It takes place when the promisee

1. Dispenses with a part or whole of the performance of a promise or

2. Extends the time for a performance by the promisor or

3. Accepts a lesser sum or

4. Accepts any other consideration than agreed in the contract.

For example, A owes B 5000. A pays 2000 to B and B accepts the amount in satisfaction of

the whole debt. The whole debt is discharged.

e. Waiver

Waiver means deliberate abandonment or giving up a right to which a party is entitled to it under

a contract. Consequently the other party is released from his obligations. No agreement or

consideration is required to constitute a waiver.

For example, A promises to supply goods to Y. Later on, Y exempts A from carrying out the

promise. It amount as waiver of right of performance on part of Y.

f. Merger

The conversion of the inferior right into superior right is called as merger. It is also called as

vesting of rights and liabilities in the same person.

For example, A person holds property under lease, purchases the property. On purchase, his

lease agreement is discharged.

IV. DISCHARGE BY LAPSE OF TIME

If a contract is to be performed within a specified time, each party to it must perform his promise

within the stipulated time. On the completion of the stipulated time, the contract is discharged.

Under the Indian Limitation Act, the parties can claim the rights under a contract within a

specified period of the contract is terminated.

For example, The period of limitation for recovering the debt is 3 years and 12 years for the

recovery of immovable property.

V DISCHARGE BY OPERATION OF LAW

In some situations, a contract may be terminated by the operation of law. According to Section

37, if, under the provisions of the Act or any other law, the contract is discharged or terminated,

it is not necessary for the parties to perform their obligations under the contract. In the following

circumstances, the contract is discharged by the operation of law.

1. Death

The contract that requires personal skill is discharged on the death of the promisor. However,

any benefit received before the performance shall be returned by the legal representative of the

deceased party.

For example, A agrees to paint a picture for B. A dies. Contract is discharged.

2. Merger

The conversion of the inferior right into superior right is called as merger. It is also called as

vesting of rights and liabilities in the same person.

For example, A man holds property under a lease. Subsequently he buys that property. Now his

right as a lessee vanishes. It is merged into the right of ownership, which he has now acquired.

3. Insolvency

The contract of a loan or credit is discharged by the operation of the law of insolvency. It

happens so only when the debtor is financially in very tight position and therefore, not in a

position to pay off his debts in full. So, where the court passes an order discharging the insolvent

(the debtor), the order gees him from all liabilities left unpaid.

4. Unauthorized Material Alteration

The alteration which changes the nature of the contract is material alteration. If one party makes

any material alteration in the terms of the contract without the approval of the other party, the

contract comes to an end.

For example, One of the parties without the consent of the other party changes the date of

payment or the place of delivery.

VI. DISCHARGE BY BREACH OF CONTRACT

It means the failure of a party to fulfil his obligation or promise under the contract. When there is

a breach of contract, certain remedy or consequences are available to the aggrieved party. The

aggrieved party means a party who is not at a fault.

Consequences of Breach of Contract

The aggrieved party is not required to perform his part of the promise. The aggrieved party is

having various remedies depending upon the type of breach. The breach of contract is of the

following two types:

1. Actual breach

2. Anticipatory breach

a) Actual Breach of Contract

An actual breach of contract means any party to contract refuses or fails to perform his promise

on the due date of performance, or during the performance. The actual breach of contract may

take place expressly or impliedly.

For example, A agreed with B to sell 500 TV sets on 21 January. A refuses to deliver the TV

sets on the due date. This is a breach of contract on the due date.

Following are the consequences of the actual breach of contract:

1. If time is the essence of the contract

1. The contract is voidable at the option of the aggrieved party.

2. The aggrieved party can claim the compensation for the loss for non-performance.

3. The aggrieved party cannot claim compensation when he accepts delayed

performance.

2. If time is not the essence of the contract

If time is not the essence, the contract is not voidable but the aggrieved party can claim

compensation for any loss caused for non-performance.

Cort vs. Ambergate Rly.Co.

A contracted with a Railway Company to supply it certain quantity of railway-chairs at a certain

price. The delivery was to be made in instalments. After a few instalments had been supplied, the

Railway Company asked A to deliver no more. Held : A could sue for breach of contract.

b) Anticipatory Breach of Contract

When any party declares his intention of not performing the contract before the performance is

due, it is called as anticipatory breach of contract.

For example, A agrees with B to sell his car on 21 January. Before this date he informs B that he

will not sell it. This is an anticipatory breach of contract.

There are two modes of anticipatory breach (a) express repudiation and (b) implied repudiation.

The express repudiation means when the party refuses expressly to perform his obligation before

the performance due. The implied repudiation means the party acts in such manner that it

becomes impossible for him to fulfill his obligation under the contract. In the case of implied

repudiation, the party does something which indicates his unwillingness to perform the contract.

Following are the consequence of anticipatory breach.

1. The aggrieved party may treat the contract as alive.

2. The aggrieved party can rescind the contract and claim damages.

Here, the damage will be equal to the difference between the contract price and the price as on

the date of communication. When a contract becomes void, any benefit received under such

contract is bound to restore such benefit or to make compensation for such benefit to the person

from whom he received it.

Leading Case: Avery v. Bowden

A agreed to load a cargo of wheat on B’s ship at Odessa by a particular date but when the ship

arrived A refused to load the cargo. B did not accept the refusal and continued to demand the

cargo. Before the last date of loading had expired the Crimean War broke out, rendering the

performance of the contract illegal. Held : The contract was discharged and B could not sue for

damages

Measure of Damages in case of Anticipatory Breach:

1. When breach accepted immediately:

Damages= Difference between Price at the time of breach and Contract Price

2. When breach not accepted immediately and contract kept alive till due date:

Damages= Difference between Price prevailing on the due date and Contract Price.

Activity Two – Check your progress

1. If one of the parties dies, then __________?

2. Replacing old contract with new one but parties remain same is called _________?

3. If parties are new then _____________?

4. Doctrine of supervening impossibility is called __________ in English law.

5. If any party commits breach then ___________?

(Hints : 1. Contract is discharged, 2. Alteration, 3. Novation, 4 Doctrine of frustration,

5. Contract is discharged.)

Check your progress- Case Studies (Activity -3)

1. A desires B, who owes him Rs. 100, to send him a promissory note for Rs. 100 by post. B posts a

promissory note to A. Is the debt discharged?

(Hint: The debt is discharged as soon as B puts into the post a letter containing the promissory

note duly addressed to A.)

2. A promise to deliver goods at B’s warehouse on the 1st January. On that day A brings the goods

to B’s warehouse, but after usual hour for closing it and they are not received. Is the performance

by A complete?

(Hint: No, A has not performed his promise, as he brings goods after the working hours)

3. A promises to paint a picture for B by a certain day, at a certain price. A dies before that day.

Can the contract be enforced by A’s representative?

(Hint: No, the contract cannot be enforced by A’s representative.)

4. A promises to pay B a sum of money. A does not pay personally but sends his agent to pay to B.

Is it valid tender?

Summary

A contract can be performed by

Actual performance

Attempted performance or tender

A contract can be discharged by

Performance

Lapse of time

Operation of law

Forming an agreement

Breach of contract

Impossibility of performance

(Hint: Yes, A may perform this promise, either by personally paying the money to B or by

causing it to be paid to B by another)

5. A undertakes to deliver 1,000 quintals of jute to B on a fixed day. Can A deliver goods at any

place to B?

(Hint: No, A must apply to B to appoint a reasonable place for the purpose of receiving it, and

must deliver it to him at such place.)

6. A owes B Rs. 5,000. C pays B Rs. 1,000, and B accepts them in satisfaction of his claim on A.

Does this payment discharge the whole claim?

(Hint: Yes, the whole debt stands discharged)

7. A and B enter into a contract that A shall deliver certain goods to B by the 15th

of this month and

that B shall pay the price on the first of the next month. A does not supply the goods. Can B

cancel the contract?

(Hint: Yes, B may rescind the contract, and need not pay the price as A committed actual

breach.)

8. A sold to B certain goods supposed to be on a voyage. The goods had ceased to exist due to the

perils of the sea. Discuss about the validity of contract.

(Hint: The contract was void)

9. C let a music hall to T for a series of concerts for certain days. The hall was accidentally burnt

down before the date of the first concert. Can C sue T for the Charges?

(Hint: No. Held, the contract was void)

10. A contracted to sell a specified quantity of potatoes to be grown on his farms. The crop largely

failed. Is the contract discharged?

(Hint: Yes, the contract is discharged due to impossibility of performance)

11. A promises to paint a picture for B by a certain day at a certain price. A dies before the day. Can

B enforce the contract on A?

(Hint: No, the contract cannot be enforced either by A’s representative or by B.)

12. A and B contract to marry each other. Before the time fixed for the marriage, A goes mad. Is the

contract discharged?

(Hint: Yes, the contract becomes void.)

13. D leased some land to B and agreed to erect a building on the adjoining land. The adjoining land,

after some time, was acquired under statutory powers by a railway company which built a

railway station on it. D could not perform the contract and therefore B sued D. Can D escape

from liability?

(Hint: Yes, held, D was excused from performance of the contract)

14. D enters into a contract with P on 1st March for the supply of certain imported goods in the

month of September of the same year. In June by an Act of Parliament, the import of such goods

is banned. Is the contract is discharged?

(Hint: Yes, because of change of law)

15. Contracts to take in cargo for B at a foreign port. A’s Government afterwards declares war

against the country in which the port is situated. Is the contract frustrated?

(Hint: Yes, because of outbreak of war)

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. Define offer of performance?

2. Who can perform in a tender?

3. Is a tender made for a lesser amount a valid tender?

4. Define the following

(a) Remission (b) Novation (c) Accord & Satisfaction

(d) Alteration (e) Waiver

2. What is supervening impossibility of performance?

3. Can the contract discharge by expiry of time?

4. Explain how the contract can be discharged by operation of law.

5. Explain the kinds of breach.

6. How can a breach be committed by a party?

7. What are the consequences of breach of contract?

8. Differentiate between actual and anticipatory breach by using examples.

9. Can an agreement become void because of impossibility of performance?

Long Questions

1. What re the essential requisites of a valid tender of performance? What is the effect of

refusal by the promise to accept correct tender of goods and money?

2. What do you understand by performance of contract?

3. Explain, with illustration, what is meant by the frustration of a contract.

4. Explain ‘breach of contract’ as a mode of discharge of contract.

5. What do you understand by ‘anticipatory breach of contract’? State the rights of the

promise in case of such breach.

6. Explain the various modes to discharge a contract.

7. Discuss the effect of supervening impossibility on the performance of a contract.

Chapter – 7

Remedies for breach of contract

REMEDY

Remedy is the act of legal redressal. Remedy is the means given by law for the enforcement of a right.

Remedy means a course of action available to an aggrieved party when the other party

breaches the contract. When one party to contract breaches the contract, the other party who

is not at fault has certain remedy available to him. But all the remedies are not available at the

proper time.

The aggrieved party has one or more remedies available, depending upon the facts and

circumstances of each such case.

I. RESCISSION OF A CONTRACT—SECTION 39

The rescission of a contract means the right of the party to cancel the contract. In case of

breach of contract, the other party may rescind the contract.

Effects of Rescission of a Contract

When the contract is rescind by the aggrieved party as a result of the breach of contract, it has

the following effects:

1. The aggrieved party is not required to perform his part of obligation under the

contract.

2. The aggrieved party can claim compensation for any loss.

Learning Objectives:

In this chapter, the students will come to know

Various remedies for breach of contract

Types of damages

Quantum meruit

3. The party is liable to restore benefit, if any.

In certain circumstances, on the application of any party to the contract, the court may also

rescind the contract. If the court rescinds the contract, it is said that the court has set aside the

contract. Generally, the court may set aside the contract when the contract is voidable.

Example: A induced B by undue influence, to buy his car at a very high price, and delivered

his car to B. However, B decided to rescind the contract. In this case, B is bound to return

back A’s car.

Limits of Rescission:

The aggrieved party may lose the right to rescind the contract when:

(i) When the aggrieved party affirms (accepts) the contract.

(ii) When the aggrieved party does not rescind the contract within the prescribed time

or the reasonable time.

(iii) Where before the aggrieved party could have rescinded the contract, some third

party acquired a right in the subject matter of the same contract.

(iv) Where restoration of goods is not possible. For example: A suit got stitched

cannot be returned

Rescission leads to Restitution

On rescission of contract, the restitution is to be done i.e:-

(i) Compensate the losses suffered, and

(ii) Restore the benefits gained.

II. RESTITUTION

Restitution means to put the parties into the original positions as they were before

entering into the contract.

Precisely restitution means:

(i) When an agreement is discovered to be void ; or

(ii) When a contract becomes void;

(iii) Then any person who received any benefit out of it, must restore it (return it)

or/and

(iv) If some loss was suffered, the loss must be compensated.

Example: By supervening impossibility of law, the contract becomes void and hence

restitution is sought.

III. SUIT FOR A SPECIFIC PERFORMANCE

It means demanding an order from the court that the promise agreed in a contract shall be

carried out. And the court may direct the defaulting party to carry out his obligation

according to the terms of the contract. Specific performance is a remedy in the hands of the

aggrieved party, whereby the aggrieved party does not want any compensation for non-

performance of contract but wants that the other party should perform what he was supposed

to perform in the contract.

When a Specific Performance Is Allowed?

The specific performance of a contract may be allowed by the court, where the subject matter

of the contract is not an ordinary article of commerce or where the goods are not easily

available in the market. The specific performance may be ordered by the court in the

following situations:

1. Where the actual damages arising from the breach are not measurable.

2. Where the monetary compensation is not an adequate remedy.

When a Specific Performance Is Not Allowed?

In the following cases, specific performance is not allowed:

1. When the damages are an adequate remedy.

2. Where the performance of a contract requires a number of minute details and

therefore, not possible for the court to supervise eg. Building contracts

3. Where the contract is personal in nature eg. Contract to marry.

4. Where the contract made by the company is beyond its power. (ultra-vires)

5. Where one party to contract is minor.

6. Where the contract is inequitable to either party.

Example: A agrees to sell B, an artist an old painting of Mughal Period for Rs 30,000. Later

on, he refused to sell it. Here, B can file a suit against A for the specific performance of the

contract.

IV. SUIT FOR INJUNCTION

The injunction may be defined as an order of the courts restraining a person from doing

something which he promised not to do. It means a stay order granted by the court. This

order prohibits a person to do a particular act. Where there is a breach of contract by one

party and the order of a specific performance is not granted by the court, the injunction

may be granted. The injunction is granted by the courts at their discretion.

In general words, Injunction is:

(i) A judicial process

(ii) By which the court issues an order;

(iii) To refrain the wrongdoer;

(iv) To restrain from doing the wrongful act.

Example: Film actress agreed to act exclusively for W for one year and for no one else.

During the year, she contracted to act for Z. (Warner Bros. vs. Nelson)

V. QUANTUM MERUIT

Quantum Meruit is a Latin phrase. It means ‘as much as is earned’ i.e., in proportion to the

extent of work done. In other words, quantum meruit is the compensation for the proportion

of work done. It is right to claim compensation for the work already done. The quantum

meruit arises only when the original contract is discharged.

Claim on Quantum Meruit by a Party Not at Fault

Following are the cases in which a claim on quantum meruit may arise:

1. When one party prevents the other from a completion of the contract.

2. Where the contract has become void before the completion of the contract.

3. In case of quasi contracts.

Example: A agreed with B to supply 500 units of TV before a particular date. A supplied 400

units only, before the date, and declared his intention not to deliver the remaining units. B

retained the 400 units. A, therefore, is entitled to recover the price of 400 units on quantum

meruit.

VI. SUIT FOR DAMAGES

Damage means a sum of money claimed or awarded in compensation for a loss or an injury.

The object of the Law of Restitution is to put the parties to the contract in the original

position as they were before forming contract i.e. to restore benefits and compensate the

losses. On the basis of the Law of Restitution, whenever a party to the contract commits

breach, the aggrieved party (i.e. the innocent party) can claim the monetary compensation for

the loss so suffered by him. This monetary compensation awarded to the aggrieved party for

the non-performance or breach by the other party is called as Damages.

The remedy of damages is available when:

(i) A party to the contract commits breach of contract.

(ii) The aggrieved party suffers a loss due to the breach by the other party.

(iii) To compensate the loss so suffered, the aggrieved party has a right to claim

damages.

It means the monetary compensation allowed for a loss. The purpose is to compensate the

aggrieved party and not to punish the party at fault.

In India, the rules relating to the damages are based on the English judgment of Hadley vs.

Baxendale. This case is a leading case on the remoteness of damage.

The facts of case were—H's mill was stopped due to the breakdown of the shaft. He

delivered the shaft to a common carrier to repair it, and agreed to pay a certain sum of money

for doing this work. H has not informed B that the delay would result into a loss of profit. B

delivered the shaft a reasonable time after the repair. H filed a suit for the loss of profit. It

was held that B is not liable for the loss of profit. The court laid down a rule that the damage

can be recovered, if the party has a breach of contract. While determining the damages, the

court takes the following points into account:

1. Inconvenience caused by the non-performance.

2. Motive of breach.

3. Manner of breach.

Activity One – Check you progress

1. If third party acquires any right out of voidable contract, can contract be cancelled?

2. If actual damages arising from breach are not measurable and monetary compensation

is not an adequate remedy, what is the remedy available?

3. A judicial process by which court issues an order to refrain the wrong doer is called

__________________?

4. Compensation for the proportion of work done is called _____________?

5. Amount paid to compensate the loss in case of breach is called ____________?

(Hints: 1. No, 2. Specific, 3. Injunction, 4. Quantum Meruit, 5. Damages)

KINDS OF DAMAGES

Following are the different kinds of damages:

(I) Ordinary Damages or Proximate Damages or Natural Damages or General Damages

These are the damages which are payable for the loss arising naturally and directly as a result

of the breach of contract. These are paid for the loss occurred due to breach of contract and

not due to remote causes. The purpose of ordinary damage is that the injured party is to be

put in the same financial position as he would have been, if the contract had been performed

according to the terms of the contract. Such losses should be the nearest consequence of the

breach of the contract. These damages are also called as ORDINARY DAMAGES.

Example: Amar has agreed to give his car on lease to Akbar for a period of 1 year for Rs.

30,000. Amar later on refuses to give the car on lease and breaches the contract, and

therefore, Akbar has to enter in lease for taking the car on lease for Rs.40,000. In this case,

Amar is liable to pay Akbar Rs. 10,000, the difference between the contract price and the

price. Akbar pays for the lease of the car from some other person. Here, Rs. 10,000 is

ordinary damage.

(II) Special Damages

These are damages which are payable for the loss arising due to some special circumstances.

These damages can be claimed only if such special circumstances have been disclosed to

other party in advance. If the defaulting party has no knowledge of the special circumstances,

he will not be liable for the special damages.

Simpson vs. London and North Railway Co.

A sent a sample of his products for exhibition to an agent of a railway company for carriage

to ‘New Delhi’ for an exhibition. The consignment note stated: ‘Must be at New Delhi

Monday Certain’. Due to the negligence of the company, the goods reached only after the

exhibition was over. Held, the company was liable for the loss caused by the late arrival of

the products because the company's agent was aware of the special circumstances.

(III) Exemplary or Punitive or Vindictive Damages

These damages are imposed to penalize the defaulting party. Ordinarily, the damages for the

breach of contract are intended to compensate the person who has suffered loss due to breach

of contract and not to punish the defaulting party. But the exemplary damages are allowed not

to compensate the party but as a means of punishment to the defaulting party. The courts

generally do not award vindictive damage but it may award these damages in the case of:

1. Breach of contract to marry—loss based on mental injury.

2. Wrongful dishonor of the cheque---smaller the amount, larger the damage.

Westesen vs. Olathe State Bank (1925)

A banking corporation, agreed to give loan to Ashi for a trip to California by crediting her

account with such sums as she might need after reaching her destination. Ashi reached

California, but the bank refused to give her the promised credit. The court allowed

damages for humiliation and mental suffering.

(IV) Nominal Damages

Where the party suffers no loss, the court may allow nominal damages, simply to satisfy the

party who has suffered loss due to breach of contract. The nominal damage is very small in

amount. The nominal damages are awarded only at the discretion of the court. The aggrieved

party cannot claim the nominal damages as a matter of right.

(V) Damages for Inconvenience

If the party has suffered physical inconvenience, discomfort, or mental agony as a result of

the breach of contract, the party can recover the damage for such inconvenience.

Example: A photographer agreed to take photographs at a wedding ceremony but failed to do

so. The bride brought an action for the breach of contract. Held, she was entitled to the

damages for her injured feelings.

(VI) Remote or Indirect Damages

Damages which are payable for the losses arising due to some remote or indirect causes are

called remote damages.

LEGAL RULES FOR THE PAYMENT OF DAMAGES

(i) The ordinary damages are recoverable

The ordinary damages which are due to the natural and probable consequences of the breach

are recoverable from the party in default. These damages are assessed on the basis of actual

loss suffered by the aggrieved party.

(ii) The special damages are recoverable only if the parties knew about them

The special damages are payable in case of some special or unusual circumstances. These

damages are recoverable only if the special circumstances were in the knowledge of the

parties at the time of making the contract, or if these special circumstances were brought to

the notice of the defaulting party.

(iii) The remote or indirect damages are not recoverable

The remote or indirect damages are not due to natural and probable consequences of the

breach of the contract i.e., these are the damages which arise indirectly from the breach.

These damages are not recoverable.

(iv) The nominal damages are awarded at the discretion of the court

The nominal damages are those which are very small in nature. These damages are awarded

simply to establish the party’s right to claim damages for the breach of contract. It may,

however, be noted that the party cannot claim these damages as a matter of right.

(v) The exemplary or vindictive damages are not allowed

The exemplary damages are claimed with the intention of punishing the party in default. As a

general rule; the exemplary damages are not awarded for the breach of contract as they are

punitive in nature.

(vi) The party is not entitled to recover damages unless he has actually suffered some loss

Sometimes, the party does not suffer any loss on account of the breach of the contract. In such

cases, he cannot claim damages as a matter of right.

(vii) The damages for mental pain and suffering are not recoverable

Ordinarily, the damages for mental pain and sufferings caused by the breach are not allowed.

However, such damages may be allowed in special cases, for eg., where the breach was

reckless and caused bodily harm.

(viii) The damages are compensation and not penal

We have already discussed that the damages are given by way of compensation for the loss

suffered by the injured party, and not for the purpose of punishing the defaulting party.

Liquidated Damages and Penalty

The party may pre-specify an amount at the time of entering into a contract. This amount can

be a liquidated damage or a penalty. If the specified sum represents fair and genuine pre-

estimate damages which may arise due to breach, it is called as a liquidated damage. But if

the specified sum is more than the damages, it is called as a penalty.

Example: A gives B a loan of Rs 1000 at the rate of interest at 12% repayable at the end of

six months, with a condition that in case of default, the interest shall be payable at the rate of

75% from the date of default. This is a penalty and A is only entitled to recover from B such

compensation if the court considers reasonable.

Difference between Penalty and Liquidated Damages

Points of

Difference

Penalty Liquidated Damages

1. Meaning Penalty is the unreasonable/exorbitant

amount fixed by the parties to

intimidate/scare the other party to

perform.

A genuine per-estimate of the loss

by the parties caused by breach of

contract is called as liquidated

damages

2. Sum Payable Is unreasonable. A genuine pre-estimated sum is

fixed.

3. Intention Intention of fixing penalty is to

frighten/intimidate the party to perform.

The intention is to assess the

damages for breach of the contract.

4. Non-payment

by a certain time

In penalty, the breach may also occur

when a party does not pay by a certain

time.

In liquidated damages, this is not the

case.

5. Example A agrees to pay B Rs. 1000 on 1st Sept.

and if he fails to pay by 1st Sept. he shall

pay Rs. 2500. This Rs. 1500 extra is

penalty

A company stipulated that payment

can be made in the installments, but

in case of default of installment the

interest shall be charged. This

interest amount is liquidated

damages

Activity Two – Check your progress

1. Special damages are paid if ________________?

2. Vindictive damages are paid to ____________ the aggrieved party.

3. When other party suffers no loss, the court may allow _________ damages.

4. __________ damages are not recoverable.

5. The damages are ________________ and not penal in nature.

(Hints: - 1. Special circumstances are disclosed to other party, 2. Penalize, 3. Nominal, 4

Remote, 5. Compensatory)

Activity 3 – Check your progress- Case Studies

1. A contract to sell and deliver 50 quintals of Farm Wheat to B at Rs. 475 per quintal,

the price to be paid at the time of delivery. The price of wheat rises to Rs. 500 per

quintal and A refuses to sell the wheat. Can B claim damages? Also discuss the

measure of damage.

(Hint: B can claim damages at the rate of Rs. 25 per quintal.)

2. D sold tyres to N who contracted not to re-sell them, of offer them for sale, at a price

below D’s list price. N agreed to pay a sum of Rs. 5,000 by way of liquidated

damages for every breach of the agreement. N sold a tyre at less than the list price. D

filed a suit for damages for breach. Is the remedy available called as penalty?

(Hint : No. Held, the sum fixed by the parties was a genuine per-estimated of the

damage and not a penalty.)

3. W agreed to sing at L’s theatre, and during a certain period to sing nowhere else.

Afterwards W made contract with Z to sing to another theatre and refused to perform

the contract with L. Can Z restrain W by an injunction?

(Hint: Yes, Held, W could be restrained by injunction from singing for Z.)

4. N, a film actress, agreed to act exclusively for W for a year and for no one else.

During the year she contracted to act for Z. Can injunction be used as a remedy?

(Hint: Yes, she could be restrained by injunction from doing so.)

5. A agreed to erect a plant for B by 31st January, 2014. The contract provided that B

should pay Rs. 500 per month for every month that A took beyond the agreed date. A

Summary

Remedy means a course of action available to an aggrieved party when the other

party breaches the contract.

Aggrieved party can have one of the following remedies:

1. Rescission

2. Restitution

3. Specific performance

4. Injunction

5. Quantum meruit

6. Damages

was late by six months. B sued A for Rs. 6,500 the actual loss caused to him as a

result of the delay. To what damages, if any, is B entitled?

(Hint: Rs. 3,000 i.e. Rs. 500 for six months (Hadley v. Baxendale, Sec. 73))

6. S agreed to act as sales manager for Company X for a period of three years at a

monthly salary of Rs. 1,000. S worked for six months and then left and joined another

company at a higher salary. What are the rights of company X?

(Hint: Company X may not only treat the contract as rescinded but also bring suit

against S to recover any monetary loss suffered by it as a result of the breach.

Review Questions

Short Questions

1. Write a short note on :

(a) Quantum Meruit

(b) Injunction

(c) Restitution

(d) Specific Performance

2. When is the remedy of damages available to an aggrieved party?

3. What is the difference between General and Special Damages?

4. Differentiate between penalty and liquidated damages.

Long Questions

1. Explain the kinds of damages.

2. What remedies are available to an aggrieved party for the breach of the contract?

3. “The damages are given as compensation for the loss suffered and not to punish for

breach”. Discuss the statement explaining the remedy of damages for breach.

4. Under what circumstances is a party entitled to specific performance?

Chapter - 8

Indemnity and Guarantee

Learning Objectives

In this chapter, the students will come to know

Meaning of a contract of indemnity and contract of guarantee.

Rights of an indemnity holder.

Difference between a contract of indemnity and a contract of guarantee.

Different types of guarantees.

Rights of surety.

I. Contract of Indemnity

A contract of indemnity is a special contract. All the general principles of the contract are

equally applicable to it.

Definition under section 124: “The contract by which one party promises to save the other

from the loss caused to him by the conduct of the promisor himself or by the conduct of any

other person is called a ‘contract of indemnity”.

The person who promises to make good the loss is called the indemnifier (Promisor) and the

person whose loss is to be made good is called the indemnity holder (Promisee). A contract of

indemnity is really a class of contingent contracts.

For example: A contracts to indemnify B against the consequences of any proceedings which C

may take against B in respect of a certain sum of 200. This is a contract of indemnity. A is an

indemnifier or a promisor while B is an indemnity holder or a promisee.

ESSENTIALS OF A VALID CONTRACT OF INDEMNITY:

1. It should fulfill all essential elements of a valid contract.

2. The liability of indemnifier is primary by nature.

3. Loss may be due to the conduct of the promisor or any other person or act of God.

4. The contract of indemnity can be express or implied.

II. Contract of Guarantee

Definition under section 126: “A contract of guarantee is a contract to perform the promise, or

discharge the liability of a third person in case of his default.”

A guarantee may be either oral, or written (Section 126). The contract of guarantee may be

express, or implied, and may even be inferred from the course of conduct of the parties

concerned.

PARTIES TO THE CONTRACT:

The person who gives the guarantee is called the ‘Surety’.

The person in respect of whose default the guarantee is given is called the ‘Principal

Debtor’

The person to whom the guarantee is given is called the ‘Creditor’.

Essentials of Contract of guarantee

1. Existence of a Debt

The contract of guarantee exists only to secure the payment of a debt. Therefore, until

and unless there is a debt that exists, the guarantee cannot be given. There should be

someone who is liable as a principal debtor to one principal creditor, only then the surety

can undertake to be liable on the default made by the debtor.

Swan V. Bank of Scotland (1836)

A bank made an overdraft to a customer. The overdraft was guaranteed by Z. The

overdraft were contrary to a statute, which did not impose any penalty upon the parties to

such drafts but also made them void. The customer having defaulted, Z was sued for the

loss. It was held that Z was not liable because the principal debtor (customer) was not

liable since the overdraft was void.

2. Tripartite Agreement

The contract of guarantee is a Tripartite Agreement which contemplates the principal

debtor, the creditor, and the surety. Here, the following three collateral contracts may be

distinguished:

between the creditor and the principal debtor, there is a contract of debt between

them .

between the surety and the creditor, there is a contract by which the surety

guarantees to pay to the creditor if principal debtor defaults.

between the surety and the principal debtor, there is a contract that the debtor shall

indemnify the surety if surety pays in case of debtor’s default. This is generally an

implied contract.

3. Nature of liability

In a contract of guarantee the debtor is liable to the creditor and on default in the payment

by debtor, the surety is liable to the creditor.

(i) Primary liability : It is the primary liability of the debtor that he must pay his debt

to the creditor.

(ii) Secondary liability : On the default in payment by the debtor to the creditor, the

surety stands liable to pay the debt to the creditor. Therefore the liability of surety

is secondary by nature.

4. Benefit to principal debtor is sufficient consideration

Like every other contract, a contract of guarantee should also be supported by some

consideration. It may be any or some consideration. Only it should not be totally absent.

But there need not be direct consideration between the surety and the creditor. Section

127 clearly provides that “anything done or any promise made for the benefit of the

principal debtor may be a sufficient consideration to the surety for giving the guarantee.

5. Consent of surety free of misrepresentation and concealment

The creditor should not have obtained the consent of surety in the contract of guarantee

either by misrepresentation or concealment of any material facts about the contract.

Where the creditor obtains the consent of surety either by concealing some material

(important) fact or by misrepresentation, the contract of guarantee shall be declared to be

invalid.

6. Writing not necessary

A guarantee may be either oral or written. It may be express or implied. Implied

guarantee may be inferred from the course of conduct of the parties concerned. But in

England, a guarantee must be in writing and signed by the party to be charged.

7. The promise to pay must be conditional

It is another important essential element of a contract of guarantee. There must be a

conditional promise to be liable on the default of the principal debtor. In other words, the

liability of the surety should arise only when the principal debtor makes a default.

8. The contract of guarantee must satisfy the requirements of a valid contract

A contract of guarantee is a special kind of contract. As such, it must have all the

essential elements of a valid contract such as consideration, free consent, competence of

the parties, legality of object and consideration.

Distinction between Indemnity and Guarantee

Bases of Difference Indemnity Guarantee

1. Number of Parties There are only two parties i.e.

indemnifier and indemnified.

There are three parties i.e.

principal debtor, creditor and

surety.

2. Number of Contracts There is only one contract i.e.

between indemnified and

indemnifier.

There are three contracts i.e.

between creditor and principal

debtor and surety.

3. Nature of Liability Liability of the indemnifier is

primary i.e. only indemnifier is

liable in case of loss against which

indemnity has been given.

Liability of surety is

secondary i.e. surety becomes

liable only the principal debtor

commits default in the

discharge of his obligation

4. Existence of Liability The possibility of liability or loss

is only a contingency which may

or may not arise.

There is an existing liability or

debt, the discharge of which is

guaranteed by the surety.

5. Purpose It provides security against loss. It provides security to the

creditor for the debt given to

the principal debtor.

6. Interest of the Parties The indemnifier has some interest

in the transaction other than

indemnity.

But the surety has no such

interest except that of

guarantee.

Types of Guarantee

The guarantee may be of two types:

1. Specific guarantee

Guarantee is specific when it is for one particular transaction whether of loan or of credit. In a

specific guarantee, the surety furnishes guarantee only for one transaction. Such guarantee is

discharged with the performance of that transaction. For example, B advances a loan to C on the

guarantee of A. The guarantee is specific.

2. Continuing Guarantee

When guarantee is provided for a series of transaction, it is known as continuing guarantee. Such

a guarantee is given either for a certain period or for an indefinite period. It is just like a standing

offer.

For Example, A furnishes a guarantee to B for allowing credit to C whenever C demands for a

period of one year, this guarantee is for a number of transactions but the period during which the

transactions may take place is specific.

Nature & Extent of Surety’s Liability

The surety is generally called as a Favored debtor, this statement can be understood from the

rules given below:

1. Liability of surety is secondary

The liability of surety is of secondary nature. It means that surety is liable only on default of

the principal debtor.

2. Liability of surety is co-extensive

The first principle that governs the extent of the liability of the surety is that the liability of

the surety is co-extensive with that of the liability of the principal debtor. The surety is liable

exactly for that amount for which the principal debtor is liable. Therefore, the maximum

extent of the surety’s liability is the liability of the principal debtor in the contract.

Example:- A guarantees to B the payment of loan given to C. C defaults the payment of the

loan to B. Held, the liability of A (surety) is co-extensive with that of the C (the debtor),

therefore A is liable not only for the repayment of the loan but also for interest on the loan.

3. Creditor may proceed against the surety first

Sometimes, the creditor may choose to proceed against the surety first, unless he has agreed

with the surety to the contrary. The creditor may even omit to sue the principal debtor and

may sue only the surety.

Bank of Bihar vs. Damodar Prasad (1969)

A bank lent a loan to Damodar Prasad on the guarantee given by Paras Nath Sinha. Inspite

of demands made by the bank, the loan was neither repaid by Damodar Prasad, nor by Paras

Nath. The bank filed a suit against both debtor and surety. The surety (Paras Nath) pleaded

that the bank could not take an action against him until an action was taken against the

debtor (Damodar Prasad). It was held, that the bank could proceed against surety (if it wants

to) without proceeding against the debtor.

4. Surety not discharged on death of debtor:- In case where the debtor dies, the surety is not

discharged from the debt to the creditor due to the death of debtor.

5. Limit of Surety’s Liability:- The surety may expressly declare that his liability shall be

limited to a fixed amount. In such a case, whatever may be the total amount of debt owed by

the principal debtor to the creditor, the surety shall be liable for the sum so specifically

fixed.

6. Surety’s liability where the original contract between creditor and principal debtor is

void or voidable:- When the original contract between the principal debtor and creditor is

void. For example, where the principal debtor is a minor, the surety will remain liable.

Where the original contract is voidable at the option of principal debtor who has exercised

his option and revoked the contract, the surety may not be discharged from his liability.

Activity one – Check your progress

1. One who gives guarantee is called _____________?

2. The liability of surety is ______________?

3. Guarantee provided for series of transaction is called _____________?

4. Can liability of surety exceed that of principal debtor ______________?

5. If debtor dies, is surety discharged? __________

(Hints : 1. Surety, 2. Secondary, 3. Continuing guarantee, 4. No. 5. No.)

RIGHTS OF THE SURETY

The rights of the surety may be categorized as follows:

Rights to Surety

A. Rights Against Creditors

The rights of the surety against creditors are as under:

1. To insist the creditor to sue principal debtor

The surety may insist the creditor to sue the principal debtor to recover the guaranteed

money after it has become due and before being called upon to pay.

2. Right to securities (Sec. 141)

If the creditor has some security from the principal debtor at the time when the

contract of suretyship is entered into, the security has right to such security whether

the surety knows of the existence of such security or not. Here it is to be noted that

the surety becomes entitled to this benefit only after paying off the creditor. After

making the payment in full, the surety assumes the position of the creditor.

Against the Creditor Against the debtor Against the Co-sureties

1. To insist creditor to sue

principal debtor

1. Right of subrogation 1. Right of equal

Contribution

2. Right to securities 2. Right to indemnity 2. Right of co-sureties bound

in different sums 3. Right if securities Sold

4. Right to set off

3. Right of surety if creditor parts with the security:

It becomes the duty of the creditor not to lose or part with such securities belonging to

the principal debtor which he possesses at the time of making of the contract of

guarantee. If the creditor, without the consent of the surety loses or parts with such

securities, this is an act prejudicial to the interest of the surety and he is discharged

thereby.

4. Right of set off

It may happen that a debtor is also having some claims against the creditor. In such a

case, the debtor can take advantage of setting off his debt to the extent of his claims

against the creditor.

For example, A gives guarantee of C for a loan of Rs 2000 to bank. Bank has his FD

of Rs 1000. C defaults. A can ask bank to set off C’s FD against loan and can pay

only Rs. 1000.

B. Rights against the Principal Debtor

(a) Right to Subrogation (Section 140)

On payment of the guaranteed debt or performance of the guaranteed duty; the surety

acquires all the rights which the creditor had against the principal debtor. Thus the

surety steps into shoes of creditor which is called right of subrogation.

(b) Right to indemnity

There is an implied promise by the principal debtor to indemnify the surety. But the

surety is entitled to recover from the principal debtor under implied promise of

indemnity, only the right or just payment to the creditor. He can also recover any

interest paid thereon. Since, the surety is entitled to full indemnification, he can only

claim the actual amount paid to the creditor.

For example: A had given guarantee of B to C. B defaulted and A paid Rs. 20,000 to

C. Here A can recover the amount from B as he has right to indemnity.

C. Right against the co-sureties

(i) Right to Equal Contribution (Sec. 146)

Where there are more than one sureties for a debtor, they all are called as co-sureties.

Such co-sureties are liable to contribute equally (in absence of any contract) in case

of default by the debtor.

Example: X.Y, Z are sureties to Suresh for the sum of Rs. 6000 lent to Geeta. Geeta

makes a default in payment. Held, X, Y, Z are each liable for Rs. 2000.

(ii) Liability of Co-sureties bound in different sums (Sec. 147)

The principal of equal contribution is however, subject to the maximum limit fixed

by a surety to his liability. Sec. 147 provides that where the co-sureties have agreed

to become liable for different sums, they should contribute equally but not exceeding

the sums which they have agreed to pay.

For example: - A,B and C as sureties for D enter into three several bonds each with

different penalty, namely, A for 10,000 rupees, B for 20,000 Rupees and C for

40,000 rupees, D makes default to the extent of 30,000 rupees. A, B and C are liable

to pay 10,000 rupees each.

Discharge of Surety

The surety is said to be discharged when his liability in the contract of guarantee comes to an

end. The liability of the surety arises on the default by the debtor in the payment and when the

surety pays off the debt on behalf of the debtor to the creditor, his liability extinguishes. Addition

to this, surety can be discharged through following mode:

Discharge of surety

In case of continuing Discharge by Conduct Discharge by

guarantee of Creditor Invalidation of Creditor

1. By notice of revocation 1. By Variation 1. Misrepresentation

2. By death of surety 2. Release of debtor 2. Concealment

3. By Novation 3. Compounding by Creditor 3. Failures of co-sureties

to join

4. Loss of Security

A. DISCHARGE BY REVOCATION OF CONTINUING GUARANTEE :

(i) Revocation of continuing guarantee by giving notice

According to Section 130 of the Indian Contract Act, a continuing guarantee can be

revoked by the surety at any time with respect to future transaction by the surety giving a

notice to the creditor of his intention to revoke the guarantee; which implies that, after

such notice has been given to the creditor, the surety is not held responsible for any future

transaction.

Hargopal Aggarwal v. S.B.I. (1956)

The directors of a company guaranteed the payment of the company’s overdrafts. The

director resigned later. The bank was informed about the resignation of the directors. The

bank sued the directors for the guaranteed overdraft amount. It was held that the directors

shall be liable only for that amount which was due up to the date of their resignation.

(ii) Death of surety (sec. 131)

In case of a continuing guarantee, the death of a surety also discharges him from liability

for all the transaction after his death, unless there is a contract to the contrary. The

surety’s property will not be liable for any transaction entered into after surety’s death,

even if the creditor has no notice of the death.

(iii) Revocation by novation

Novation means a substitution of a fresh contract is place of old one either between the

same parties or between different parties (Sec.62). Thus, a surety is discharged from his

liability under a contract of guarantee by novation because original contract comes to an

end.

B. DISCHARGED BY CONDUCT OF THE CREDITOR :

(i) Variation in terms of the contract (Sec. 133)

Once the contract of guarantee is entered into, it becomes the duty of the creditor not to

make any change in the terms of the original contract between him and the principal

debtor. If the creditor makes any variance without the consent of the surety, then the

surety is discharged as to the transaction subsequent to the change.

Bonar vs. Macdonald

A was surety for the conduct of a bank manager. Subsequent to this agreement, the bank

enhanced manager’s salary and the manger agreed to the liable for ¼ of the losses on

discounts allowed by him. This arrangement between the bank and its manager had been

made without the knowledge of A. it was held that this arrangement had resulted in the

discharge of surety.

(ii) Release or discharge of principal debtor (Sec. 134).

This section provides for the following two ways of discharge of surety from liability:

(a) The surety is discharged by any contract between the creditor and the principal debtor, by

which the principal debtor is released. Any release of the principal debtor is a release of

the surety also.

(b) The surety is also discharged by any act or omission of the creditor, the legal

consequence of which is the discharge of the principal debtor.

(iii) By composition, extension of time, and promise not to sue (Section 135)

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 sue the principal debtor,

discharges the surety, unless the surety assents to such contract.

This provision provides for three modes of discharges from liability:

Composition

Promise to give time, and

Promise not to sue the principal debtor.

Kalir prasanna Vs. Ambica Charan (1872)

In this case, the interest for extended period was accepted by the creditor in advance

without the consent of the surety. In the opinion of the court, it operated as an agreement

to give time to the principal debtor and as such discharged the surety.

(iv) Loss of security (Sec. 141)

If the creditor loses or parts with any security given to him without the consent of the

surety, the surety is discharged from liability to the extent of the value of security.

C. DISCHARGE BY INVALIDATION OF CONTRACT:

(1) Guarantee obtained by Misrepresentation (Sec. 142)

Any guarantee obtained by means of misrepresentation made by the creditor regarding

material fact of the contract. Such a guarantee is invalid.

(2) Guarantee obtained by Concealment (Sec. 143)

Any guarantee obtained by concealing material information is also invalid.

Example: The creditor conceals from the surety regarding a theft done by his clerk (the

debtor). Later the debtor again commits theft, the surety is discharged.

(3) Failure of Co-sureties to Join (Sec.144)

Where more than one person has agreed to stand as surety for the debtor, until and unless

all the co-sureties join, the guarantee given shall be invalid.

Activity Two – Check your progress

1. If creditor has some security, then after paying the debt, Can surety claim the security?

2. After paying creditor, can surety claim the debt from principal debtor?

3. If debtor & creditor changes terms of contract without knowledge of surety, is surety

discharged?

4. Guarantee given for a specific transaction is _____________?

5. Guarantee obtained through misrepresentation is __________?

(Hints : 1. Yes, 2. Yes, 3. Yes, 4. Specific guarantee, 5. Invalid)

Check your progress- Case Studies (Activity – 3)

1. P requests C to sell and deliver to him goods on credit. C agrees to do so, provided S will

guarantee the payment of the price of the goods. S promises to guarantee the payment in

consideration of C’s promise to deliver the goods. Is the consideration of S valid?

(Hint: yes)

2. P contracts with C for a fixed price to build a house for C within a stipulated time, C

supplying the necessary timber. S guarantees P’s performance of the contract. C omits to

supply the timber. Is S discharged from his suretyship?

(Hint: Yes, S is discharged from his suretyship)

3. A surety gives a guarantee for the fidelity of the manager of a bank. The manager

indulges in some malpractices to which the directors willfully shut their eyes. Is the

surety liable?

(Hint: No, they surety stands discharged from the obligation by conduct of the directors)

4. A and B stood as co-sureties in favour of a bank in respect of loan granted to certain

principal debtors. The surety A informed the bank that the principal debtors were likely

to wind up their business and, therefore, he withdrew the guarantee. The other surety, B,

did not take any such step. Discuss the status of liability of co-sureties.

Summary

The contract by which one party promises to save the other from the loss

caused to him by the conduct of the promisor himself or by the conduct of

any other person is called a ‘contract of indemnity’.

A contract of guarantee is a contract to perform the promise, or discharge

the liability of a third person in case of his default.

Guarantee can be either specific guarantee or continuing guarantee.

Surety is a favored debtor and its liability is secondary and co-extensive with

that of principal debtor.

(Hint: it was held that the co-surety A stood released from the liability, and only co-

surety B was liable for repayment of loan along with the principal debtors.)

5. P purchased a motor car from C under a hire-purchase agreement on guarantee of S for

the due performance of the agreement. C for valuable consideration gives P further time

for payment of one of the installments. Is S liable?

(Hint: No. Held, the giving of time to P discharged S from any further liability under the

guarantee.)

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. Define the term indemnity.

2. Differentiate between indemnity and guarantee.

3. What is a tripartite agreement?

4. What is a continuing guarantee?

5. Is a specific guarantee different from a continuing guarantee?

6. What is Right of Subrogation?

7. When can a continuing guarantee be revoked?

Long Questions

1. What is continuing guarantee? How can it be revoked?

2. “A surety is undoubtedly and not unjustly an object of some favour both at law and at

equity.” Explain.

3. Briefly discuss the rights of a surety against

(i) Creditor (ii) principal debtor and (iii) co-sureties.

4. What are the rights of surety? How the surety is discharged?

5. “The liability of a surety is secondary; it is co-extensive with that of the principal debtor.”

Explain.

6. What is a contract of guarantee? What are its characteristics? Distinguish between a

contract of guarantee and a contract of indemnity.

Chapter - 9

Bailment and pledge

Learning Objectives

In this chapter, the students will come to know about

What is Bailment & Pledge of goods?

Types of Bailment

Duties & Rights of Bailee.

Duties & Rights of Bailor.

Termination of Bailment.

Lien

Pledge

Rights of Pledgor & Pledgee.

Bailment

A bailment is a contract which results from the delivery of goods. In a contract of bailment,

personal property of one person, temporarily, goes into the possession of another person for

some specific purpose. It may be noted that the ownership of the articles or goods remains with

one person, while the possession is with another person. The term ‘bailment’ is defined in

Section 148 of the Indian Contract Act, which reads as under:

“A bailment is the delivery of goods by one person to another for some purpose, upon a contract

that they shall, when the purpose is accomplished, goods be returned or otherwise disposed of

according to the directions of the person delivering them.”

The following are the two parties to a contract of bailment:

1. Bailor : The person who delivers the goods is known as the bailor.

2. Bailee: The person to whom the goods are delivered is known as the baliee.

Example:- A deposited his luggage in a cloak room at the railway station. This is a contract of

bailment between A and The Railways.

Essentials of Bailment

1. There must be a contract:

There must be an agreement between the bailor and the bailee. Such agreement may be

express or implied. However, a contract of bailment can be imposed by law also. For

example, bailment between a finder of goods and owner of goods is an implied contract.

2. Delivery of goods

There must be delivery of goods for the contract of bailment. It means that possession of

goods must be transferred. The delivery can be actual or constructive.

(i) Actual Delivery: A delivery is said to be actual where the goods are physically

handed over by one person to another. For example, Delivery of a car for repair to a

workshop dealer.

(ii) Constructive Delivery [Section 149]: A delivery is said to be constructive where it is

made by doing anything which has the effect of putting goods in the possession of the

intended bailee or of any person authorized to hold them on his behalf. For example,

delivery of the key of a car to a workshop dealer for the repair of car.

3. Purpose

The delivery of goods must be for some intended purpose. For example, wrong delivery

of goods to Jaipur Golden Roadways instead of Patel Roadways, does not create any

bailment.

4. Return of Specific Goods

The goods which form the subject matter of a bailment must be returned to the bailor or

otherwise disposed off according to the directions of the bailor, after the accomplishment

of purpose or after the expiry of period of the bailment. It may be noted that the same

goods must be returned in their original form or desired form. For example. Delivery of

old gold jewellery to a banker for safe custody creates a bailment because same old gold

jewellery in its original form is to be returned.

Kinds of Bailment

Bailment on the basis of benefit

1. Bailment for the exclusive benefit of the bailor, e.g. bailor leaves goods in the safe

custody of the bailee without any compensation to be paid.

2. Bailment for the exclusive benefit of the bailee, e.g. a loan of some article. Thus where

A borrows B’s fountain pen to use in the examination hall, the bailment is for the sole

benefit of A, the bailee.

3. Bailment for the mutual benefit of the bailor and the bailee. It is the most common

type of bailment. Contracts for repair, hire, etc., fall within this class, wherein the bailor

receives the benefit of service and the bailee benefits by the receipt of the agreed charges.

Bailment on the basis of charges

1. Gratuitous bailment

It is one in which neither the bailor nor the bailee is entitled to any remuneration, e.g.,

loan of a book to a friend, depositing of goods for safe custody without any charge.

2. Non-gratuitious bailment

It is also called as a ‘bailment for reward’. Here, either the bailor or the bailee is entitled

to remuneration, e.g., motor car let out for hire, cloth given for tailoring for charges.

Bailment for quasi contracts

Implied Bailment

Where the parties do not enter into a contract with their mutual consent, but the law

enforces the contract, such contracts are called quasi contracts. Sometimes a contract of

bailment emerges from such quasi contracts which are enforced by law and therefore

called as involuntary bailment contract.

Example: A finder of lost goods is under the duty to take care of the lost goods just like a

Bailee and then find the true owner and return the goods to him (the BAILOR).

Duties of a Bailor

The law requires a bailor to perform the following duties:

1. To disclose the faults in the goods (Sec. 150)

A gratuitous bailor is bound to disclose to the bailee all the faults in the goods bailed

which materially interfere their use or expose the bailee to extraordinary risks. But the

bailor must be aware of those faults. If he fails to do so, he will be liable to pay such

damages to the bailee which have resulted due to the faults. For example, X lends a

horse, which he knows to be risky to B. He does not disclose the fact that the horse is

vicious. The horse runs away. B is thrown and injured. X is responsible to B for damage

sustained.

However, it must be noted that a non-gratuitous bailer would be liable for known as

well as unknown defects. A bailor for reward is responsible for all defects in the goods

bailed whether he is aware of the defects or not.

Example: Ram hires a carriage of Sham. The carriage is unsafe though Sham is not

aware of it, and Ram is injured. Sham is responsible to Ram for the injury.

2. To repay the necessary expenses (Sec. 158)

In the case of gratuitious bailment, it is the duty of the bailor to reimburse the bailee for

all the expenses incurred by the bailee for the purpose. In case of bailment for reward, the

bailor has no duty to reimburse the bailee for ordinary expenses incurred by him. In this

case, the bailor has to reimburse the bailee for any extra ordinary expense, provided the

expense incurred were not due to the negligence or default of the bailee.

For example, If A leaves his cow in the custody of B to be taken care of and B is to

receive no remuneration for keeping the cow, all expenses incurred by B i.e. feeding

charges, medical expenses etc. should be reimbursed by A to B.

3. To indemnify the bailee (Sec. 159)

If a gratuitous bailment is made for a specified time or purpose and the bailor compels the

bailee to return the goods before the expiry of the time, having a right to do so, he has to

make good the loss suffered by the bailee due to such untimely return of goods.

4. Responsibility for lack of title (Sec. 164)

The bailor is responsible to the bailee for any loss which the bailee may sustain due to

defective title of the bailor to the goods bailed.

Example: A gives B’s horse to C for his riding without B’s knowledge or consent. B

sues C and recovers damages, C is entitled to recover this amount from A.

5. To receive back goods

It is a right as well as a duty of the bailor to receive back the goods after the expiry of the

term or accomplishment of the purpose of bailment. In case of default by the bailor, the

bailee becomes entitled to receive compensation from him for any necessary expenses

incurred by him on safe custody of goods.

Duties of Bailee

The duties of a bailee are as under:

1. Taking proper care of the goods bailed

In all cases of bailment, gratuitous or non-gratuitous, it is the duty of the bailee to take as

much care of the goods bailed to him as a man of ordinary prudence would, under similar

circumstances, take of his own goods. If the bailee has taken reasonable care of goods

and there is a loss, destruction or deterioration of goods in spite of it, the bailee cannot be

held responsible for such loss, destruction or deterioration.

Sunder Lal Vs. Ram Swarup (1952)

A man hired a wooden ship and it was burnt by the mobs during the communal riots in the

city, the bailee was not held liable as the ship was destroyed due to no negligence on the part

of the hirer.

2. Not making unauthorized use

According to Section 154, if the bailee uses the goods under bailment in manner which is

not authorized under the contract, then he is liable to pay damages to the bailor for the

deterioration of the goods by such usage. For example, A lends his horse to B for his

personal riding, and B lets another person use the horse for riding, resulting in an

accident that injured the horse. In this case, A would be entitled to claim damages from B

for the unauthorized use of his horse by the latter.

Altas V. E.M. Patil (2004)

Where a vehicle was delivered to a workshop for repair and the owner of the workshop

allowed an unlicensed employee to drive the vehicle and he caused an accident resulting in

the death of a person, it was held that the bailee was liable to compensate the deceased as

also the owner of the vehicle because it was unauthorized use of the vehicle and the liability

was absolute.

3. Not mixing bailor’s goods with his own

It is the duty of the bailee not to mix the goods under bailment with his own goods.

4. Returning the goods bailed

After the expiration of the stipulated time period or the fulfillment of the objective of

bailment, the bailee should return the goods to the bailor without the bailor having to

demand their return. If the bailee fails to do that he is responsible for any damages or loss

suffered by the bailor after that period.

5. Returning any accretion or profit

According to Section 163, the bailee is liable to return any accretion in the goods under

bailment of a profit that accrues therefrom because of any other contract to the bailor. For

example, A gives a cow in bailment to B for a specific period. If the cow gives birth to a

calf during this period, B is liable to return both the cow and the calf to A.

6. Not setting up an adverse title

According to Indian Evidence Act, Section 147, it is the duty of the bailee not to do any

act that has an adverse effect on the title of the bailor or on the goods under bailment. The

baileee cannot sell or pledge the goods that are kept with him under the contract of

bailment.

Rights of the Bailor

(1) Enforcement of Rights

The bailor has the right to enforece all the duties of bailee.

(2) Right to terminate bailment

The contract of bailment is a voidable contract at the option of the bailor. In other words,

the bailor can terminate the contract if the bailee does anything against the terms of

contract of bailment.

(3) Gratutious Bailment. (Sec. 159)

In a gratuitous bailment the bailor can anytime demand back the goods even though the

purpose or the time of the contract has not expired

(4) Right against a Third Person (Sec. 180)

If a third person deprives the bailee of the use or possession of goods or does any injury

to the goods then the bailor has the right to sue such a third person.

Rights of Bailee

1. Rights to claim damages [Section 150]

If the bailor does not disclose the defects in the goods which are known to him and the

bailee suffers some loss due to such defects, the bailee has a right to claim damages.

2. Right to cliam reimbursement of expenses

The bailee has a right to claim reimbursement of all the necessary expenses which he has

already incurred for the purpose of bailment.

3. Right to recover loss in case of bailor’s defective title [Section 164]

The bailee has a right to be indemnified in case he suffers any loss because of the

defective title of the bailor.

4. Right to recover loss in case of bailor’s refusal to take the goods back

The bailor has a right to be indemnified in case he suffers any loss because of bailor’s

refusal to take the goods back.

5. Right to deliver goods to anyone of the joint bailors [Section 165]

In the absence of any contract to the contrary, the bailee has a right to deliver back the

goods to anyone of the joint owners or may deliver the goods back according to the

directions of one joint owner without the consent of all [Section 165]

6. Right to deliver the goods to bailor in case of bailor’s defective title [Section 166]

If the bailor has no ownership of the goods, and the bailee (in good faith) delivers them

back to bailor, the bailee is not responsible to the owner in respect of such delivery.

7. Right to particular lien [Section 170]

Where the bailee has rendered any service involving the exercise of labour or skill in

respect of the goods bailed, he has a right to retain such goods until he receives due

remuneration for the services he has rendered in respect to them

Example: A delivers a rough diamond to B, a jeweler, to be cut and polished which is

accordingly done. B is entitled to retain the stone till he is paid for the services he has

rendered.

Termination of Bailment

Every contract of bailment comes to end under the following circumstances:.

(a) On the expiry of Fixed Period. A bailment is terminated on the expiry of fixed

period if the goods are bailed for a fixed period.

(b) On fulfillment of the Purpose. A bailment is terminated on the fulfillment of the

purpose if the goods are bailed for a specific purpose.

(c) Inconsistent Use of Goods. A bailment may be terminated if the bailee does not use

the goods according to the conditions of the bailment.

(d) Destruction of the Subject Matter of Bailment. A bailment is terminated if the

subject matter of the bailment (i) is destroyed, or (ii) becomes incapable of being used

for bailment because of some change in the nature of goods.

Termination of Gratuitous Bailment : A gratuitous bailment may be terminated by the

bailor at any time even though the bailment was for a fixed period. However, the bailor is

required to indemnify the bailee in case the loss due to premature termination exceeds the

benefit actually derived by the bailee.

Activity One – Check your progress

1. If bailor and bailee don’t get any remuneration, the bailment is called _______?

2. In case of gratuitous bailment, can bailer demand goods anytime?

3. Bailor has ________ lien on goods

4. After fulfillment of specified purpose, the contract of bailment is _________?

5. If subject matter is destroyed, the contract of bailment is _____________?

(Hints: - 1. Gratuitous, 2. Yes, 3. Particular, 4. Terminated, 5. Terminated)

Pledge

“The bailment of goods as security for payment of a debt or performance of a promise is called

‘pledge’. The bailor in this case is called the ‘pawnor.’ The bailee is called the ‘pawnee’ (Sec.

172).

Example: A borrows Rs. 100 from B and keeps his watch as security for payment of the debt.

The bailment of watch is called a pledge.

Thus a pledge is only a special kind of bailment. Here goods are deposited with a lender or

promisee as security for the repayment of a loan or performance of a promise. Otherwise, like a

bailment a pledge also involves only a transfer of possession of goods pledged.

Essentials of pledge

1. Delivery of goods

Like a contract of ordinary bailment, delivery of goods is necessary for a contract of

pledge. The delivery of goods may be actual or constructive.

2. Delivery of goods as security

In the contract of pledge, the goods are delivered by the pledger to the pledge (or money

lender) as security for the repayment of a loan.

3. Two parties

A pledge requires two parties i.e. the pledger and the pledgee. One who delivers the

goods is known as the pledger and the person to whom goods are delivered is known as

the pledgee.

4. Transfer of possession

In creating a pledge, the possession of goods is transferred from the pledger to the pledge.

In other words, a pledge involves only a transfer of possession of goods and not the

transfer of title. The ownership remains with the pledger or pawner.

5. Other essentials

Like other contracts, a pledge also requires all the essentials of a valid contract.

Rights of Pawnee

1. Rights of retainer (Section 173)

The pawnee may retain the goods pledged

(i) for payment of the debt or the performance of the promise,

(ii) for the interest of the debt, and

(iii) all necessary expenses incurred by him in respect of the possession or for the

preservation of the goods pledged.

Example: Manav pledges stock of goods for certain loan from a bank, the bank has a

right to retain the stock not only for adjustment of the loan but also for payment of

interest.

2. Right to claim reimbursement of extraordinary expenses (Section 173)

The pawnee is entitled to receive from the pawnor extraordinary expenses incurred by

him for the preservation of the goods pledged.

3. Right of retainer for subsequent advances (Sec. 174)

The pawnee can retain the goods only for the payment of that particular debt for which

the goods were pledged. But in the absence of anything to the contrary, he can retain the

goods for subsequent advances. This right does not extend to any previous debt due to the

pawnee.

4. Right in case of default by the pawner (Sec. 176)

If the pawner makes default in the payment of the debt or performance of promise at the

stipulated time, the pawnee may exercise any of the two rights :

i) He may bring a suit against the pawner upon the debt or promise and retain the

goods as collateral security.

ii) He may sell the goods on giving the pawner a proper notice of the sales.

The right to sell the goods may be exercised only after giving a reasonable notice to the

pawner.

Duties of Pawnee or Pledgee

1. Duty to take reasonable care of goods

2. Duty not to mix goods

3. Duty not to use the goods – Pawnee is not allowed to use the goods

4. Duty to return the goods

5. Duty to return any accretion to goods

Rights of Pawnor or Pledger

1. Right to get back the goods pledged

According to Sections 160 and 161, on the performance of the promise at the stipulated time

or on payment of the debt, the pawnor has the right to get back the goods pledged with the

pawnee.

2. Right to increase or profit

According to Section 163, if there is any increase in the value of, or profit from, the goods in

pledge, the pawnor has the right to such increase or profit.

M.R. Dhawan vs. Madan Mohan (1969)

In this case, A pledged certain shares of a company with D. During the period of the pledge,

the company issued bonus shares, Held, the original shares as well as the bonus shares

belonged to the pawner.

3. Right to redeem

According to Section 177, if there is a time limit fixed for the repayment of a loan or the

performance of a promise, and the pawnor makes a default in doing that, then he has the right

later, before the goods are actually sold, to get the goods released on the payment of the

amount of loan plus the expenses incurred by the pawnee because of such default.

DUTIES OF THE PAWNOR OR PLEDGOR

1. Duty to reimburse ordinary expenses : All the ordinary expenses incurred by pawnee in

possession of goods and preservation of goods must be reimbursed by the pawnor [U/S

173.]

2. Duty to reimburse extra ordinary expenses incurred by the pawnee U/S 175.

3. Duty to repay the debt plus any interest due on the debt U/S 174.

4. Duty to ensure that the goods pledged are free from any charge or encumbrances.

PLEDGE BY A NON-OWNER

The general Rule is that pledgor should be OWNER of the goods only then it is a valid pledge. In

other words, it is only the owner of the goods who has the right to pledge the goods.

Exceptions to the Rule

There are few cases where even non-owner can create a valid pledge i.e. A Non Owner Can

create a valid pledge. Those cases are as follows:

1. Pledge by a Mercantile Agent (Section 178)

If a mercantile agent acts unauthorisedly against the instructions of his principle, the

pledge made shall be valid if the following conditions are fulfilled.

(a) The pawnor must be a mercantile agent.

(b) Mercantile agent must be in possession of goods or documents of title to goods.

(c) Mercantile agent must be in possession with the consent of the owner.

(d) Pledge must have been made by the mercantile agent, when acting in the ordinary

course of business of a mercantile agent.

(e) The pawnee must have acted in good faith.

(f) The pawnee must not have the notice that the pawnor has no authority to pledge.

2. Pledge by a Co-owner in Possession

Pledge by a co-owner is valid if the following conditions are fulfilled:

(a) The goods must be owned by more than one person.

(b) The goods must be in the possession of one of the co-owners

(c) Such sole possession must be with the consent of other owners.

3. Pledge by person in possession under a voidable contract. (Sec. 178 A)

a. If a person has possession of goods under a voidable contract.

b. The contract has not been rescinded / avoided before forming the contract of pledge.

c. The pawnee acts in good faith.

d. The pawnee has no knowledge that pledgor has no right to pledge.

Then, such pledge by a person who has the possession of goods under a voidable contract

shall amount to a valid pledge.

Philips vs. Brooks Ltd. (1919)

In Philips V. Brooks Ltd. A person, North, went to the P’s shop and selected some

jewellery. He falsely represented himself to be ‘Sir George Bullough”, a man of credit,

and thereby persuaded P to take the payment by cheque, and hand over the ring

immediately. The cheque was subsequently dishonoured. Before P could avoid the

contract on the ground of fraud by North, North had pledged the ring to D.D had taken

the ring in good faith and without any notice of the fact that the goods with North

(Pawnor) were under a voidable contract. It was held that the pledge was valid.

4. Pledgor having limited interest (Sec. 179)

Where a person pledges goods in which he as only a limited interest, the pledge is valid

to the extent of that interest. Thus, a person having a lien over the goods may pledge

them to the extent of his interest.

Thakurdas vs Mathura Prasad

A delivers a suit length to B, the tailor master, for making a suit and agrees to pay Rs.

1,500 as sewing charges. B pledges the suit with C for Rs. 3,000. The pledge is valid to

the extent to B’s interest in the suit, namely, Rs. 1,500 (Sewing charges). A can, therefore

recover the suit only on paying Rs. 1,500 to C, the pledgee.

5. Pledge by the seller in possession.

A seller may remain in possession of the goods even after their sale. Such a seller is no

more the owner of the goods but if he pledges the same goods, the pledge is valid

provided the pledgee takes the goods in good faith.

6. Pledge by the buyer in possession

Where a person, who has agreed to buy the goods, obtains their possession with the

consent of the seller, before the actual sale, and pledges the same goods to a person who

takes them in good faith, the pledge is valid.

Example : A agrees to sell a horse to B who takes the horse for a week for trial. B

Pledges the horse with C as security, the pledge is valid.

Activity Two – Check your progress.

1. The contract of bailment for security of payment of debt is called ____________?

2. If there is some increase in pledged goods ________ has right to such increase

3. Can agent pledge goods of his principal?

4. Has pledge right to use pledged goods?

5. Pledge is a ____________ kind of bailment.

(Hints: - 1. Pledge, 2. Pawnor , 3. Yes, 4. No, 5. Special.)

Difference between Bailment and Pledge

Basis of Distinction Bailment Pledge

1. Meaning Bailment is delivery of goods

for a purpose upon a contract

that when the purpose is

accomplished the goods shall

be returned or disposed off

according to directions of

owner.

Pledge is a special kind of

bailment as a security for

obtaining a debt.

2. Parties Bailor and Bailee Pledgor and Pledgee

3. Purpose Any Purpose As a security for obtaining a

debt.

4. Right to sell The bailee can retain the

goods but has no right to sell

the goods.

In case of default by pledgor

to repay the debt, the pledge

can sell the goods after giving

notice to pledgor.

5. Right to use the goods. Bailee can use the goods, if

mentioned in the contract.

Pledgee has no right to use the

goods.

6. Kinds Bailment can be Gratuitous

(without Reward) or Non

Gratuitous (with Reward)

There are no further kinds of

pledge.

7. Example A gave his car for repair to

mechanic it is a non-gratuitous

bailment.

X pledged his property with

money lender to obtain a loan.

Summary

The delivery of goods by one person to another person for a specific purpose with a

condition to return the goods when the purpose is over or otherwise disposed off

according to the direction of the person is called bailment.

Bailment can be gratuitous or non gratuitous.

Activity three - Check your progress - Case Studies

1. A lends his horse to B, a friend, for two days. The feeding charges are to be paid by B.

The horse meets with an accident. Will A have to repay B medical expense, incurred by

B?

(Hint: Yes, all extra-ordinary expenses have to borne by bailor.)

2. A lends his motor car to B for a drive by him only. B allows his daughter C, who is an

expert car driver, to drive the vehicle. C drives the car carefully but its axle suddenly

breaks and the car is damaged. Is B liable for the damage?

(Hint: Yes (Sec. 154), bailee used car for un-authorized purpose hence is liable.)

3. P who wanted to attend a cinema left his car in D’s grounds after having paid a rupee and

obtained a “car park ticket”. He returned from the cinema and found that the car had been

stolen by someone. P sues D as bailee for negligence. Decide.

(Hint: D is liable to make good P’s loss (Sec. 151 and 152))

4. Some cattle belonging to A were agisted (given for feeding grass against payment) with

B. Without any negligence on B’s part the cattle were stolen. B did not inform the owner

or the police or make any effort to recover them, because he thought it would be useless

to do so. Is B liable?

(Hint: Yes, held, B was liable for the loss.)

5. A gives some cloth to a tailor for making a suit of it. The tailor’s charges are settled at

Rs. 150 after the suit is ready. A tender Rs. 150 for the charges but the tailor refuses to

deliver the suit till A pays an old debt of Rs. 30. Is the tailor entitled to do so?

(Hint: No, because the tailor can also use particular lien to claim his debts U/S 170.)

6. Madhu was admitted to hospital where her jewellery was handed over to the hospital

officials for safe custody. The jewellery was stolen. Are the hospital officials liable for

the loss?

(Hint: Yes, Held, the hospital officials were bailee for reward and were liable for the loss

as they failed to exercise a care which the nature and quality of the article required.)

7. The producer of a firm borrowed a sum of money from a financier-distributor and agreed

to deliver the final prints of the film when ready. Is the contract a pledge?

(Hint: No. Held, the agreement was not a pledge, there being no actual transfer of

possession.)

8. A lends a horse, which he knows to be vicious to B. he does not disclose the fact that the

horse is vicious. The horse runs away and B is thrown and injured. Explain the legal

relationship between A and B and advise B as to his rights.

(Hint: A is responsible for damage sustained by B (Sec.150))

9. A lends an old discarded bicycle to B gratuitously for three months. B incurs Rs. 120 on

its repairs. A asks for the return of the bicycle after one month only. Will A have to

compensate B for premature terminations?

(Hint: Yes, A will have to compensate B for expenses incurred by B in excess of the

benefit derived by him because in a gratuitous bailment, where the bailor prematurely

terminates bailment, he must compensate bailee for any loss.)

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. Define bailment.

2. Differentiate between

(a) Bailment and Pledge

(b) Bailment and Sale

(c) Pledge and Mortgage

(d) Pledge and Lien.

3. What is a Gratuitous Bailment?

4. Explain the kinds of bailment.

5. Discuss the essentials of bailment.

6. Write a short note on actual and constructive delivery giving illustrations.

7. What is accretion of goods?

8. Can the pawnee sell the goods pawned?

Long Questions

1. What are the rights and duties of a bailor and a bailee in a bailment for hire and in a

bailment by way of pledge?

2. Define bailment. Discuss the rights and responsibilities of a gratuitous bailee. How does a

bailment differ from a pledge?

3. When is a pledge created by non-owner valid?

4. When does a bailment come to an end?

5. Define pledge. What are the respective rights and duties of pawnor and pawnee?

Chapter – 10

Contract of Agency

Agency is the contract between two persons where one person authorizes the other to act on his

behalf and form contractual relationship with a third person.

First Person : Who authorizes the other = PRINICIPAL

Second Person : Who acts on behalf of the first person = AGENT

Third Person : With whom a contract is formed = CLIENT

Section 182 of the Act lays down that –

“An agent is a person employed to do any act for another or to represent another in dealing with

third persons. The person for whom such act is done or who is so represented is called the

principal”.

Test of Agency

1. If the person (acting as the representative of a principal) has the capacity to bind the

principal and make him answerable to the third parties or

2. If he can create legal relations between the principal and such third parties and thus

establish a privity of contract between the principal and the third parties,

Learning Objectives:

After going through the chapter, students will be able to know

What is contract of agency

Duties and rights of an agent

Is agent personally liable to third party?

What is the nature of agent’s liability?

Modes of creation and termination of agency

Then he will be an agent.

For example: A domestic servant renders to his master a personal service, he will not be an

agent as he can’t bind his master for his acts.

Creation of Agency

Agency can be created by various modes as follows:

(A) (B) (C)

I. Agency by Express Agreement

A contract of agency may be created by an express agreement. When a principal appoints an

agent either by words spoken or written to represent and act for him, an express agency is

created. No particular form or set of words is required for appointing an agent. When a person

gives a power of attorney to another person, an express agency is created.

II. Agency by Implied Authority (Section 187)

An agency which has to be understood from the conduct and behavior of the parties is called

implied agency. It is to be inferred from the circumstances of the case and things spoken or

written.

a. Agency by Estoppel

Agency by estoppel arises where a person by his words or conduct induces third person

to believe that a certain person is his agent. Therefore he is presumed to have given the

authority to this another to act as his agent and hence he is liable for the acts of his agent

towards third party. This kind of agency is governed by the LAW OF ESTOPPEL.

Modes of Creation of Agency

By implied agreement By express agreement By Ratification

Oral Written By estoppel By holding out By necessity Agency between husband & wife

Kashinath Das vs. Nisakar Rout (1962)

In this case, a landlord appointed a tehsildar to manage his agricultural lands. The

tehsildar let out the lands to tenants on certain terms. Actually no authority of this kind

was given to him but the agreements of tenancy were held binding on the landlord who

created an appearance of authority by making the tehsildar incharge of his lands.

b. Agency by Holding Out

Where one person because of his prior acts makes the other party believe that another is

his agent then the first person cannot deny this fact later. But for agency by holding out a

prior/previous act on the part of the principal is required to establish the relationship of

agency.

For example: A allowed his servant B, to purchase some goods on credit from C. B

usually purchased goods from C on credit, and A used to pay the price. On one occasion,

A gave cash to B to purchase the goods. But B misappropriated the money and purchased

the goods on credit in A’s name. In this case, A is bound by his prior conduct in holding

out that B was his agent. And thus, C can recover the price from A.

c. Agency by Necessity

When one person acts as an agent for another, without any communication to that other

person, under urgent circumstances, such agency is called agency by necessity.

G.N. Railway Co. vs. Swafield (1874)

In this case, a horse was consigned to the dependent at certain railways station. But no

one took delivery of the horse at the destination. The station master had to feed the horse.

It was held that the railway company was the agent by necessity and the dependent was

held liable to pay the feeding charges.

d. Agency between husband and wife

A wife is allowed to pledge the credit of her husband for necessaries. In other words, a

wife acts as an agent for her husband (the principal) and can pledge his credit for buying

necessaries. But for this the following conditions should be satisfied:

(i). it is necessary that the husband and wife should be living together.

(ii) Husband and wife should be living together in a common establishment of their own.

(iii) Wife pledges the credit of husband only for necessaries.

(iv) Wife is not already given maintenance allowance for running the household expenses.

III. Agency by Ratification

All acts of an agent done in the discharge of his duties and within the scope of his authority

are binding upon the principal. Acts performed by an agent beyond the scope of his authority

are not binding upon the principal. However, the principal may in such a case either adopt or

reject the act of the agent. In case, the principal adopts the act of the agent done without his

authority, he is said to have ratified that act. On ratification, the act of the agent becomes the

act of the principal and he becomes bound by the same. The agency in this case is called ex

post facto, because it is created subsequent to the contract.

For example : A insured B’s goods without his authority. Subsequently B confirmed A’s act of

insuring the goods and accepted the insurance policy. In this case, the insurance policy is as valid

as if A had been authorized by B to insure the goods. (Williams v. North China Insurance Co.)

Ratification can be expressed or implied. If it is shown through the conduct of principal, its

called implied ratification.

For example: A, without authority, buys goods for B. Afterwards B sells the goods to C on his

own account. B’s conduct implies a ratification of the purchase made for him by A.

Essentials of Ratification

For a valid ratification, the following essentials are necessary:

1. Transaction in the name of another person

For a valid ratification, it is necessary that the transaction should expressly be made by

the agent in the name of another person as a principal. In other words, the act must have

been done by the agent in the name of a certain person so that at the time of the act, the

third party may know the principal.

2. Ratification must be made by the person on whose behalf the act was done

Ratification implies that the act is ratified by the person on whose behalf it was done.

Ratification by a third party has no legal significance.

For Example, If A has given a loan of B’s money to C, and M ratifies A’s action, the

ratification would not be valid. The ratification would have to be from B to be valid.

3. The principal must be in existence when the contract is made

Ratification is only possible when the principal exists. A Company, for example, cannot

ratify the contract entered into by the promoters on its behalf before its incorporation.

Kelner vs. Bextor (1866)

In this case, Kelner agreed to sell a hotel to Baxer, who agreed to purchase it for a

company yet to be incorporated. The company ratified the contract after its incorporation.

Held the ratification was invalid and, therefore, Baxter was held personally liable for the

contract.

4. Principal competent to contract

The principal must be competent to contract at the date when the contract is made and at

the time of its ratification. Therefore, a minor for whom a contract is made, cannot ratify

it on attaining majority.

5. Ratification must be done within a reasonable time

If ratification is made after the expiry of the reasonable time, it will not be valid.

6. The whole transaction must be ratified

A person ratifying any unauthorized act done on his behalf ratifies the whole of the

transaction of which such act formed a part. It is not open to the principal to ratify one

part and refuse to accept other part of a transaction.

For example, Where an agent without having any authority purchased 30 bonds, it would

not be open to the principal to ratify the purchase of 22 of them without ratifying the

purchase of other 8 bonds.

7. Ratification must be with full knowledge of facts

According to Section 198, it is essential that the person doing the ratification has full

knowledge of what he is ratifying, otherwise the ratification will not be valid.

8. The act to be ratified must be lawful

An act which is illegal or an act which is void cannot be ratified. If the act to be ratified is

illegal and the principal is unaware of this, the ratification shall not be considered valid

and hence shall be unenforceable.

Activity One – Check your progress

1. The person who acts on behalf of first person is called _____________?

2. When a person, by his conduct, induces other party to believe that certain person is his

agent, this is called ____________?

3. If agent exceeds his authority, and principal ratifies his act, this is called

_____________?

4. If principal is incompetent at the time of making contract, can he ratify the contract?

5. Can principal ratify part of transaction?

(Hints: 1. Agent, 2. Agency by estoppel, 3. Agency by ratification, 4. No, 5. No.)

Substituted Agent

At times, the agent appointed by the principal cannot perform certain obligations on behalf of the

principal himself and gets it done by some other person with the express or implied authority of

the principal. Such other person is called a substituted agent.

For example, Ram directs his solicitor Panna Lal to employ an auctioneer to auction his estate,

Panna Lal appoints Roop Lal for this purpose. Here, Roop Lal is not a subagent but a substituted

agent and is liable to Ram.

A substituted agent is a person who is named by the agent holding an express or implied

authority to name another person, to act for the principal in the business of the agency.

Sub-Agent

When an agent appoints any person as his agent, that person is known as a sub-agent. A sub-

agent has been defined under the act in these words :

“A sub-agent is a person employed by and acting under the control of the original agent in the

business of the agency.

Relations between principal, agent and sub-agent

Section 192 and 193 deal with the relations between the principal, the agent and a sub-agent.

Their relations may be divided into two parts:

A. Where sub-agent is properly appointed.

Where the sub-agent is appointed with the prior permission of the principal or under such

circumstances where delegation of authority is permitted due to the nature of the agency,

the sub-agent is treated as properly appointed. Where a sub-agent is properly appointed,

the relations between principal agent and sub-agent are governed by the following

provisions:

1. The sub-agent represents the principal while dealing with the third parties. It means

the principal is liable to third parties for the acts of the sub-agent.

2. The agent is responsible to the principal for the acts of the sub-agent. It means the

principal may hold the agent liable for the acts of the sub-agent.

3. The sub-agent is responsible towards the agent and not towards the principal, except

in case of fraud and willful negligence. It means that the principal may proceed

against the agent as well as the sub-agent for any fraud or willful negligence.

B. Where sub-agent is appointed without authority.

Where the agent is appointed without the express or implied authority of the principal,

the following consequences will arise.

i) The agent stands as a principal for the sub-agent and therefore the agent is

responsible to the principal as well as the third parties for the acts of the sub-

agent.

ii) The principal is not represented by the sub-agent and therefore he is not liable for

the acts of the sub-agent.

iii) The sub-agent also is not responsible to the principal at all. He is answerable only

to the agent.

Difference between sub agent and substituted agent

Basic Distinction Sub-agent Substituted agent

1. Work He works under the control of

original agent.

He works under the control of

principal.

2. Privity There is no privity of contract

between a sub-agent and

principal and hence both

cannot sue each other except

that in case of fraud or willful

wrong committed by a

properly appointed sub-agent,

the principal can sue sub-

agent.

There is a privity of contract

between a substituted agent

and principal hence both can

sue each other.

3. Original agent’s

responsibility

The Original agent is

responsible for the acts or

negligence of the sub-agent.

The original agent is not

responsible for the acts or

negligence of the substituted

agent if in selecting such agent

he has exercised the same

amount of diligence which he

would exercise in his own

case.

Duties of an agent

1. Duty to Act according to the Directions of Principal Custom of Trade (Section 211)

An agent is bound to conduct the business of his principal according to principal’s directions

or the custom of trade (in the absence of principal’s directions). When the agent acts

otherwise and any loss is incurred, he must compensate the loss to his principal.

Lilley vs. Doubleday (1881)

An agent was instructed to warehouse his principal’s goods at a particular place. He placed a part

of them at a different warehouse which was equally safe. But the goods were destroyed without

negligence. The agent was held liable for the loss.

2. To work with reasonable care, skill and diligence (Section 212)

An agent is bound to conduct the business of the agency with as much skill, care and

diligence as he would use in his own business. If the agent fails to do that, and the principal

is put to a loss because of carelessness of misconduct on the part of the agent, the latter is

liable to compensate the principal for such loss.

3. Duty to render accounts (Sec. 213)

It is the duty of an agent to keep proper accounts of his principal’s money or property. He

will have to render accounts to principal as per his demand or periodically if so provided in

the agreement.

4. Duty to communicate (Sec. 214)

In case of difficulty, it is the duty of an agent, to use all reasonable diligence in

communicating with his principal, and in seeking to obtain his instructions, before taking any

steps while facing the difficulty or emergency.

5. Duty not to deal on his own account (Secs. 215 and 216)

An agent must not deal on his own account in the business of agency i.e. he must not himself

buy or sell principal goods. He can do this after obtaining the consent of his principal after

disclosing all material facts to him.

6. To pay all sums received for principal (Section 218)

Any amount which an agent receives on behalf of the principal has to be paid to the principal.

Of course, the agent can make deductions from it in respect of his expense and remuneration

for the business of the agency.

7. Not to earn secret profit

An agent must not make any secret profit in conducting the affairs of the agency besides

what is due to him as commission or remuneration because the principal has the right to

claim such profit.

8. Not to delegate authority

An agent must not delegate his authority to another person. He himself must perform the act

for which he has been appointed as an agent. If the situation demands, or the practice of the

trade is such, the agent may, with the consent of the principal, appoint a subagent.

9. Duty on termination of agency by principal’s death or insanity (sec. 209)

When an agency is terminated by the principal dying or becoming of unsound mind, the

agent must take, on behalf of the representatives of his late principal, all reasonable steps for

the protection and preservation of the interest entrusted to him.

Rights of an agent:

1. Right of retainer (Sec. 217)

The agent has right to retain, out of any sums received on behalf of the principal in the

business of agency, all money due to him in respect of :-

(i) Remuneration,

(ii) Advances made, and

(iii) Expenses incurred in conducting the business of the agency

2. Right to receive remuneration (Sec. 219 and 220)

The agent has a right to receive his agreed remuneration. If nothing is agreed already then

he can claim a reasonable remuneration. But if he acting gratuitously then he can’t claim

remuneration. It is important that the agent can claim remuneration once he has

completed his work even though the contract is never executed on account of breach.

For example: An agent is appointed to secure orders from the manufacturer, he can

claim his commission on orders actually obtained by him. If the manufacturer is unable to

execute them, still the commission will be paid to agent.

3. Right of lien

An agent is entitled to retain goods, papers and other property of the principal until the

amount due to him for commission, disbursements, and services in respect of the same

has been paid.

4. Right to be indemnified against consequences of lawful acts (Section 222)

A principal is bound to indemnify an agent against lossess sustained by an agent in the

course of the agency business. An agent can claim indemnity only in respect of lawful

acts done by him in exercise of the authority.

Kinds of agents

1. Auctioneer

An auctioneer is one who is entrusted with the possession of goods for sale at a public

auction. He has only a particular lien on the goods for his charges.

2. Factor

A factor is an agent to whom goods are delivered or consigned for their sale. Usually, the

factor is appointed by the principal to sell the goods in other cities or foreign countries.

The factor is entrusted with the possession of goods. He usually sells the goods as a

principal. He may sell the goods on credit, may receive payment of price and issue a valid

receipt.

3. Del Credere agent

A del credere agent is basically a factor. When a factor guarantees to his principal the

recovery of the credit from the customers, he is known as a del credere agent. For this

guarantee, he is allowed by the principal an extra commission called the del credere

commission.

4. Broker

A broker is an agent who has an authority to negotiate the sale or purchase of goods on

behalf of his principal, with a third person. He himself has no possession of the goods. He

merely makes the two parties to enter into a contract. He gets his commission whenever

any transaction materialize through his efforts.

5. Commission agent

A commission agent is a mercantile agent who buys or sells goods for his principal on the

best possible terms in his own name and who receives commission for his labour. He may

have possession of goods or not.

6. Banker

Sometimes a banker also acts as an agent for its client on transactions such as :

(i) Buying or selling securities on behalf of customers

(ii) Paying bills on behalf of customers.

(iii) Collecting dividends, bonus for customers.

7. General agent.

A general agent is one who is employed to do all acts connected with a particular

business or employment, e.g., a manager of a firm.

8. Special agent

A special agent is one who is employed to do some particular act or represent his

principal in some particular transaction, e.g., an agent employed to sell a motor car. As

soon as the act is performed, the authority of such an agent comes to an end.

Principal’s Liability to Third Party

The general law stipulates “qui facit per alium facit per se”, which means ‘he who acts through

an agent, acts himself’. So far as third parties are concerned, it makes no difference whether an

act is done by the principal personally or through his agent. The principal is liable for all acts of

the agent that are within the extent of the agent’s authority, or are done by the agent with his

knowledge and consent, or which the principal has ratified after they are done.

Position of principal and agent in relation to third parties

The position of a principal and his agent as regards contracts made by the agent with third parties

may be discussed under the following three heads :

1. Where the principal’s existence and name are disclosed by the agent i.e. where the

principal is named.

2. Where the principal’s existence is disclosed but not his name, i.e. where the principal is

unnamed.

3. Where both the existence and the name of the principal are not disclosed, i.e., where the

principal is undisclosed.

I. Named Principal. The position of the named principal for the acts of his agent is as follows:

a. When the agent has acted upon his authority: An act of the agent is an act of the

principal. If the agent has acted within the limits of his authority and during the validity

of the agency, the principal is liable to the third party for the agent’s act.

Example: - A is P’s agent with authority to receive money on his behalf. He receives

from T a sum of money due to P. T is discharged of his obligation by paying money to P.

b. When the agent exceeds his authority : When an agent exceeds his authority, the

principal is bound by the part of the work which is within his authority and which can be

separated from the part which is beyond his authority (Sec. 227)

Example: - P authorizes A to buy 10 sheep for him, A buys 10 sheep and 20 lambs for

one sum of Rs. 6,000. P may repudiate the whole transaction.

c. Notice given to agent as notice to principal:- If any notice is given to agent in course of

business, the principal will bound by the notice.

d. Liability for misrepresentation or fraud by agent:- Where an agent commits fraud,

within the scope of his authority, the principal is liable no matter whether the fraud was

committed for the benefit of agent only.

Example: - A customer had a locker in a bank. The manager of bank fraudulently opened

the locker and stole money, Held, bank was liable.

e. Liability of principal for torts : The principal is liable to the third parties when the tort

is committed by the agent while acting in the course and within the scope of his agency.

II. Where the principal is unnamed

A principal is unnamed, where the agent discloses the fact that he is an agent but at the same

time conceals the name of the principal at the time of entering into a contract. In such

circumstances, the principal is liable to the third parties and not the agent.

The unnamed principal will be liable if the following conditions are fulfilled :-

(i) The principal must be in existence at the time of making the contract and

(ii) The third party knows that there is a principal although identity is not disclosed.

III. Where the principal is undisclosed :- A principal is said to be an undisclosed principal

where the agent has entered into a contract without :-

(i) Disclosing the name of the principal or his representative character and

(ii) Disclosing the existence of the principal.

When the principal is undisclosed the agent is personally liable for the contract, in

such case he can sue or be sued in his own name because he is the real contracting

party in the eyes of law.

In this case,

a. The undisclosed principal has a right to enforce the contract against the third party as

long as the agent acts within his authority.

b. Position of third party. If the principal discloses himself before the contract is completed,

the other contracting party may refuse to fulfill the contract. the other party can refuse

only if he can show that: if he had known who the principal was, he would not have

entered into the contract.

Liability of agent towards third parties

An agent is never personally liable to the third parties for the acts done on behalf of the principal.

Neither can an agent be made personally liable, nor can an agent personally enforce a contract

which he formed on behalf of the principal.

(i) Agent cannot be made personally liable for the lawful acts done by him for the

principal.

(ii) No specific performance can be demanded against the agent. Agent can not be forced

for a suit of specific performance because an agent just acts on behalf of principal, so

all legal rights are with the principal.

(iii) Agent can not personally enforce the contract entered into by him on behalf of the

principal.

Board of Trustee of Port of Madras v. Southern Shipping Corpn

Where a consignment was landed from a ship but the consignee did not take delivery

and the question arose as to who was liable to pay demurrage, it was held that the

liability was solely that of the consignee and not that of the shipping agent.

Exceptions to the Rule.

In the following cases, however the agent is held personally liable:

1. The agent expressly agrees

When at the time of making contract with the third party, the agent agrees to be

personally liable upon the contract.

2. The agent acts for a foreign principal

Where an agent contracts for the sale or purchase of goods for a merchant residing

abroad, he is presumed to be personally liable.

3. The agent acts for an unnamed principal

Where an agent acts for an unnamed principal and declines to disclose the identity of the

principal, or when the principal stops existing before the agent disclosed his name to third

parties.

4. The agent acts for an undisclosed principal

Where an agent acts for an undisclosed principal and contracts in his own name, he is

personally liable to the third party. But if the third party comes to know about the

existence of the principal, he may elect to sue the principal, or the agent, or both.

5. When agent acts for a principal who cannot be sued

In some cases, the agent may act on behalf of a principal, but such a principal can not be

sued by law because of some reasons, due to which the agent becomes personally liable

for the acts.

6. When agent forms the contract in his own name

In situations, where the agent enters into the contract and signs the contract in his own

name, he is bound by the contract personally.

Alliance Mills v. India Cements Ltd.

The agent entered into a contract for the purchase of goods in his own name describing

himself as the purchaser. He did not disclose that he was acting as an agent. It was held

that in such a situation, the agent could personally enforce the contract, and also could be

made personally liable for the same.

7. When the agent exceeds his authority

When the agent acts beyond the limit of his authority, and the principal does not ratify his

acts, he becomes liable to third parties for his acts.

8. When the authority of the agent is coupled with interest

When the personal interest of the agent is involved in the subject-matter of the contract

entered into by him with a third party, his authority and interest are involved in such

contract. The agent, in such case, has the right to sue, or be sued, to the extent of his

interest in the subject-matter.

9. For misrepresentation and fraud

If an agent acts beyond his authority and commits a fraud or does misrepresentation, he is

liable for the consequence of such act.

10. Liability for breach of warranty

When a person acts without the authority of agency or an agent exceeds his authority, he

is said to commit breach of warranty of authority. In such a case, he incurs personal

liability to the third party with whom he makes a contract.

TERMINATION OF AGENCY

An agency may be terminated in any of the following ways :

A. By acts of the parties, or

B. By operation of law,

A. Termination by Act of the Parties :- An agency comes to an end by act of the parties in

the following cases :

1. By agreement between the parties

The relation of agency can be terminated at any time by an agreement between the

principal and the agent. Such agreement may be made even before the expiry of a

certain period of agency or before the completion of the business of the agency.

2. Revocation by the principal (Secs. 203-207)

Section 203 empowers the principal to revoke the authority of the agent at any time

before the agent has exercised his authority so as to bind the principal, unless the

agency is irrevocable. Further, revocation may be expressed or implied. Thus where

X empowers Z to let X’s house and afterwards lets the house himself, it is an implied

revocation of Z’s authority.

Termination of

Agency

By acts of the

parties

By operation of

law

3. By renunciation by the agent (Sec. 201)

The agent may renounce his employment at any time by giving the principal a

reasonable notice of his intention. It is so because a person cannot be compelled to

continue as agent against his will. But where an agency is for a certain period, the

agent cannot renounce the agency without sufficient cause before the expiry of the

period of agency. If he does so, he shall be required to compensate the principal.

B. Termination by Operation of Law:- An agency comes to an end automatically by

operation of law in the following cases:

1. By performance of contract (Sec. 201)

When the agent is appointed for a single transaction, the agency comes to an end

when the transaction is completed or the duty entrusted to the agent is performed. For

example, an agency for the sale of goods by auction terminates when the goods are

sold by the agent through auction.

2. By expiry of period

When agency is created for a certain period, the agency terminates automatically on

the expiry of the period even if the business of the agency is not completed.

3. By the death of the principal or the agent (Sec. 201)

The agent acts on behalf of the principal. Therefore, the relationship between the

principal and the agent terminates on the death of the principal. Similarly, on the

death of the agent, the agency terminates automatically. No other person can act as a

substitute for the deceased agent unless the principal authorizes him to do so.

4. By insolvency of the principal (Sec. 201)

Insolvency of the principal puts an end to the agency. In certain cases, where

insolvency of the agent is necessary, the insolvency of the agent also terminates the

relation of agency.

5. By dissolution of a company

In certain cases, the principal or agent, may be a joint stock company. In such a case,

the relation of agency terminates by the dissolution of the company.

6. Destruction of the subject-matter

The contract of agency which is created to deal with certain subject-matter will be

terminated if that subject-matter is destroyed. For example, where the agency was

created for the sale of a house and the house is destroyed by fire, the agency ends.

7. Principal or agent becomes alien enemy

If the principal and agent are residents of two different countries and a war breaks out

between the two countries, the contract of agency is terminated.

Activity Two – Check your progress

1. Agent appointed by agent at the order of principal is called __________?

2. If agent further appoints an agent without principal’s permission, Is principal liable?

3. If agent further appoints an agent, without principal’s permission, the other agent is

called __________?

4. If agent doesn’t disclose name and existence of principal, then he____________?

5. If principal or agent dies, the contract of agency is __________?

(Hints: 1. Substituted agent, 2. No, 3. Sub agent, 4. Himself is liable to third party. 5.

Terminated)

Summary

Agency is the contract between two persons where one person authorizes the

other to act on his behalf and form contractual relationship with a third person.

Agency can be created by

Express agreement

Implied agreement

By ratification

Agent has to perform his duties as per the contract.

Agent is not liable to third party but in exceptional cases he can be held liable.

An agency may be terminated in any of the following ways :

1. By acts of the parties, or

2. By operation of law

Activity 3 - Check your progress- Case Studies

1. Identify the position of C in the following case :

A directs B, his solicitor, to sell estate by auction, and to employ an auctioneer for the

purpose, B names C, an auctioneer, to conduct the sale. Is C is an agent, a subagent of a

substituted agent?

(Hint: C is not a sub-agent, but is substituted agent for the conduct of the sale.)

2. A employs B to beat C, and agrees to indemnify him against all consequences of the act.

B thereupon beats C and has to pay damages to C for so doing. Is A liable to indemnify

B?

(Hint: No, A is not liable to indemnify B for those damages as the act was unlawful.)

3. A directs B to sell goods for him and agrees to give B five percent commission on the

price fetched by the goods. A, afterwards, by letter, revokes B’s authority. B, after the

letter is sent, but before he receives it, sells the goods for Rs. 100. Can B recover his

commission?

(Hint: Yes, because U/S 208, the agency can terminate only when the fact of termination

becomes known to the agent, therefore, the sale is binding on A and B is entitled to five

rupees as his commission.)

4. A, an agent for the sale of goods, having authority to sell on credit, sells to B on credit,

without making the proper and usual enquiries as to the solvency of B. B, at the time of

such sale, is insolvent. Is A liable to his principal?

(Hint: Yes, A must make compensation to his principal in respect of any loss thereby

sustained U/S 212.)

5. P owned a motor car and delivered it to A, a mercantile agent, for sale at not less than

575 Pounds. A sold the car for 340 Pounds to T, who bought it in good faith and without

notice of any fraud. A misappropriated the 340 Pounds and P sued to recover the car from

T. Can P recover the car back from T?

(Hint: No. Held, as A was in possession of the car with P’s consent for the purpose of

sale, T got a good title.)

6. A without authority, buys goods for B. Afterwards, B sells them to C on his own account.

Is B liable for the sale?

(Hint: Yes, B’s conduct implies a ratification of the purchase made for him by A.)

7. N gave his wife authority to buy goods from D. N became insane, but the wife continued

to buy from D, who did not know of N’s insanity. Is N liable to D?

(Hint: Yes, N continues to be liable unless the termination of the authority of the wife by

the insanity of N becomes known to D (Sec. 209.))

8. P appoints A, a minor, to sell his bicycle for cash for a price not below Rs. 400. A sells it

to T for Rs. 280. Explain the position of A and T.

(Hint: T gets a good title to the bicycle. A is not liable to P for his negligence in the

performance of his duties because he is a minor)

9. A who had appointed B as agent to sell his house, revoked B’s authority and informed B

about it. Notwithstanding the revocation, B enters into a contract to sell the house to C

and takes an advance of Rs. 10,000 from C and absconds with the money. Examine the

right of A, B and C.

(Hint: If C had bought the goods in good faith from B, then C gets a good title.)

10. P instructed his agent A to sell a picture at a named price. P died. Afterwards before the

fact of his death became known to A, A sold and delivered the picture. Was this sale

binding on P’s executors?

(Hint: Yes, as the revocation of A’s authority on the death of P takes effect from the time

the death of P becomes known to A (Sec. 209)).

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. Define the term agency.

2. Who is a sub-agent? How is the different from substituted agent?

3. What is agency by ratification?

4. Define: (a) Agency by estoppel (b) Agency by Holding out.

5. Write a short note on agency by necessity.

6. Who is a del credere Agent?

7. Can an agent delegate his authority?

8. Who is an un-named principal and undisclosed principal?

Long Questions

1. What are the various ways or modes in which the relation of agency arises?

2. What is meant by agency by ratification? State the conditions that must be fulfilled before

the doctrine of ratification can apply to an act of an agent?

3. What is the extent of the liability of the principal when his agent exceeds authority?

4. Explain the effect of a contract made by an agent with a third party-a) where the agent

discloses the existence but not the name of the principal; and (b) where the existence of

the principal is not disclosed.

5. When is an agent personally bound by contracts entered into by him on behalf of his

principal?

6. Discuss the different modes in which the authority of an agent may terminate.

7. State briefly the duties of an agent to the principal. What are his rights against the

principal? What is the degree of skill required of an agent?

Chapter – 11

Contract of Sale

The sale of goods is a common transaction of all commercial contracts. Earlier the legal

provisions relating to the contract of sale were contained in Sections 76 to 123 of the Indian

Contract Act, 1872. However, as a result of the developments of modern commerce, certain

amendments were required in these provisions. To suit these developments, in the modern

commerce, Sections 76 to 123 of the Indian Contract Act were repealed. A new Act known as

THE SALE OF GOODS ACT, 1930 was passed in 1930 for the exclusive contracts dealing with

the sale of only movable goods. This Act does not deal with the sale of immovable property.

CONTRACT OF SALE

According to Sec. 4 of the Sale of Goods Act, “A contract of sale of goods is a contract

whereby the seller transfers or agrees to transfer the property in goods to a buyer for a price.”

A contract of sale may be absolute or conditional. In the contract of absolute sale, the property in

goods transfers to the buyer from seller immediately. Thus, the sale of goods on the counter of

the shop is an absolute sale. Whereas in conditional sale, property in goods transfer to the buyer

from seller subject to the fulfillment of certain conditions either by the seller or buyer. A contract

of sale may be express or implied. The contract of sale is a general term. It includes:

1. Absolute sale and

2. Agreement to sell i.e. conditional sale.

Learning Objectives

After going through the chapter, the students will be able to learn about

Contract of sale

Conditions and warranties

Doctrine of caveat emptor

Absolute Sale: According to Section 4(3), when the ownership of goods is transferred from the

seller to the buyer under a contract of sale, a sale is said to have been made.

Example: Ashok pays Rs. 900 to Rajesh and buys a watch, or he promises to pay Rajesh Rs. 500

and buys a watch.

Agreement to Sell: When the transfer of ownership of goods under the contract of sale is to be

taken place at a future date or on the fulfillment of a condition, it is called an agreement to sell.

At the agreed time, or when the agreed condition is fulfilled, when the transfer of ownership of

goods takes place, the agreement to sell becomes a sale.

Example: Amit makes agreement with Rajan to buy his watch for Rs. 500 after 15 days. In this

contract, it has been agreed that the transfer of ownership is to take place in future. The price of

goods is to be paid, and the transfer of ownership is to be effective in 15 days time.

Distinction between Sale and Agreement to Sell

Basis of distinction Sale Agreement to sell

1. Transfer of ownership In case of sale, transfer of

ownership of goods takes

place immediately

In case of agreement to sell,

transfer of ownership of goods

takes place at a future time or

subject to fulfillment of some

conditions

2. Executed contract or

executory contract

It is an executed contract

because nothing remains to be

done.

It is an executory contract

because something is yet to be

done.

3. Transfer of risk In case of sale, risk of loss of

goods is transferred

immediately because

ownership is transferred.

Hence, in case of destruction

of goods, the loss shall be

borne by the buyer even

In case of agreement to sell,

risk of loss of goods is not

transferred because ownership

is not transferred. Hence, in

case of destruction of goods

the loss shall be borne by the

seller even though the goods

though the goods are in the

possession of the seller.

are in the possession of the

buyer.

4. Effect of insolvency of

seller having possession of

goods

In case seller becomes

insolvent, buyer can claim the

goods from the official

receiver of assignee because

ownership of goods is with the

buyer.

In this case if seller becomes

insolvent, buyer cannot claim

the goods even when he has

paid the price because the

ownership is still with the

seller.

5. Effect of insolvency of the

buyer before paying the price

In case buyer becomes

insolvent, seller must deliver

the goods to the official

receiver or assignee because

the ownership of goods has

been transferred to the buyer.

In case if buyer becomes

insolvent, seller can refuse to

deliver the goods unless buyer

has paid full price of the goods

because the ownership has not

been transferred to the buyer.

6. Right of Usage The buyer has the right to use

the goods he buys, i.e. he

becomes the sole owner of

goods and can use them in any

manner.

It is only a contract between

the buyer and the seller, and

does not give the buyer the

right to use the goods till the

ownership of goods is

transferred to the buyer.

7. Consequence of Breach If the buyer defaults in making

the payment for goods, the

seller can sue the buyer for

such payment.

If the buyer fails to take

delivery of goods and pay for

the same, the seller is entitled

to sue the buyer for damages

only and not the cost of goods.

Essential Elements of a Contract of Sale

1. Seller and Buyer

There must be a seller as well as a buyer. “Buyer’ means a person who buys or agrees to

buy goods. ‘Seller” means a person who sells or agrees to sell goods. A person cannot be

a seller as well as a buyer at the same time because a person cannot buy his own goods.

That is why distribution of goods among partners at the time of dissolution of a firm does

not amount to sale of goods because the partners are joint owners and they cannot be both

sellers and buyers. (State of Gujarat V. Raman Lal & Co.)

2. Goods

The ‘goods’ are the subject matter of contract which are transferred from the seller to

buyer. The goods which form the subject matter of sale must be the movable goods of

any kind except the ‘actionable claims’ and ‘money’. A debt is an actionable claim. The

goods may be either existing goods or future goods. Thus, for this act goods includes the

goods like stocks, shares, debentures, copyrights, furniture, growing crops, grains and

trees (forming part of land but can be separated from it for the purpose of sale).

Associated Hotel of India V. Excise and Taxation officer (1966)

A hotel company provided residence and food making a consolidated charge for both the

services. No rebate was allowed if food was not taken by customer. It was held that

supply of food was not sale of goods but simply a service as the transaction was an

indivisible contract of multiple services and did not involve any sale of goods.

3. Price

Goods are always sold for a price. Price is a consideration in terms of money. There must

be a consideration for the sale of goods, and the consideration must be in terms of money.

In other words, in a valid contract of sale, the goods must be exchanged for money.

Exchange of goods for goods i.e. a barter is not deemed to be a sale.

4. Transfer of property

Here, transfer of property means transfer of ownership. To constitute a contract of sale,

the seller must transfer or agree to transfer the ownership of the goods to the buyer. A

mere transfer of possession of the goods cannot be termed as sale.

Example: A agrees to transfer the ownership of his car to B for Rs. 50,000. This is an

agreement to sell the car.

5. Essential Elements of a Valid Contract

In addition to the aforesaid specific essential elements, all the essential elements of a

valid contract as specified under Section 10 of Indian Contract Act, 1872 must also be

present since a contract of sale is a special type of a contract. For example, an agreement

to sell smuggled gold is not valid because its object is unlawful.

CONDITIONS AND WARRANTIES

At the time of selling the goods, a seller usually makes certain statements or representations

with a view to induce the intending buyer to purchase the goods. All the statements made by

the seller with reference to goods to convince the buyer to buy the goods from him are called

representations. Such representations may or may not become a part of the contract.

The representations which become a part of the contract are called stipulations. However,

every stipulation is not of equal importance. A stipulation which is not important for the

formation of the contract of sale is known as a ‘condition’. But a stipulation which is of

lesser importance for the formation of the contract of sale is known as a ‘warranty’.

CONDITION

Section 12 (2) lays down that :- “A condition is a stipulation essential to the main purpose of

the contract, the breach of which gives rise to a right to treat the contract as repudiated

(cancelled)”.

It is the very basis of contract of sale, the breach of which causes irrepairable damages to the

buyer, and he may terminate the contract.

Essentials of conditions

1. It is essential to the main purpose of the contract.

2. Its non – fulfillment would defeat the very purpose for which the contract is made.

3. The failure of fulfillment of condition causes irrepairable damages to the aggrieved party.

4. The breach of condition gives a right to the aggrieved party to put an end to the contract

and recover the damages arising out of such breach.

Baldry V. Marshall (1925)

B consulted M For a car ‘suitable for touring purpose’. M suggested him a ‘Bugatti’ car

and B bought that car from M. Bugatti proved to be unfit for touring purposes. It was

held that the stipulation ‘for touring purposes’ was a condition and since the condition

was not fulfilled, the buyer could reject the car and claim the refund of the price.

WARRANTY

According to Sec. 12 (3), “A warranty is a stipulation collateral to the main purpose of the

contract, the breach of which gives rise to a claim for damages but not to a right to reject the

goods and treat the contract as repudiated”.

Example: A goes to a horse trader and says that he wants to buy a good horse. The trader offers

him a horse and says that it can run at 40 km an hour. A buys the horse. Later, he comes to know

that the horse can only run 30 km in an hour. Here the commitment of the trader is only a

warranty and is not an essential condition of the contract. Non-fulfillment of a warranty only

entitles the buyer to receive damages from the seller, not to repudiate the contract.

Distinction between conditions and warranty

Basis of distinction Conditions Warranty

1. Essential vs. Collateral It is a stipulation which is

essential to the main purpose

of the contract.

It is a stipulation which is only

collateral to the main purpose

of the contract.

2. Right in case of breach The aggrieved party can

terminate the contract.

The aggrieved party can claim

damages but cannot terminate

contract.

3. Treatment A breach of condition can be

treated as a breach of warranty

in certain circumstances. For

example, a buyer may like to

retain the goods and claim

only damages.

A breach of warranty cannot

be treated as a breach of

condition.

When breach of conditions is to be treated as breach of warranty:

1. Voluntary waiver by buyer

Although on a breach of condition by the seller, the buyer has a right to treat the contract

as repudiated and reject the goods, but he is not bound to do so. He may instead elect to

waive the condition, i.e. to treat the breach of condition as a breach of warranty and

accept the goods and sue the seller for damages for breach of warranty.

Example: A agrees to supply B 10 bags of first quality sugar @ Rs. 625 per bag but

supplies only second quality sugar, the price of which is Rs. 600 per bag. There is a

breach of condition and the buyer can reject the goods. But if the buyer so elects, he may

treat it as a breach of warranty, accept the second quality sugar and claim damages @ Rs.

25 per bag.

2. Acceptance of goods by buyer

Where the buyer has accepted the goods and subsequently he comes to know of the

breach of condition, he cannot reject them, but can only maintain an action for damages.

This case does not depend upon the will of the buyer but the law compulsorily treats a

breach of condition as a breach of warranty.

3. Treat the condition as warranty

Where a condition is not fulfilled in a contract of sale, the buyer has a right to repudiate

the contract and demand his price by rejecting the goods. But if he elects to treat the

breach of conditions as breach of warranty, he can ask for repair of the goods instead of

rejecting them.

Activity one – Check your Progress

1. Sale of goods act was passed in ________

2. When transfer of ownership of goods under the contract of sale is to be taken place at a

future date, it is called _________

3. Stipulation, breach of which gives right to cancel the contract is called ___________

4. Stipulation collateral to main purpose of contract is called __________

5. If person treat condition as warranty, can he cancel the contract afterwards?

(Hints: 1. 1930 ; 2. Agreement to Sell ; 3. Condition ; 4. Warranty ; 5. No)

EXPRESS AND IMPLIED CONDITIONS AND WARRANTIES

The terms that have been expressly made as conditions and as warranties by the parties shall be

called as express conditions and express warranties.

Implied Conditions and Warranties

These are those conditions and warranties which the law incorporates into every contract of sale.

Apart from the express conditions and warranties, implied conditions and warranties that have

been provided under section 14-17 of Sale of Goods Act, 1930 are binding on the parties in every

contract of sale. Breach of implied conditions can lead to repudiation of contract and breach of

implied warranties can only enable the aggrieved party to claim damages.

IMPLIED CONDITIONS

1. Condition as to title (Section 14)

There is an implied condition in every contract of sale, that the seller has the right to sell

the goods and in an agreement to sell he will have right to sell. This right of the seller to

sell the goods is an implied condition as to title. If the title of the seller is defective e.g. if

the goods are stolen goods, the buyer can reject the goods. In such a case, if the buyer has

to return the goods to the true owner of the goods, the buyer is entitled to recover the

price of the goods from the seller.

Rowland vs. Divall (1923)

R had purchased a car from D and used it for several months. The car was seized by the

police as it was found that the car was a stolen one. It was held that R could recover the

price of the car from D for breach of conditions as to title.

2. Condition as to description (Section 15)

The goods can be sold by description. In such cases, the implied condition is that the

goods shall correspond or match with the description. The term ‘correspondence with

description’ means that the goods purchased by the buyer must be the same as described

by the seller. If subsequently, it is discovered that the goods do not match with the

description, the buyer may reject the goods and claim the refund of the price, if it has

been paid.

Varley vs. Whipp (1990)

A agreed to purchase a second hand reaping machine, which he had never seen and the

seller stated that the machine was only one year old. On delivery, A found that the

machine was a very old one and returned it to the seller. The seller refused to accept the

machine back and refused to refund price. It was held that A was entitled to reject the

machine, because it did not correspond to the description given by the seller.

3. Condition in a sale by sample as well as by description (Sec. 15)

When goods are sold by sample as well as by description, there is an implied condition

that the bulk of the goods shall correspond both with the sample and with the description.

If the goods supplied correspond only with the sample and not with the description or

vice versa, the buyer is entitled to reject the goods. The bulk of the goods must

correspond with both.

Example: N agreed to sell G some oil described as ‘foreign refined rape oil’, warranted

equal to sample. The oil supplied, though corresponded with the sample, was adulterated

with hemp oil. Held, that since the oil supplied was not in accordance with the

description the buyer was entitled to reject the same (Nichol vs Godts).

4. Condition as to quality or fitness (Sec. 16(1))

The general rule is that there is no implied condition or warranty as to the quality or

fitness for any particular purpose of goods supplied under a contract of sale. Where a

buyer makes known to the seller the particular purpose for which the goods are required

and he relies on the seller’s skill and judgment as the seller deals in such goods, there is

an implied condition that the goods will be of reasonable quality and fit for such purpose.

The implied condition as to quality or fitness will be applicable only under the following

conditions:

1. The buyer requires the goods for some particular purpose.

2. The buyer make the purpose known to the seller

3. The buyer has relied on the skill and judgment of the seller.

4. The seller deals in those goods, whether he manufactures the goods or not is

immaterial.

Priest vs. Last (1923)

X purchased a hot water bottle from a chemist He had no knowledge of the product and its

usage. The chemist provided him with a hot water bottle which could hold hot water for use.

But the bottle burst while it was being used and injured his wife. It was found that the bottle

was not fit for use and the chemist was held liable for damages, because the condition as to

fitness was not fulfilled.

5. Sale by Sample

As per Section 17, when goods are sold by sample, there is an implied condition that:

(i) The bulk should match with the sample.

(ii) The buyer should have reasonable opportunity to check and compare bulk with the

sample.

(iii) The goods should be free from any defect.

6. Condition as to merchantability

There is an implied condition in every contract of sale that the goods shall be of

merchantable quality. The word merchantable quality means that the goods must be of such a

quality that a man of ordinary prudence would accept them as goods of that description and

the goods are immediately saleable in the market under the name or description by which

they are purchased. These goods are not of merchantable quality:

A television which does not give picture

A refrigerator which do not cool the eatables

A watch which does not keep time

The implied conditions as to merchantability become operative under the following

conditions:

1. Where the goods are bought by description.

2. Where goods are purchased from a seller who deals in goods of that description only.

Example: X bought from a dealer a bottle of wine. While opening its cork in the normal

manner, the bottle broke off and injured X’s hands. X was entitled to claim damages because

the bottle was not of merchantable quality. (Morelli V. Fitch & Gibbons)

There can be two cases:

A. Patent Defect: The defects which can be revealed by reasonable level by examination are

called as Patent Defects. If buyer was given reasonable chance to examine goods and he over

looked patent defects then seller shall not be liable.

B. Latent Defect: In case of Latent Defects which can’t be revealed even after a reasonable

examination, then the seller is held liable.

7. Condition implied by custom or usage of trade

There can be an implied condition as to quality or fitness for a particular purpose which may

be assumed by custom or usage of trade.

Jones V. Bowden (1813)

In sale of drugs by auction, it was a trade usage to declare any sea damages. Therefore, when

no such declaration was made by seller while selling drugs, it was an implied condition that

the drugs so sold were free from any sea damages.

IMPLIED WARRANTIES

1. Quiet Possession

There is an implied warranty in every contract of sale that the buyer will have and enjoy

quiet possession of the goods purchased by him. It is a warranty against any disturbance

in possession by the seller himself or any other person. If the possession of the buyer is

disturbed by a person having a superior right than that of the seller the buyer is entitled to

hold the seller liable for breach of warranty.

Manso Vs. Burningham (1949)

A lady purchased a second hand typewriter and used it for some months after spending

some money on its repair. But she had to return it to the true owner of the typewriter as it

was a stolen property. It was held that she was entitled to recover not only the price but

also the cost of its repair from the defendants.

2. Warranty of freedom from charges

There is an implied warranty that the goods should be free from any charge in favour of

any third person. The breach of this warranty gives buyer a right to claim damages from

the seller.

Example: X borrowed Rs. 500 from Y and hypothecated his radio with Y as security.

Later on X sold his radio to Z who bought in good faith. Here, Z can claim damages from

X because his possession is disturbed by Y having a charge.

3. Disclosure of Dangerous Nature of Goods

There is an implied warranty on the part of seller to disclose to the buyer where he knows

that the goods are inherently dangerous or they are likely to be dangerous for the buyer if

such a disclosure is not made. The seller must warn the buyer of the probable danger. If

he fails to do so and the buyer suffers injury thereupon he (buyer) is entitled to recover

damages from the seller.

DOCTRINE OF CAVEAT EMPTOR

The maxim, Caveat Emptor means “Let the Buyer Beware”. The Doctrine of Caveat Emptor

sates that when the Buyer was given a chance of examining the goods but he did not examine

them, in fact relied on his own skill and judgment and makes a bad selection then he cannot

blame anybody except himself. In other words unless the buyer specifies his purpose for buying

the goods, it is not the duty of the seller to give the buyer suitable goods required by him (buyer).

In nut shell, Doctrine of “Caveat Emptor” states:

When Buyer does not rely on the skill and judgment of seller but relies on his own skill

and judgment.

Buyer had a chance of examining the goods.

Buyer does not specify the purpose for which goods were required by him (buyer)

Then, the seller is not liable for any loss suffered by the buyer on account of goods.

Andrew Yule And Co. (1932)

The buyer ordered for hessian cloth without specifying the purpose for which he ordered the

cloth. It was actually needed for packing. Because of the unusual smell, the cloth was

unsuitable for the purpose. It was held that buyer had no right to reject the goods even when

the goods were unfit for his purpose because he never mentioned the purpose to the seller.

EXCEPTIONS OF THE RULE

1. Where the buyer relies the seller’s skill or judgment (Implied Conditions as to

quality)

The doctrine of caveat emptor will not apply and the seller will be liable for breach of the

implied conditions as to quality or fitness of the goods if

(i) The buyer has made known to the seller the particular purpose for which he

requires the goods expressly or by implication.

(ii) The buyer has relied on the skill or judgment of the seller and

(iii) The seller deals in such goods

Example: Priest Vs. Last (This case law has been explained earlier in SLM)

2. Merchantable quality (Implied Condition as to Merchantability)

Where

(a) The goods are bought by description, and

(b) Seller deals in similar goods.

Then, there is an implied condition that the goods should be of merchantable quality. If

there is any defect in the goods, then seller shall be liable.

3. Conditions as to wholesomeness

It is a part of the condition as to merchantability. This condition is applicable in cases of

eatables i.e. foodstuffs and other goods which are used for human consumption. In such

cases, in addition to the implied condition as to merchantability, another implied

condition is that the goods must be wholesome i.e. sound, pure and fit for consumption at

the time of sale. As a matter of fact, the goods shall not be merchantable if they are not fit

for human consumption.

Example: A purchased some milk from B, a milk dealer. The milk contained some

typhoid germs. After consuming the milk, A’s wife got infection and died. It was held

that A was entitled to recover damages from the milk dealer. In this case, the milk was

not wholesome as it was not pure and fit for human consumption.

4. Sale by description

When the sale of goods is made by description, it involves some implied conditions and

warranties and the caveat emptor doctrine is not applicable. The goods sold must match

their description; otherwise the buyer can refuse to accept the goods and is entitled to

receive damages from the seller.

5. Sale by fraud

Where the consent of the buyer was obtained through fraud by the seller, and the buyer

suffers any loss then the seller shall be liable.

6. Where the seller conceals a latent defect

A latent defect is a defect which cannot be revealed with ordinary examination of the

goods. Where a seller concealed a latent defect of the goods while selling goods to the

buyer and the buyer subsequently suffered loss due to that latent defect, then in such

situation, the rule of CAVEAT EMPTOR does not apply. Therefore the seller is held

liable for the latent defects.

Activity Two – Check Your Progress

1. The condition imposed by law is called __________

2. The bulk of goods should match with the sample. It is an ________ Condition

3. The goods should be of merchantable quality. It is an ________ Condition

4. Defect which can’t be revealed even after reasonable examination are called _________

5. Let the buyer beware is called ____________

(Hints: 1. Implied condition ; 2. Implied ; 3. Implied ; 4. Latent ; 5. Caveat emptor.)

Summary

A contract of sale of goods is a contract whereby the seller transfers or agrees to

transfer the property in goods to a buyer for a price.

A condition is a stipulation essential to the main purpose of the contract, the

breach of which gives rise to a right to treat the contract as repudiated.

A warranty is a stipulation collateral to the main purpose of the contract, the

breach of which gives rise to a claim for damages but not to a right to reject the

goods and treat the contract as repudiated.

In some situations, breach of condition can be treated as breach of warranty.

There are some implied conditions and warranties in a contract of sale.

The Doctrine of Caveat Emptor sates that when the Buyer was given a chance

of examining the goods but he did not examine them, in fact relied on his own

skill and judgment and makes a bad selection then he cannot blame anybody

except himself. But there are some exceptional cases where buyer can blame

seller and can recover damages.

Activity 3 - Check your progress (Case Studies)

1. X purchase a typewriter from Y on Y’s undertaking that though it is old, it is in excellent

condition. X finds later on that the typewriter does not work at all. Can he reject the

typewriter and recover his money?

[Hint: Yes, X can reject the typewriter and recover his money. Where goods have been

sold by description, there is an implied condition that the goods shall correspond with the

description.]

2. A contracts to sell ‘java sugar’ according to sample produced by him. On the delivery of

the same to B, the buyer, it appears that the sugar agrees with the sample, but it is not

Java sugar. Will B be entitled to any remedies?

[Hint: Yes, Section 15 of the Sales of Goods Act lays down that when goods are sold by

samples as well as by description there shall be an implied condition that the goods shall

correspond both with the sample as well as description.]

3. A buys a watch from B, a dealer in watches. The watch is discovered after two days to be

defective. Can X get his money back?

[Hint: In this case it is a sale by description. Section 16(2) of the Sales of Goods Act

provides where goods are bought by description, there is an implied condition that the

goods shall be of merchantable quality.]

4. P bought milk from D. The milk contained typhoid germs. P’s wife took the milk and got

infection, as a result of which she died. Is P entitled to any damages?

[Hint: Yes. P is entitled to damages from D. In the case of eatable and provisions there is

an implied condition as to wholesomeness i.e. sound and free from injurious substances.]

5. A bought 1000 tins of preserved milk from B. The tins were labeled in such a way that

they infringed a particular trade mark. A was sued by the owner of the trade mark and he

had to pay certain damages and also to remove the labels. He suffered a loss by selling

these tins. Can he recover this loss from B?

[Hint: Yes, A can recover all this loss from B. In a contract of sale of goods there is an

implied warranty that the buyer shall have and enjoy quiet possession of the goods.]

6. X sold one horse out of 25 horses for Rs. 75,000 to Y, to be delivered the next day and Y

was to make the payment on delivery. But the horse died before it could be delivered and

paid for. Who will bear the loss?

[Hint: Y should bear the property passes to the buyer at the time of making a contract of

sale.]

7. A gives a diamond ring to B on approval basis. B delivers the diamond ring to C on sale

or return basis who lost the ring. Who should bear the loss?

[Hint: B should bear the loss because he has adopted the transaction by transferring it to

C.]

8. A bought a second hand car for B for Rs. 1,10,000 and paid for it. After using if for six

months A was deprived of the car because B had no title to it. Can A recover the price of

the car from B? Advise A.

[Hint: In every contract of sale, there is a implied condition that the seller has right to

transfer title. If there is defect in seller’s title to the goods the buyer has the right to reject

the goods.]

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal,

Taxmann Allied Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. What is a contract of sale?

2. What is an agreement to sell?

3. Distinguish between a sale and an agreement to sell?

4. Define condition in a contract of sale.

5. What is a warranty in a contract of sale.

6. Distinguish between condition and warranty.

7. What is implied condition as to title on the part of the seller?

8. What is implied condition in the case of sale by sample?

9. What is implied condition in the case of sale by description?

10. What do you understand by implied warranty of quite possession?

11. Explain implied warranty of freedom from charges.

12. What is meant by caveat emptor?

13. Under what circumstances the rule of caveat emptor is not applicable?

Long Questions

1. Explain clearly the essential elements which must co-exist for constituting a valid sale of

goods. In what respect does a sale differ from an agreement to sell?

2. What is a contract of sale? State its essential characteristics.

3. (a) Define and distinguish between a condition and a warranty.

(b) Under what circumstances can a breach of condition be treated as a breach of

warranty?

4. Explain briefly the implied conditions and warranties in a contract of sale.

5. What are the implied conditions under the Sales of Goods Act as applicable in a contract

of sale with regard to the following

(a) Merchantability

(b) Quality or fitness

(c) Sale by sample.

6. Explain the doctrine ‘Caveat Emptor’ and state the exceptions to it.

7. Explain clearly the principle of Caveat Emptor as applied in a contract of sale. Are there

any circumstances in which the principle of Caveat Emptor does not apply? Discuss

8. “Nemo Det Quod Non Habet.” (No One can give who possesses not). Comment giving

exceptions, if any, to this rule, and also suitable illustrations.

Chapter - 12

Transfer of Property and Rights of Unpaid Seller

A contract of sale is performed in two inter-related stages with respect to the goods which form

the subject matter of a contract of sale :-

1. Transfer of possession of goods and

2. Transfer of ownership of goods or property in goods from the seller to the buyer.

Transfer of Possession

When the custody of the goods is given by the seller to the buyer, then we say that the possession

of goods has been transferred.

Example: A gives his car for repair to a mechanic. Here only the possession of goods is given

and not ownership rights.

Transfer of Property

Transfer of property means transfer of ownership rights by the seller to the buyer.

Example: A sold his car to B for Rs. 1,50,000 and transferred the ownership documents in the

name of B although the car is still in custody of A.

The question as to when ownership passes from the seller to the buyer is important for the

following reasons:-

Learning Objectives

After going through the chapter, the students will be able to learn

When property is transferred under the contract of sale

Who is an unpaid seller

Rights of an unpaid seller

1. Risk of loss:- The risk of loss also passes with the ownership of the goods from the seller

to the buyer. In case of loss or destruction of goods, it is the owner who suffers.

2. Only owner can sue:- If the goods are destroyed or damaged by the action of a third

party, it is only the owner who has ownership in goods, who can sue or take legal action

against the third party.

3. Insolvency of the buyer or the seller:- Where the buyer or the seller has become

insolvent, the question whether the official receiver of official assignee can take over the

property in goods or not depends upon the fact whether the ownership in goods at that

time lies with the buyer or the seller.

RULES REGARDING TRANSFER OF PROPERTY UNDER SECTIONS

20-24

Rules Regarding Transfer of Property

Under Section 20-24

Specific Goods in Specific Goods not Specific Goods where Unascertained Goods send on Sale

Deliverable State in Deliverable State Price is yet to be Goods or Return Basis

determined

1. When goods are in a deliverable state (Sec. 20)

Where there is an unconditional contract for the sale of specific goods in a deliverable

state, the property in the goods passes to the buyer as soon as the contract is made, and it

is immaterial whether the time of payment of the price or the time of delivery of the

goods, or both are postponed.

Sec. - 20 Sec. - 21 Sec. – 22 Sec. - 23 Sec. - 24

Example: A buys a bicycle for Rs. 300 on a month’s credit and asks the shopkeeper to

send it to his house. The shopkeeper agrees to do so. The bicycle immediately becomes

the property of A.

2. Where the goods are not in deliverable state (Section 21)

Where there is a contract of sale of specific goods and the seller is bound to do something

to the goods for the purpose of putting them into a deliverable state the property does not

pass until such thing is done and the buyer has notice thereof.

Example: Mona contracts to buy 10 bags of sugar. 6 Bags were filled in front of Mona

but before the remaining bags could be filled, a fire broke out and the entire quantity of

sugar was destroyed. Held, Mona shall bear the loss of 6 bags of sugar as they were in

deliverable state and the seller shall be liable for the remaining 4 bags which were not in

deliverable state.

3. When the goods have to be measured etc., to ascertain price (Sec. 22)

Where there is a contract for the sale of specific goods in a deliverable state, but the seller

is bound to weight, measure, test or do some other act with reference to the goods for the

purpose of ascertaining the price, the property does not pass until such act is done and the

buyer has notice thereof.

Example: The buyer contracts to buy 10 quintals of oil from the seller @ Rs. 2000 per

quintal. The seller weighted 3 quintals of oil and delivered them to the buyer, the buyer

paid for 3 quintals of oil. The ownership of the remaining 7 quintals shall be transferred

only when it shall be weighted.

4. Unascertained Goods (Section 23)

Where there is a contract for sale of unascertained goods, the property in goods does not

pass to the buyer until the goods are ASCERTAINED. But the unascertained goods shall

be unconditionally APPROPRIATED by the seller with the assent of the buyer and must

be for the same goods for which description was given by seller. The property in such

goods passes the buyer when all the below given conditions are fulfilled:

(i) When such goods are appropriated: Appropriation means identifying the goods

regarding which the contract of sale is done.

(ii) Appropriation must take place with mutual assent

(iii) Goods appropriated must correspond to the description so given :

(iv) Goods appropriated must be in Deliverable State

(v) Appropriation must be unconditional.

5. Where goods are sent on approval or ‘sale or return’ basis [Sec.24]

Where in a contract of sale, the goods are delivered on the basis of approval by the buyer

at some time later on or “on sale or return” basis, the property in those goods passes to

the buyer

i) When he signifies his approval or acceptance to the seller and retains the goods ;

or

ii) When he does some other act, which implies that he has accepted the goods ; or

iii) When he does not signify his approval but retains the goods :-

a) If a time was fixed for the return of the goods, on the expiry of that time; and

b) If no time was fixed for the return of the goods, on the expiry of reasonable

time

ELPHIC vs. BARNES (1880)

The Plaintiff delivered a horse to be tried for 8 days and to be returned if the buyer did not like it.

But the horse died before the stipulated period of 8 days without the fault of any party. The seller

filed a suit for the recovery of the price of the horse. It was held that the defendant was not liable

because the property in the horse was not transferred to the buyer.

SALE BY NON-OWNERS [SECTION 27]

For transfer of ownership from the seller to the buyer, the general principle is that “No one can

transfer a better title than he himself has”. It is based on the maxim “Memo Dat Quod non

habet” which means that “No one gives what he has not”.

This principle is based on the assumption that the seller is a full owner of the goods, and

on transfer of its ownership, the buyer also becomes an absolute owner of the goods. If the seller

is not the absolute owner, the buyer also cannot become the absolute owner of the goods

purchased by him, although he may have acted in good faith and even paid the price for the

goods.

LEO VS. BAYES (1856)

A stolen horse was sold at a public auction. The fact of theft being known neither to the

auctioneer not to the buyer who bought it in good faith. It was held that the buyer had obtained

no title against the true owner of the horse and therefore the buyer had to return the horse to its

true owner.

Exceptions to the rule

There are exceptional circumstances where non owners can also sell and transfer a better title.

These are as follows:

1. Unauthorized sale by a mercantile agent [Section 27]

Mercantile agent means an agent who has the authority either to sell the goods or to

consign the goods for the purpose of sale, or to buy the goods or to raise money on the

security of the goods. A mercantile agent can transfer a valid title if the following

conditions are satisfied:

(i) He is in possession of the goods or documents of title of the goods (i.e proof of

possession) with the consent of the owner.

(ii) The sale is made by him while acting in the ordinary course of his business, and

(iii) The buyer acts in good faith believing that he has authority to make the sale. Such

a rule is valid even if the agent has no actual authority to sell.

FOLKES vs. KING (1923)

The plaintiff had delivered his car to a mercantile agent to sell not below a reserve price.

But the agent sold the car below its reserve price to Mr. X who sold the car to the

defendant. The plaintiff filed a suit for the recovery of the car from the defendant. Held

that the car could not be recovered from the defendant as the property in car had passed

over to the defendant.

2. Sale by one of the joint owners [Sec. 28]

Where one of the joint owners sells the goods to a person who buys them in good faith

and without notice that the seller has no authority to sell the goods, the property in goods

stands transferred to such buyer.

The sale by a joint owner is valid only if the following conditions are satisfied:

1. One of the joint owners is in sole possession of the goods

2. He is in possession of the goods with the permission of all the joint owners.

3. The buyer has purchased the goods in good faith and has no notice that the seller has

no authority to sell the goods.

Example: X, Y and Z purchased a beautiful horse to be sold at profit later on. The

horse was left in the custody of Z till they decided to sell it. Z sold the horse to Mr. A

who was not aware that Z had no authority to sell it and hence purchased the horse in

good faith Mr. A got good title.

3. Transfer of title by estoppel

If the owner of goods, by his actions, conduct or behavior convinces the buyer that the

seller is the owner of goods or has the authority of the owner to sell the goods, and

induces the buyer to purchase the goods, he cannot later claim that the seller had no right

to sell the goods.

For example, B sells A’s bicycle to C. A is present when the sale is made, but he makes

no comment, nor does he say that the bicycle belongs to him. Here, A’s conduct

convinces C that he is the owner of the bicycle. In such case, A because of his conduct,

cannot later say that B had no right to sell the bicycle, and C will have a good title to it.

4. Sale by a person in possession under a voidable contract [section 29]

A person who has possession of the goods under a voidable contract can transfer a valid

title if following conditions are satisfied:

(i) The possession must have been obtained under a voidable contract and not under

a void contract.

(ii) The voidable contract must not have been rescinded (i.e. put to an end) by the

time of sale.

(iii) The buyer must have acted in good faith, and without the notice of the seller’s

defective title.

PHILLIPS vs. BROOKS ltd. (1919)

A person posing as a respectable person obtained from a shopkeeper a valuable ring by

giving a fake cheque. Before the fraud could be discovered, he had pledged the ring with

a bonafide pledgee. It was held that the pledgee had acquired a good title because though

the contract was voidable by the reason of fraud before it could be rescinded, the goods

had gone into the hands of a third person.

5. Sale by a seller in possession of goods after sale [Section 30 (1)]

At times, the seller continues to be in possession of goods even after sale. In such a case

if he sells these goods again to another person, the second buyer gets a good title

provided:

(i) The seller should continue to be in possession of the goods or documents of title

of goods after having sold them.

(ii) Such possession has been obtained with the consent of the buyer.

(iii) The second buyer buys the goods in good faith.

(iv) The second buyer should not have the notice of the previous sale.

Example: X sold certain goods to Y, but continued to remain in possession of them with

the consent of the buyer. Thereafter, X sold the goods to Z. Z bought the goods in good

faith and without any notice of prior sale. Held, Z had acquired the good title.

6. Sale by buyer in possession before buying Section 30 (2)

Where a person having bought or agreed to buy goods, obtains with the consent of the

seller, possession of goods or documents of title of goods and sells them to a third party

(who buys in good faith & without notice of defective title), then this buyer, (the third

party) gets a better title.

7. Sale by an unpaid seller [Section 54 (3)]

A seller who has not received his payment is called as an unpaid seller.

An unpaid seller who:

(i) Has exercised his right to lien or right to stoppage in transit;

(ii) But has still not received the payment from his buyer.

(iii) Such an unpaid seller may re-sell the same goods.

Then, such a new buyer shall acquire a better title of the goods.

8. Sale by Pawnee

Where the pawnor does not pay back the payment of debt obtained from the pawnee, the

pawnee may either sue him for the debt or may sell the goods pledged after giving a

reasonable notice to the pawnor.

9. Sale by a finder of goods

Finder of goods can sell the goods if following conditions are fulfilled:

(i) The owner cannot be found after reasonable diligence; or

(ii) The owner was found but he refused to pay the lawful charges of finder; or

(iii) If the goods are perishable and will lose greater part of its value if not consumed;

or

(iv) If the lawful charges of the finder in respect of the thing found amounts to two

third of its value.

Activity One – Check Your Progress

1. If property has been transferred to buyer, then risk of loss is of _____________

2. Can a mercantile agent make a valid sale?

3. If one of the joint owner sell the goods, will it be a valid sale?

4. If one person makes other to believe that the seller is owner of goods, it is called _____

[Hints: 1. Buyer ; 2. Yes ; 3. Yes ; 4. Transfer of title by estoppel)

WHO IS AN UNPAID SELLER?

Under Section 45, Seller is said to be unpaid when:

(i) When the seller does not receive whole or part of the price ; or

(ii) Where the seller had a negotiable instrument such as a bill of exchange and that

instrument has been dishonoured ; or

(iii) Where the seller was to get the price on expiry of credit period and the credit period

has expired but price has still not been received by him

(iv) But, where the buyer tendered (offered) the price and the seller refused to accept it,

there the seller shall not be called as an unpaid seller and therefore, cannot later claim

the price from the buyer.

RIGHTS OF AN UNPAID SELLER

An unpaid seller has two kinds of rights:-

1. Rights against the goods, and

2. Right against the buyer personally

(A) (B)

(1) (2)

)

Right to LIEN Right to STOPPAGE Right to RESELL Right to WITHHOLDING

IN TRANSIT DELIVERY

A. RIGHTS OF AN UNPAID SELLER AGAINST THE GOODS

I. When the property has been passed to buyer

1. Right of lien [Sec. 47-49]

Right of lien means the right to retain the possession of the goods and refuse to deliver

them to the buyer until the price due in respect of them is paid or tendered. The right of

lien can be exercised in the following cases:

Rights of Unpaid Seller

Against the Goods Against the Buyer

Where the property had

passed to the Buyer

Where the property had

not passed to Buyer

a) Where the goods were sold otherwise than on credit

b) Where the goods were sold on credit but the term of credit has expired

c) Where the buyer has become insolvent.

d) Where the buyer is liable to pay but does not pay.

Where the goods are sold on credit and the buyer becomes insolvent, he can exercise the

right of lien even if the period of credit has not yet expired.

The right of lien can be exercised as long as the seller has possession of the goods. If the

possession of the goods is lost, the right of lien is also lost.

Termination of lien

The right of lien is linked to the possession of the goods and this right is lost if the possession is

lost. An unpaid seller loses his right of lien in the following cases:

i) By delivery to the carrier: Delivery of the goods to a carrier for the purpose of

transporting to the buyer means as delivery to the buyer himself and therefore the

right of lien is lost, but the seller still has the right of stoppage in transit. The delivery

to the carrier puts an end to the right of lien.

ii) By delivery to the buyer: The right of lien is lost when the goods are delivered to the

buyer or his agent. When the seller has given the buyer possession of goods under the

contract of sale, all his rights in the goods are lost.

iii) By waiver: Where the seller has waived the right of lien, explicitly or implicity, the

right of lien is terminated

iv) By tender of price: Where the buyer tenders the price for the goods purchased by

him, the seller no more remains an unpaid seller, therefore his right of lien is also lost.

2. Right of stoppage of goods in transit

Another remedy which an ‘unpaid seller’ has against the goods is to stop them while they

are in transit. This right arises solely upon the ‘insolvency’ of the buyer. Thus when

the seller delivers the goods out of his own possession, and put them in the hands of a

carrier for delivery to the buyer, and he discovers that the buyer is insolvent, he may

retake the goods, if he can, before they reach in the buyer’s possession, and may retain

them until the price is paid.

When the right of stoppage can be exercised

Right of stoppage in transit can be exercised by the seller only if the following conditions

are met:

1. The seller is ‘unpaid seller’

2. The buyer is insolvent

3. The property in the goods has already been passed to the buyer

4. The seller has parted with the possession and the buyer has not acquired it, i.e., the

possession is with some independent entity like railways, or a shipping company, etc.

BETHEL vs. CLARK (1887)

Mr. Y who had purchased some goods from Mr. X asked the seller to send the goods by a certain

ship to Melbourne. The goods were first to be taken to London by railway and then shipped to

Melbourne. Mr. Y having become insolvent by that time, the, seller gave notice to the railway

authorities to stop the delivery, but it was too late. Mr. X gave a fresh notice to the shipping

company claiming back the goods before the ship arrived at Melbourne. One arrival at

Melbourne, the official receiver of Mr. Y demanded the possession of the goods. It was held that

the notice was within time and therefore, the goods were successfully stopped in transit.

Duration of transit:- The right of stoppage in transit can be exercised only when the goods are

in transit. Therefore, it is an important question till when the goods are deemed to be in transit.

When does the transit come to an end?

The transit comes to an end under the following circumstances:-

i) Delivery to buyer: - The transit comes to an end when the goods are delivered to the

buyer or his agent.

ii) Interception by the buyer:- The transit comes to an end when the buyer or his agent

gets the delivery of the goods from the carrier before goods arrive at the appointed

destination.

iii) Acknowledgement to the buyer:- The transit comes to an end when the goods arrive

at the appointed destination and the carrier acknowledges to the buyer or his agent

that now he is holding the goods on his behalf.

iv) Wrongful refusal to deliver:- The transit comes to an end when the goods have

arrived at their destination and the carrier wrongfully refuses to deliver the goods to

the buyer or his agent.

3. Right to Resell (Section 54)

Right to re-sell the goods by the unpaid seller can be exercised when :

(i) Where the goods are of perishable nature. No notice of resale is required when

goods are perishable.

(ii) Where the seller has exercised his right to lien or stoppage in transit but did not

get his price. Now the seller can give notice of re-sale to the buyer. If after

receiving such notice, the buyer does not pay within the reasonable time, the

seller has the right to re-sell the goods ; or

(iii) Where the seller expressly reserves a right to re-sell in case of default by the

buyer.

Loss of Profit on Re-Sale

(i) Loss on Re-sale: The seller can recover any loss from original buyer that he suffered

by getting a lesser amount on re-sale to a new buyer. The original buyer shall be

responsible for such loss because it is he who committed breach.

(ii) Profit on Re-sale: On the other hand if the seller receives a higher amount on re-sale

to the new buyer than the contracted price with the original buyer, then such profit on

resale can be retained by the seller himself.

II. Rights of unpaid Seller where Property has not Passed

1. Right of withholding Delivery (Sec. 46(2)). Where the property in goods has not passed,

the buyer can exercise the right to withhold delivery of goods until payment is received.

This right is a mix of right to lien and right to stoppage in transit.

B. RIGHTS OF UNPAID SELLER AGAINST THE BUYER PERSONALLY

The seller has the following rights against the buyer personally in addition to his rights

against the goods.

1. Suit for price (Section 56) :

(i) Where the property has passed: Where the property in goods has passed to the

buyer and the wrongfully neglects or refuses to pay for the goods, the seller is

entitled to sue for price, whether the possession is with the buyer or the seller.

(ii) Where the property has not passed: Where the property in goods has not passed

and the price is payable on certain day irrespective of delivery, the buyer

wrongfully neglects or refuses to pay for the goods on the fixed day, the seller is

entitled to sue for price.

2. Suit for interest (Section 6)

If under the contract of sale, the seller delivers the goods to the buyer and the buyer

wrongfully refuses to accept and pay for them, the court may award an interest as it

thinks fit on the price from the date of delivery. If the price is to be paid on particular day

irrespective of delivery, interest will run from that day and if the goods are sold on credit,

the interest will become payable from the expiry of period of credit.

3. Suit for Damages for Non-Acceptance (Sec. 56)

Where the buyer refuses to accept and pay for the goods, the seller may sue him for

damages for non-acceptance of goods. The measure of damages is the estimated loss that

results from the breach of the contract by the buyer. As a general rule, the measure of

damages is the difference between the contract price and the price existing at the time of

committing the breach.

Measure of Damages = Contract Price – Market Price on date of breach

Example: A seller contracted to supply 100 units of machine bolts to a buyer @ Rs. 5000

per unit on 14th

Aug., 2014. The seller sent the consignment on 14th

Aug. 2014, but the

buyer refused to accept it. The seller had to sell the consignment to another buyer but @

Rs. 4500 per unit. Held the seller could sue the buyer for damages of non-acceptance of

goods @ Rs. 500 per unit as the difference in price as on contract date and the price at

which he had to sell goods.

Buyer’s remedies for breach of contract

A buyer has the following remedies against the seller for breach of contract :

1. Suit for damages for non-delivery [Sec.57]:- Where the seller wrongfully neglects of

refuses to deliver the goods to the buyer, he may sue for damages for non-delivery of

goods. The damages are measured on the same principles as in the case of a suit for non-

acceptance of goods by the buyer.

2. Suit for specific performance [Sec.58]:- when the seller wrongfully neglects or refuses

to deliver the goods to the buyer, the court may order the specific performance of the

contract i.e. the court can compel the seller to deliver the goods he has sold under the

contract of sale. This order of specific performance can be passed under the following

circumstances :-

a) Where the goods are specific or ascertained.

b) Where the buyer considers that the damages are not an adequate remedy for the

breach of the contract.

c) Where the goods are of special value or unique e.g. an antique painting or a rare

manuscript or a rare book etc.

3. Suit of breach of warranty [Sec.59]:- Where the seller has committed a breach of

condition, the buyer has a right to reject the goods and rescind the contract of sale. But

where there is a breach of warranty by the seller or where the buyer elects to treat the

breach of condition as a breach of warranty, the buyer has the following remedies :-

i) The buyer can sue the seller for damages for the breach of warranty if the price

has already been paid.

ii) The buyer can demand reasonable reduction in the price to the extent of damages,

if he has not yet paid the price of the goods.

4. Anticipatory breach of contract [Sec.60] :- Where the seller has repudiated the contract

of sale well before the date of delivery of the goods, the buyer may :-

a) Consider the contract as existing till the actual date of delivery of the goods ; or

b) Consider the contract as repudiated and sue the seller for damages for the breach of

the contract.

5. Suit for price and interest [Sec.61]:- When there is a breach of contract of sale on the

part of the seller, the buyer can sue the seller to recover the price of the goods which he

has already paid to the seller. The buyer is also entitled to sue for interest on the amount

paid as price from the date of payment of the price. This remedy is not available to the

buyer if he elects to sue for damages only. He is entitled to sue for interest only if he is

entitled to recover the price.

Activity Two – Check Your Progress

1. If a seller doesn’t receive his payment, he is called ______

2. To retain the possession of goods until payment is called right of ________

3. When goods are of perishable nature, the unpaid seller has right to _______ the goods.

4. If any profit happens on reselling the goods, can seller retain the profit?

5. If buyer don’t receipt the goods, how much damages will he has to pay?

[Hints : 1. Unpaid seller ; 2. Lien ; 3. Resell ; 4. Yes ; 5. Damages = Contract Price –

Market price on date of breach]

Summary

Timing of transfer of property has extreme importance under contract of sale as

risk of loss is also transferred along with the transfer of property. There are

rules regarding transfer of property under the act.

Generally a non owner can’t make a valid sale. But there are exceptional

circumstances where a non owner can make a valid sale.

When the seller does not receive whole or part of the price or where the seller

had a negotiable instrument such as a bill of exchange and that instrument has

been dishonoured , he is called as unpaid seller. He has certain rights against

goods as well as buyer under the act.

Activity 3 - Check your progress (Case Studies)

1. A agrees to sell 100 maunds of rice to B, out of a larger quantity lying in his godown.

According to the agreement B sends gunny bags for the rice and puts 100 maunds of rice

in them and informs B of the same. But before B could take delivery, the godown catches

fire and the bags are damaged. Who is to suffer the loss?

[Hint. It is the owner who is to bear the loss. In a sale of specific goods in a deliverable

state the ownership of goods passes from seller to the buyer when the contract of the sale

of goods is made.

2. A delivers to B a gas meter on 1st March 1991, on ‘Sale or Return’ basis. B returns it on

October 1991, but A refuses to take it back and sues B for price. Will be succeed? Give

reasons.

[Hint. Yes, A will succeed in this case. When goods are delivered to the buyer in ‘sale or

return’ the property therein passes to the buyer when he signifies his approval or

acceptance to the seller or does any other act adopting the transaction.

3. X bargained for the purchase of a horse from Y. The horse was delivered to X upon trail

for eight days, the agreed price being Rs. 500. If it is found suitable the bargain was then

to be absolute. The horse died within eight days, who should bear the loss?

[Hint. Y cannot recover the price from X]

4. A finds a ring and after making reasonable efforts to find out the owner, sells it to B who

buys without knowledge that A was merely a finder. Can the true owner recover the ring

from B?

[Hint. In this case the true owner can recover the ring from B. Here the sale is not valid as

A has got no title on the ring]

5. A lent his new suit to B who was going to Delhi to attend the youth festival. The suit

fitted C better than it fitted B and C purchased it from B in good faith. Later A discovers

all this and claims his suit from C. Will he be able to recover his suit? Give reasons.

[Hint. Where gods are sold by a person who is not the owner thereof, the buyer acquires

no better title to the goods than the seller had.

6. A sells to B a quantity of sugar in A’s warehouse. It is agreed that 3 month’s credit

should be given. B allows the sugar to remain in A’s warehouse. Before the expiry of the

three months B becomes insolvent and the official assignee demands delivery of the

sugar from A without offering to pay the price. Is A entitled to retain the goods for the

price?

[Hints. A has the right of lien over the goods and can refuse delivery of goods to official

assignee till paid for them.]

7. X sold some goods to Y, who paid the price by issuing of a cheque in favour of X. Before

Y could obtain the delivery of the goods, the cheque issued by him was dishonoured by

the bankers. X refused to give the delivery of the goods. Y filed a suit for the delivery of

the goods. Decide.

[Hint. X is justified to exercise his right to lien.]

8. X sold to Y a quantity of potatoes lying in the cold store of Z, on one month’s credit and

the potatoes were allowed to remain in the cold store. Before the expiry of one month, Y

became insolvent and his official assignee demands the delivery of the potatoes from X

without offering the price. Can X retain the goods till he is paid?

[Hint. Yes, X is entitled to retain the goods because in the event of insolvency of the

buyer the seller can retain the goods if the goods have been sold on credit.]

9. X of Delhi sold some goods to Y of Chandigarh to be sent by rail. Y took the delivery of

the goods from the railway authorities by producing the necessary documents. Before the

goods could be removed from the railway godown, a telegram was received by the

railway authorities from the unpaid seller not to give the delivery. Can the railway

authorities refuse the delivery?

[Hint. No, the railway authorities cannot do it. The right of stoppage in transit cannot be

exercised because the transit has been terminated.]

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal, Taxmann Allied

Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. What is meant by the term ‘property in goods’?

2. When does the property in goods pass from the seller to the buyer in case of

unascertained goods?

3. What is mean by deliverable state?

4. Who is an unpaid seller?

5. What are the rights of an unpaid seller?

6. If an unpaid seller loses possession of the goods, does he loss the right of the lien?

Long Questions

1. When does the property in the goods sold pass from the seller to the buyer?

2. Describe the rules relating to passing of property in the sale of goods.

3. When is a seller of the goods deemed to be an unpaid seller? What are the rights against

the goods and the buyer personally?

4. What is meant by an unpaid seller? Give the circumstances when an unpaid seller is

entitled to a lien on the goods sold? When does he lose his lien?

5. What is meant by the seller’s right of stoppage in transit? Show how it differs from

seller’s lien.

6. “The right of stoppage in transit is an extension of the right of lien.” Comment.

Chapter – 13

Negotiable Instruments

The law relating to negotiable instruments is contained in the Negotiable instruments Act, 1881.

It is mainly based upon the English Common Law. It deals with the promissory notes, bills of

exchange and cheques. It came in force on 1st March, 1882. It extends to the whole of India

except the State of Jammu and Kashmir.

The word ‘negotiable’ means ‘transfer by delivery’ and the word ‘instrument’ means ‘a written

document by which a right is created in favour of some person”.

Section 31 (i) of the Act defines negotiable instruments as :- “A negotiable instrument means a

promissory note, bill of exchange or cheque payable either on order or to bearer”.

CHARACTERISTICS OF NEGOTIABLE INSTRUMENTS

The important characteristics of negotiable instruments are as under:-

1. Freely transferable

The ownership or property in negotiable instrument is freely transferable from one person

to another. In case, the instrument is bearer, the property in it is transferred immediately

as soon as it is handed over by the transferor to the transferee. In case of order

Learning Objectives:

After going through the chapter, students will be able to learn:

What are negotiable instruments

Promissory note and its essentials

Bill of exchange and its essentials

Cheque and its essentials

Crossing of cheque

instrument, the property in it can be transferred by indorsement and delivery to the

transferee.

2. Better Title

A person who takes instrument bona fide and for value is known as ‘holder in due

course’. A holder in due course gets a good title even if the transferor has defective title.

Moreover, a general law that ‘no one can give a better title than that of his own’ does not

apply in case of negotiable instruments. It may be noted that where the transferability of

the instrument is restricted, the transferee does not get better title than the transferor.

3. Right to sue

The transferee of a negotiable instrument has right to sue in his own name for the

recovery of the amount in case the negotiable instrument is dishonored. He is not

required to give any notice of transfer to the debtor.

4. Presumptions

Certain presumptions as to consideration, reasonable time etc, apply to all negotiable

instrument unless proved contrary.

5. Payment

The negotiable instrument ensures prompt payment because in case of dishonor, the good

will of the person is adversely affected.

6. In writing

A negotiable instrument must be in writing. Just as there is no such thing as “oral

money”, an oral promise or order to pay money obviously cannot serve as a substitute for

it.

7. The Signature

A negotiable instrument must be authenticated by the signature of the maker. A signature

is a symbol executed or adopted by a party with an intention to authenticate a writing.

8. Unconditional promise or order

A promise to pay money is a note, or an order to pay money in a bill of exchange, or a

cheque must be unconditional. The reason is to make pieces of paper acceptable as a

substitute for money, certainty of their payment is required, and a conditional promise

makes the payment uncertain.

9. A sum certain in money

A negotiable instrument must represent a certain sum of money. It can call for payment in

currency, but it cannot call for payment in fish, or rice, or coats, which are things more

suitable to a barter economy.

PROMISSORY NOTE

Definition: - “A promissory note is an instrument in writing containing an unconditional

undertaking signed by the maker, to pay a certain sum of money only to, or to the order of a

certain person or to the bearer of the instrument”. (Section 4)

Therefore a promissory note is a promise in writing by a person to pay a sum of money to a

certain person or to his order. The person who makes the promissory note and signs it is

called “the maker”. The person to whom payment is to be made is known as the “payee”.

10.

11.

ESSENTIALS OF A PROMISSORY NOTE

1. It must be in writing

Every promissory note must be in writing on any paper in ink or pencil. Writing includes

type or printing. A mere oral promise to pay a sum of money does not make a valid

promissory note.

Rs. 2000 LUDHIANA,

May 16, 2015.

On demand, I promise to pay Mr. Ashok or order Rs. 2000 (Rupees Two Thousand Only) for

value received.

To

Mr. Ashok Sd/- Stamp

Chandigarh

2. It must promise to pay expressly

Every promissory note must contain an express promise to pay a sum of money. An

implied promise to pay without writing in express words will not make a valid

promissory note.

3. The promise to pay must be unconditional

To constitute a valid promissory note, the promise to pay must be unconditional. It is

unconditional when its performance does not depend upon the fulfillment of a condition

or happening of a contingency or an uncertain event because that may or may not happen.

Therefore, a promissory note to pay Rs. 2000 on the death of a person is not conditional

for it is certain that he will die one day though the date and time of death is uncertain.

4. It must be signed by the maker

To constitute a valid promissory note, it must be signed by the maker on its face. A

promissory note is incomplete unless it is signed by the maker. Signature includeS the

thumb mark or initials.

5. The maker must be certain

A promissory note is valid only where the maker of the instrument is certain. For fixing

the liability of a promissory note, it is essential that the maker must be definite. It must be

clear on the face of a promissory note who is liable as a maker of the instrument.

6. The payee must be certain

To constitute a valid promissory note, it is essential that the promissory note must contain

a promise to pay some person oR persons ascertained by name.

7. The sum payable must be certain

Every promissory note must specify a certain sum of money payable by the maker to the

payee. The amount promised to be paid must be certain and definite. Where the

promissory note does not specify the amount of money to be paid, it will not operate as a

promissory note.

8. The promise to pay must be in legal money of the country only

To constitute a valid promissory note, it is essential that the medium of payment must be

the legal money of the country only and not bonds, bill or any other form.

9. A promissory note cannot be made payable to the bearer.

10. A bank note or a currency note is not a promissory note

11. A promissory note may be payable on demand or after a definite period of time.

12. A promissory note must be stamped.

BILL OF EXCHANGE

Definition – Section 5 of the Negotiable Instruments Act defines – “A bill of exchange is an

instrument in writing containing an unconditional order, signed by the maker, directing a certain

person to pay a certain sum of money, only to, or to the order of a certain person or to the bearer

of the instrument.

A bill of exchange constitutes a legally binding written promise by the drawer that the person

who took it in payment will be paid in cash when he presents the bill for payment at the proper

time and place.

Parties to a bill of exchange: There are three main parties to a bill of exchange drawer, drawee

and payee.

Drawer – The person who creates an instrument and orders the third party to pay is called a

drawer.

Drawee – The person on whom the bill is drawn, i.e., the person who is directed to pay the

amount stated in the bill

Payee – The person to whom the amount of a bill of exchange is payable.

Points to be noted:

1. Drawer and payee may be the same person, For example, when A signs a bill of exchange

addressed to B reading – ‘pay to me or my order’, he is direction B to make payment to

himself.

2. Drawer and drawee may be the same person. For example, where a bill of exchange

issued by one branch of a firm on the other branch, the firm is acting as both – drawer

and drawee.

3. Drawee and payee may be the same person. For example, when a bill is subsequently

indorsed to the drawee in the course of negotiation, the drawee becomes the payee of the

instrument.

Specimen of a bill of exchange

4.

5.

6.

7.

8.

9.

ESSENTIALS OF A VALID BILL OF EXCHANGE

The definition of bill of exchange is very similar to that of a promissory note. Thus the essential

requirements of the bill are more or less the same as those of a promissory note. The essentials

discussed in the context of promissory note are not elaborated below.

1. It must be in writing.

2. It must contain an order to pay – It is of the essence of a bill of exchange that the drawer

orders the drawee to pay money to the payee. The word ‘order’ means direction here. The

document should express direction of the drawer to the drawee in whatever form of

words. For example, the direction to the drawee need not be expressed by the word “pay”

but any words conveying the idea of pay, say, “ credit in cash” will be sufficient.

3. The order to pay must be unconditional

4. The order to pay must be in terms of money only

5. Parties to the bill must be certain

Rs. 10,000 Delhi,

August 10, 2015

Three months after date, pay to Shyam or order the sum of rupees ten thousand for value received.

To Sachin

Delhi Stamp

- Sd-

6. It must be signed by the drawer

7. It must be delivered

8. Other formalities :- Like a promissory note, a bill should be dated and should mention the

place where it is drawn. But mere absence of these things do not invalidate the bill.

However, adequate stamping is must to maintain a suit upon a bill of exchange.

Distinction between bill of exchange and Promissory Note

Bill of exchange differs from a Promissory Note in the following respects:

Basis of distinction Bill of Exchange Promissory Note

1. No. of Parties There are three parties drawer,

drawee and payee

There are two parties – maker

and payee.

2. Promise /Order It contains an unconditional

order given by a creditor to a

debtor.

It contains an unconditional

promise given by a debtor to a

creditor.

3. Nature of liability The liability of the drawer is

secondary and conditional

The liability of the maker is

primary and absolute.

4. Acceptance It requires acceptance to

become a valuable instrument.

It does not require any

acceptance since it is a

valuable instrument right from

the beginning.

5. Same identity of payer and

payee.

The drawer and payee may be

the same person.

The maker and payee cannot

be the same person.

6. Payable to bearer. It can be payable to bearer. It cannot be payable to bearer.

7. Protest for dishonor. It requires the protesting for

dishonor

It does not require any

protesting.

8. Notice of dishonor. Notice of dishonor must be

given to all persons (including

drawer) liable to pay.

Such notice is not required to

be given to the maker.

CHEQUE

Cheques are the commonest form of payment through banks

Definition – A “Cheque” is a bill of exchange drawn on a specified banker and not expressed to

be payable otherwise than on demand and it includes the electronic image of a truncated cheque

and a cheque in the electronic form.

Specimen of a cheque

Parties to a cheque

Drawer – The person who issues a cheque.

Drawee – The banker on whom the cheque is drawn. Note that in the case of a cheque, the

drawee is always a banker.

Payee – The person to whom the cheque is payable.

The person indorsing the cheque is indorser and the person to whom the cheque is indorsed in

indorsee.

Date__________

Axis Bank,

Threeke Branch, Ludhiana

Pay………………………………………………………………………………………………………………………. or bearer the sum of

Rs………………………………………………………………………………………………………………

Cheque No…………………… Please sign above

Rs_______________

A/C NO.

ESSENTIALS OF A VALID CHEQUE

Following are the essentials of a valid cheque:

1. It must have all the essentials of a bill of exchange

Since the cheque is primarily a bill of exchange drawn on a banker, it must fulfill all the

essentials of a bill of exchange discussed earlier. These may be summed up as follows :

(i) It must be in writing – this includes typewriting and printing. It must be in ink.

(ii) It must contain an unconditional order to pay.

(iii) The order to pay must be in terms of money only.

(iv) The order to pay must mention a definite sum of money.

(v) It must contain certain parties.

(vi) It must be signed by the drawer.

2. It must be drawn on a specified banker

A cheque has to be drawn on a banker only. Thus it can be treated as a limiting case of a

bill of exchange where the drawee has to be a banker.

3. It must be payable on demand

A cheque should always be payable on demand, i.e., it should be payable whenever the

holder chooses to present it to the drawee (the banker)

Activity One – Check Your Progress

1. Negotiable instrument act was passed in ____________

2. Are negotiable instruments freely transferable?

3. Can drawer and payee be the same person?

4. In case of promissory note, the liability of the maker is _____________

5. In case of cheque, the drawee is always a ______________

[Hints: 1. 1881 ; 2. Yes ; 3. Yes ; 4. Primary ; 5. Bank]

CROSSING/ MARKING OF CHEQUES

A drawer can issue a cheque in two ways:

1. An open cheque and

2. A crossed cheque

1. Open Cheque

An open cheque can be enchased by the drawee at the counter of the bank. It is

vulnerable to a great risk of being lost or stolen because in such a case, the holder can

get the payment from the bank and the bank is not liable at all.

2. Crossed cheque

To protect the interests of the owner from the risk of loss, crossed cheques are

introduced. Crossing is a direction to the banker not to make the payment of that

cheque across the counter but to pay it to a bank only. It means that a crossed cheque

shall only be collected by a bank and then it shall be credited to the account of the

person presenting it. Thus, crossing provides a protection to the owner of the cheque

because the payment having been made through a banker and credited to the account

of the holder.

MODES OF CROSSING

There are two types of crossing :-

1. General crossing and

2. Special crossing

1. General Crossing

Section 123 provides that a cheque can be crossed generally when it bears across its face an

addition of :

i) The words “and company” between two parallel transverse lines in the top left hand corner

with or without the words “not negotiable”. Or

ii) Two parallel transverse lines simply with or without the words “not negotiable”.

Specimen of general crossing

1 2. 3. 4.

2. Special crossing

Section 124 provides that where a cheque bears across its face an addition of the name of

the banker either with or without the words “not negotiable”. Transverse lines are not

necessary for a special crossing. It requires only the name of the banker to be added across

the face of the cheque either with or without the words “not negotiable”. A special crossing

makes the cheque even safer than a general crossing, because the payee can receives the

payment only through the banker named on the cheque.

Specimen of general crossing

1. 2.

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3. Restrictive crossing

In order to avoid payment to a wrong person, there is another type of crossing which has

been adopted by commercial and banking usage. In such a crossing, the words “A/C

Payee” or “A/C Payee Only” of “Payee Account Only” are added.

DISTINCTION BETWEEN A CHEQUE AND BILL OF EXCHANGE

A cheque can be distinguished from a bill of exchange

Basis of distinction Cheque Bill of Exchange

1. Drawer It is always drawn on a

bank.

It can be drawn upon an individual as

well as a bank.

2. Payable on demand It is always payable on

demand.

It need not always be payable on

demand.

3. Payable to bearer on

demand

It can be drawn payable

to bearer on demand.

It can not be payable to bearer on

demand [Section 31 of the

Reserve Bank of India Act, 1934].

4. Acceptance It does not require an

acceptance.

It requires an acceptance of the

drawee.

5. Stamp It does not require a

stamp.

It requires a stamp.

6. Three days of grace It is not entitled to three

days of grace.

A bill, unless payable on demand is

entitled to three days of grace.

7. Crossing It can be crossed. It cannot be crossed.

8. Form Its fixed form is honored

by a banker.

There is no fixed form.

9. Notice of dishonor Notice of dishonor is not

required.

Notice of dishonor is usually

required.

10. Countermanding It can be revoked by

countermanding of

payment.

It cannot be countermanded.

Activity Two – Check Your Progress

1. When payment is transferred to the account of person presenting the cheque, the cheque

is a ______________

2. In case of ________cheque payment is made at the counter of bank.

3. A cheque is always payable on _______________

4. In case of negotiable instruments, sum payable should be ______________

5. Does promissory note require acceptance?

[Hints: 1. Crossed cheque ; 2. Open cheque ; 3. Demand ; 4. Certain ; 5. No.

Summary

A negotiable instrument means a promissory note, bill of exchange or cheque

payable either on order or to bearer.

A promissory note is a promise in writing by a person to pay a sum of money to

a certain person or to his order.

A bill of exchange constitutes a legally binding written promise by the drawer

that the person who took it in payment will be paid in cash when he presents the

bill for payment at the proper time and place.

A “Cheque” is a bill of exchange drawn on a specified banker and not

expressed to be payable otherwise than on demand.

A cheque may be open or a crossed cheque.

Activity 3 - Check your progress (Case Studies)

1. A bill of exchange is drawn stating – “Pay to the Ramesh or his order a sum of Twenty

thousand rupees”. In the margin the amount stated is Rs. 2,000. Is it a valid bill? If so,

how much amount it will represent?

[Hint. Yes, it will represent Rs. 20,000. Section 18 of the Act says that if the amount in

words and figures is different in a negotiable instrument, the amount stated in words shall

be taken as final]

2. A cheque is drawn payable to ‘X or order”. The cheque is stolen and X’s endorsement is

forged. The bank makes the payment is due normal course of business the bank liable?

[Hint. No, the bank is not liable for forged endorsements.]

3. X draws a bill of exchange on Y and negotiates it to Z Y is a fictitious person. Can Z treat

it as a promissory note made by X?

[Hint. Yes, where in a bill, the drawee is a fictitious person, it is an ambiguous instrument

and the holder has an option to treat it as a bill or note.

4. A bill is drawn, payable at 201, Bank Square, New Bagh, Delhi – 110009 but does not

contain the name of the drawee. ‘Ramesh’ Who resides at this address accepts the bill. Is

it a valid bill?

[Hint. Yes, when ‘Ramesh’ accepts the bill, he holds by his acceptance that he is the

person to whom the bill is directed.]

5. A company X. Ltd. Issued a cheque to its bankers State Bank of India. A receipt was

appended to the cheque and it ordered the banker to make the payment ‘provided the

receipt form at foot hereof is duly signed, stamped and dated”. Is the cheque valid?

[Hint. No, because its payment is conditional upon singing of the receipt.]

6. A cheque is drawn payable to ‘X or order”. The cheque is stolen and X’s endorsement is

forged. The bank makes the payment is due normal course of business the bank liable?

[Hint. No, the bank is not liable for forged endorsements.]

7. X draws a bill of exchange on Y and negotiates it to Z Y is a fictitious person. Can Z treat

it as a promissory note made by X?

[Hint. Yes, where in a bill, the drawee is a fictitious person, it is an ambiguous instrument

and the holder has an option to treat it as a bill or note.

8. A bill is drawn, payable at 201, Bank Square, New Bagh, Delhi – 110009 but does not

contain the name of the drawee. ‘Ramesh’ Who resides at this address accepts the bill. Is

it a valid bill?

[Hint. Yes, when ‘Ramesh’ accepts the bill, he holds by his acceptance that he is the

person to whom the bill is directed.]

9. A company X. Ltd. Issued a cheque to its bankers State Bank of India. A receipt was

appended to the cheque and it ordered the banker to make the payment ‘provided the

receipt form at foot hereof is duly signed, stamped and dated”. Is the cheque valid?

[Hint. No, because its payment is conditional upon singing of the receipt.]

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal, Taxmann Allied

Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

iv) Business Law, MC Kuchhal, Vikas Publishers

Review Questions

Short Questions

1. What is a negotiable instrument?

2. What are the characteristics of a negotiable instrument?

3. What is promissory note?

4. What is bill of exchange?

5. What is a cheque?

6. What is a crossed cheque?

7. What are the various types of crossing?

8. Differentiate between cheque and bill of exchange.

9. Differentiate between promissory note and bill of exchange.

Long Questions

1. Explain what is meant by a negotiable instrument. Also explain its characteristics.

2. What is a bill of exchange? How does it differ from a promissory note and a cheque?

3. Define a promissory note. Distinguish it from a bill of exchange.

4. What is meant by the term ‘crossing a cheque’? What are the various types of crossings?

Chapter – 14

Parties to Negotiable Instruments

PARTIES TO A BILL OF EXCHANGE

1. The Drawer

The party who draws bill of exchange is called the ‘drawer’.

2. The Drawee

The party on whom such bill of exchange is drawn is called the ‘drawee’. In other words,

drawee is a person who is directed to pay on the bill.

3. The Acceptor

The person who accepts the bill of exchange is known as ‘acceptor’. Generally, the

drawee and acceptor are one and the same persons. The drawee becomes liable to the

holder after he accepts the bill but not before.

4. The payee

The person to whom the bill is payable is called ‘the payee’.

5. The Indorser

When the holder indorses or transfers the bill to any other person. The holder becomes

indorser.

Learning objectives:

After going through the chapter, students will be able to know:

The parties to negotiable instruments

Liability of the parties

Capacity of the parties

How parties are discharged from their liability.

6. The Indorsee

The person to whom the bill is indorsed is called indorsee.

7. The Holder

The person who is legally entitled to the possession of the bill of exchange and to receive

or recover the amount due thereon is called ‘the holder’. He is either the original payee or

indorsee.

If the bill is payable to the bearer, the person in possession of it is called ‘the holder’. But

the finder of the bearer bill or the possessor of the stolen bill be regarded as the holder in

legal sense.

8. Drawee in case of need

Where the drawer of the bill feels that the drawee may not be able to pay the bill, he may

introduce the name of another person in the bill to whom the bill could be presented in

case of dishonor of bill by non-payment. Such name is introduced in addition to the

original drawee and such person is known as “Drawee in case of need’. Such a bill cannot

be treated as dishonoured until it is presented to the ‘drawee in case of need’ for payment.

A bill of exchange can be presented to the drawee in case of need for payment only, it

cannot be presented to him for acceptance.

Amritsar

8th

June, 2014

Three months after date pay A & B Co. Ltd.

Or order Rs. 2000/- for value received.

To :

P & Q Co. LTd

Sd/-

Drawee in case of need :

C & D Co. LTd.

For X & Y C. LTd.

Stamp

In the above bill, P & Q Co. Ltd. is the drawee. If P & Q Co. LTd. does not accept it, the bill is

presented to C & D Co. Ltd., the drawee in case of need before it is deemed to be dishonoured.

9. Acceptor for honour

The person who is not a party to the bill but voluntarily steps in and becomes a party to it

as an acceptor by accepting it for the honour of drawer or indorser, such a person is

known as acceptor for honour.

Such a situation arises on the refusal by the original drawee to accept the bill or to furnish

better security when demanded by notary. A person who comes forward voluntarily and

accepts the bill in order to safeguard the honour of the drawer or pay indorser, binds

himself by such an acceptance. Then he becomes an acceptor for honour. On such an

acceptance, the bill becomes alive and cannot be treated as dishonoured until it is

dishnonoured by the acceptor for honour.

PARTIES TO PROMISSORY NOTE

1. The Maker

The person who promises to pay the amount stated in the promissory note is known as

‘the maker’. Actually, he is the debtor

2. The Payee

The person who is entitled to the amount stated in the note called ‘the payee’. He is a

creditor.

3. The Holder

He is either the payee or someone else to whom the promissory note is indorsed.

PARTIES TO A CHEQUE

1. The Drawer

The person who draws a cheque is called ‘the drawer’.

2. The Drawee

It is drawer’s banker on whom the cheque has been drawn.

3. The Payee

The person who is entitled to receive the payment on a cheque is called ‘the payee’.

HOLDER AND HOLDER IN DUE COURSE

HOLDER

The term ‘holder’ is defined in Section 8 of the Negotiable Instruments Act, which reads as

under : “The ‘holder’ of a promissory note, bill of exchange or cheque means any person,

entitled in his own name, to the possession thereof and to receive or recover the amount due

thereon from the the parties thereto”.

A person is called holder of a negotiable instrument if he satisfies the following two conditions:

(a) He must be entitled to the possession of the instrument in his own name ; and

(b) He must be entitled to receive/recover the amount due on the instrument from the parties liable

under the instrument.

Thus, Holder means the bearer of the bearer instrument and the endorsee or payee of the order

instrument.

Example: X advanced Rs. 10,000 to Y who executed a promissory note in the name of Z a

benamidar. On Maturity Y failed to pay the amount due and X brought an action against Y. it

was held that X could not recover the amount because he was not entitled to the promissory note

in his own name. [Sarjoo Prasad v. Ramapayari Debi]

Only a holder can bring a legal action to recover the amount due on the instrument.

HOLDER IN DUE COURSE

A holder in due Course is –

(i) A person who for consideration obtains possession of a negotiable instrument if

payable to bearer; or

(ii) The payee or indorsee thereof, if payable to order, before its maturity, and without

having sufficient causes to believe that any defect existed in title of the persons from

whom he derived his title.

In other words, a person taking a negotiable instrument in good faith and for value, obtains a

valid title though he takes from one who has a defective title, such a person is known as ‘holder

in due course”.

Thus, in order to be called a ‘holder in due course’ a person must fulfil the following

conditions:

1. He must be a holder: He must have possession of the instrument in his own name under

a legal title.

2. He must be a holder for valuable consideration: he must have paid some consideration

to acquire the negotiable instrument. The consideration, however, need not be adequate.

3. He must have become the holder of the negotiable instrument before its maturity:

He must have acquire the negotiable instrument before its maturity.

4. He must have become holder in good faith without having sufficient cause to believe

that any defect existed in the title of the transferor: This is the most important

condition to be satisfied. He must exercise great care and take all necessary precautions

in finding out if the transferor’s title was defective.

For example, A lost a bearer cheque which was found by B. B purchased a ring against

cheque from C. Here C is holder in due course as he is unaware of B’ defective title and he

has paid consideration for obtaining cheque.

PRIVILEGES OF A HOLDER IN DUE COURSE

A holder in due course enjoys the following privileges under the Negotiable Instrument Act;

1. He gets a better title than that of the transferor

One who is a holder gets no better title than that of his transferor but a holder in due

course is in a privileged position. He gets a better title than that of the transferor.

Although the transferor has obtained instrument by means of an offence or fraud or for an

unlawful consideration, holder in due course gets a better title than the transferor.

For example: If P obtains an instrument ‘payable to bearer’ by theft or fraud, or for an

unlawful consideration, he cannot sue on it. But if P transfers the instrument (being a

bearer one) to R under circumstance (for value in good faith) which make R a holder in

due course, R can sue on the instrument.

2. Liability of prior parties

All prior parties to a negotiable instrument (i.e., its maker or drawer, acceptor and

intervening indorsers) continue to remain liable to a holder in due course both jointly and

severally (i.e., he can hold any or all prior parties liable) until the instrument is duly

satisfied

3. Privilege in case of fictitious bills (Sec.42)

When a bill of exchange is drawn in a fictitious name and is made payable to the

drawer’s order (i.e., where both drawer and payee of a bill are fictitious persons), the bill

is said to be a fictitious bill. Such a bill is not a good bill and cannot be enforced at law.

But the acceptor of such a bill is liable to a holder in due course provided the latter can

show that the first indorsement on the bill and the signature of the supposed drawer are in

the same handwriting.

Example: A bill of exchange is drawn in the name of Mr. A and duly accepted by Mr. B

Later the bill is endorsed in the name of Mr. C. But thereafter, Mr. B finds that Mr. A is a

fictitious person and the signature of the drawer and the endorsee are in the same

handwriting. Here Mr. B cannot deny payment to Mr. C on the ground that Mr. A is a

fictitious person.

4. Inchoate stamped instrument (Sec. 20)

An inchoate instrument means an incomplete instrument. If a holder in due course

receives an inchoate instrument but properly signed and stamped, he can fill it up for any

amount provided the stamp is sufficient. The person who has signed and delivered

incomplete instrument cannot subsequently say that the holder in due course has no

authority to fill it up. Thus, the holder in due course has the right to recover the whole

amount of the instrument even through the amount filled therein was more than what was

due to him.

Example: Mr. A signs a properly stamped but blank instrument and delivers it to Mr. B

to fill it up as a promissory note for a sum of Rs. 200. But Mr. B fills in the paper for Rs.

2000, the stamp being sufficient for Rs. 2000. Mr. B delivers the promissory note to Mr.

C for value received; who takes it in good faith i.e. without any knowledge of the

defective title due to the fraud committed by Mr. B. Mr. A is liable to pay Rs. 2000 to

Mr. C.

5. Conditional delivery has no effect [Section 46]

Where a promissory note or a bill of exchange is delivered conditionally or only for a

special purpose, to a holder in due course, the other parties to the instrument cannot

escape their liability on the ground that the delivery of the instrument was conditional or

for some special purpose only.

For example, Mr. X gives promissory note to Mr. Y on the condition that Mr. Y will

demand the payment only on the marriage of Y’s daughter. But before that , Mr. Y

endorses the instrument to Mr. Z, a holder in due course. Now Mr. X can not refuse the

payment to Mr. C on the ground that he had given the promissory note for a special

purpose only.

6. Instruments cured of all defects [Section 53]

When a negotiable instrument passes through the hands of a holder in due course, It is

cured of all defects. No prior party can refuse to make the payment on such instruments

on the ground that it was a defective instrument before coming into the hands of a holder

in due course.

7. Instrument obtained by unlawful means or for unlawful consideration [Section 58]

The person liable on a negotiable instrument cannot plead against the holder in due

course that the instrument was lost or obtained by means of fraud or an offence or for

some unlawful consideration.

8. Estoppel against denying original validity of instrument [Section 120]

Where a suit is filed by a holder in due course, the maker of a promissory note, the

drawer of a bill of exchange or cheque cannot deny the validity of the instrument as

originally made or drawn.

9. Estoppel against denying capacity of the payee to endorse [Section 121]

Where a suit is filed by a holder in due course, the maker of a promissory note or

acceptor of bill of exchange cannot deny that the payee was incompetent to contract at

the time of making the promissory note or the acceptor had no capacity to contract at the

time of accepting a bill of exchange.

10. Estoppel against denying signature or capacity of prior party [Section 122]

Where a suit is filled by a holder in due course, the endorser shall not be allowed to deny

the genuineness of the signature or capacity to contract of any prior parties to the

instrument

A Holder and Holder in Due Course – A Distinction

Basis of Difference Holder Holder in due course

1. Meaning The holder is a person who is

entitled to the possession of

the instrument in his own

name.

The holder in due course is a

person who takes the

instrument in good faith for

consideration before the date

of maturity.

2. Consideration A holder may acquire an

instrument without

consideration.

A holder in due course must

show that he has acquired the

instrument for valuable

consideration.

3. Nature of title A holder does not get the

better title than that of a

person from whom he

acquired it.

The holder in due course gets

good title even if the title of

any of the prior parties is

defective.

4. Enforcement A holder can enforce the

instrument for payment

against the transferor or who

has signed it.

The holder in due course has a

right to sue all the prior parties

until the instrument is fully

discharged.

5. Maturity A holder may posses the

instrument after the date of

maturity of the instrument.

The holder in due course must

acquire the instrument before

the date of the maturity.

6. Negotiation The person may become

entitled to instrument through

assignment.

The person becomes a holder

in due course only when he

possesses through negotiation.

CAPACITY OF PARTIES

Capacity of the parties means their competency (i.e. capability) to enter into a valid contract.

Every person who is capable of entering into a valid contract, can also become a party to a

negotiable instrument and be bound by the same. The competency of the parties to enter into a

valid contract is defined in section 11 of the Indian Contract Act, 1872. According to this

section, a person who is major, of sound mind, and is not disqualified from contracting by law, is

competent to enter into a valid contract. The following persons can become a party to a

negotiable instrument and become liable thereon.

1. Minors

We know that a minor is not competent to contract. Therefore, he cannot bind himself by

becoming a party to any negotiable instrument.

2. Persons of unsound mind.

Like minor, the persons of unsound mind are also not competent to contract and thus,

they are not liable under the negotiable instruments.

3. Insolvents

An insolvent is not competent to enter into a valid contract unless he is discharged by the

court. Thus, an insolvent cannot draw, make, accept or indorse a negotiable instrument.

4. Corporations or companies

A corporation or a company is an artificial person created by law. It has separate legal

entity independent of its members. It exists in the eyes of law, though it has no physical

shape or form. Therefore, it can become a party to a negotiable instrument through

human agents.

5. Agents

An agent is a person who acts on behalf of his principal. The authority of an agent

depends upon the terms and conditions of the agreement between an agent and his

principal. It may be noted that a person, who is capable of contracting, may make or

accept or otherwise become a party to a negotiable instrument either himself or through a

duly authorized agent acting in his name. Thus, the negotiable instruments can be drawn

or accepted by duly authorized agents on behalf of their principals.

6. Partners

We know that the principle of agency relationship is also applicable in case of

partnership. As a matter of fact, every partner is the agent of the firm, and the partners are

agents and principals of each other. The firm and other partners are liable under the

instrument, if a partner signs the instrument in the name of the firm and on behalf of the

firm.

7. Legal heirs

After the death of the holder of a negotiable instrument, his legal heirs (i.e

representatives) become entitled to the instruments. And the legal heirs of a deceased

holder can sue on the negotiable instruments for the recovery of the amount.

8. Joint Hindu Family

We know that a ‘Karta” (or manager) of a Joint Hindu Family represents the family in all

transactions of the family with the outside world. He can draw a promissory note, a bill of

exchange and cheque whenever necessary for carrying on the family business.

LIABILITIES OF THE PARTIES

1. Liability of drawer

The drawer of bill of exchange or cheque is bound to compensate the holder if bill of

exchange or cheque is dishonored by the drawee or acceptor provided due notice of

dishonor has been given to the drawer. (Sec.30)

The drawer of a bill or cheque is liable to the holder if

(i) The instrument has been dishonoured ; and

(ii) Due notice of dishonor has been given to him.

It is to be noted that the liability of the drawer in case of bill of exchange is secondary for

non-payment by the drawee, but it is primary in case of non-acceptance of bill by drawee.

If the cheque is dishonoured by bank, the liability of the drawer is ‘primary’ i.e. the

holder has right of action against the drawee of the cheque when it is dishonoured by the

bank.

2. Liability of the drawee of cheque

It is the duty of the drawee i.e. the paying bank, to pay duly presented cheque if there are

sufficient funds in the account of the drawer. If the drawee banker wrongfully dishonours

the cheque, may be liable to pay exemplary damages to the drawer.

3. Liability of maker of note or acceptor of bill

The maker of the promissory note and the acceptor of the bill are primarily liable

according to apparent tenor i.e. what appears on the face of the instrument, to the holder

of the instrument because both are principal debtors. The maker of the note and the

acceptor of the bill become liable to pay on the respective instruments at or after the date

of maturity.

4. Liability of indorser

In the absence of a contract to the contrary, the indorser who indorses a bill before the

date of maturity is liable to every subsequent holder, in case the bill is dishonoured by the

drawee. He is under obligation to compensate such holder for any loss or damage caused

to him by the dishonor of the bill.

5. Liability of prior parties

All the prior parties i.e. maker, drawer, acceptor and other intervening indorsers are all

liable to the holder in due course until the instrument is validly discharged.

Activity one- check your progress

1. The person who is not a party to the bill but voluntarily steps in and becomes a party to it

as an acceptor by accepting it for the honour of drawer or indorser, such a person is

known as _________________

2. There are ______________parties in case of a cheque.

3. A person who for consideration obtains possession of a negotiable instrument if payable

to bearer is called ___________________________

4. Can an insolvent person draw a negotiable instrument?

5. If the drawee banker wrongfully dishonours the cheque, may be liable to pay

________________ to the drawer.

(Hints: 1. Acceptor for honour 2. Three 3. Holder in due course 4. No 5. Exemplary

damages)

DISCHARGE OF PARTIES FROM LIABILITIES

The term discharge from liability used in two senses:

1. The discharge of the instrument and

2. The discharge of one or more parties liable on the instrument.

A. Meaning of Discharge of an Instrument

An instrument is said to be discharged only when the party who is ultimately liable thereon is

discharged from liability. When instrument is discharged then all rights of action under the

instrument are completely extinguished and the instrument ceases to be negotiable.

3.

An instrument can be discharged in any one of the following ways :-

1. By payment in due course

When the party who is primarily liable on the instrument makes the payment in due

course, the instrument is said to be discharged. It is most usual method of discharge of an

instrument. After making the payment the party has a right to get back the instrument and

then it ceases to be negotiable.

2. By party primarily liable becoming its holder

When the instrument is negotiated back at or after maturity and its acceptor or maker

becomes the holder in own right the instrument is discharged because none of the

intermediate parties are liable on it.

For example, A gave a cheque to B which endorsed it in favour of C and C further

endorsed cheque in favour of A. Here instrument is discharged.

Modes of Discharge of an Instrument

By payment

in due course

By party primarily

liable becoming holder

By

cancellation

Discharge as

simple

contract

By express

waiver

3. By cancellation

When the holder intentionally cancels the instrument by crossing out his signature or by

destroying it physically.

4. By express waiver

Where the holder of an instrument unconditionally renounces in writing or gives up his

right against all the parties to the instrument at or after its maturity the instrument is

discharged.

5. Discharge as simple contract

A negotiable instrument may discharge by a way as simple contract of payment

discharges, such as by novation or rescission or by expiry of period of limitation.

B. DISCHARGE OF PARTY OR PARTIES

A party is said to be discharged only when a party or parties (other than party ultimately liable on

instrument) to a negotiable instrument is or are discharged and the instrument continues to be

negotiable with the liabilities of undischarged parties attaching thereto.

The liability of the party to a negotiable instrument may be terminated by any of the following

ways :

1. By cancellation

If a holder or his agent cancel the name of any party on the instrument, with an intention

to discharge him, such a party is discharged from the liability to the holder.

2. By release

When the holder of an instrument release any party to the instrument by any method

other then cancellation, the party so released is discharged from his liability towards the

holder.

3. By payment

When the party primarily liable makes the payment of the whole amount on the

instrument to the holder or his agent the instrument is discharged and also all the parties

thereto.

4. By delay in presenting the cheque

Where the holder fails to present cheque within the reasonable time of its issue and as a

result of it the drawer suffers some actual damage the drawer is discharged to the extent

of loss or damage.

Example: A draws a cheque for Rs. 2000 and at that time there were sufficient funds to

meet this cheque. There was delay in presenting the cheque and in the meanwhile bank

fails. Thus, the drawer is discharged from his liability towards the holder.

5. When the bank makes payment in due course

Where the bank makes payment in due course against a bearer cheque, the bank is

discharged from his liability. The bank will not be liable even if the cheque if forged one.

6. By allowing drawee more than 48 hours to accept [Section 83]

If the holder of a bill of exchange allows the drawee more than 48 hours exclusive of

public holidays to accept the bill, all previous parties not consenting to such allowance

will be discharged from liability.

7. By Qualified Acceptance [Section 86]

If a holder of a bill of exchange elects to take a qualified acceptance, all previous parties

whose consent is not obtained to such acceptance are discharged from liability. If notice

is given by the holder to previous parties and they approve such acceptance, then parties

are not dischatged.

An acceptance is qualified –

(a) Where it is conditional declaring the payment to be dependent on the happening of an

event therein stated ;

(b) Where it undertakes the payment of part only of the sum ordered to be paid;

(c) Where it undertakes the payment at a time other than that at which under the order it

would be legally due.

8. Draft drawn by one branch on another

Where a bank draft is drawn by one branch of the same bank for a sum of money payable

to order, the banker is discharged from the liability, if it makes the payment in due course

even if the endorsement of the payee is forged or unauthorised.

9. By not giving notice of dishonor

Where a negotiable instrument is dishonoured and the holder does not give notice of

dishonor to the prior parties entitled to such notice whom he wants to make liable, the

parties stand discharged if the notice of dischonour is not sent to them.

10. By the operation of law

The parties stand discharged from the liability on an instrument by the operation of law in

following two cases:

a) by an order of insolvency discharging the insolvent

b) by lapse of time.

11. By payment of an altered instrument

The party making the payment of an altered promissory note or a bill of exchange or a

cheque is discharged from his liability if the instrument has been altered but does not

appear to have been so altered.

12. By material alteration

Where the instrument is materially altered without the consent of all the prior parties to

the instrument, the parties who have not given their consent to the alteration stand

discharged.

MATERIAL ALTERATION:- An alteration is said to be material if it alters the operation of

the instrument or the rights and liabilities of the parties or the character of the instrument.

Kock V. Disks (1933)

D accepted a bill of exchange drawn in London. An endorsee, in arrangement with drawer

altered the place of drawing from ‘London’ to Deissligen’ a town in Germany. It was held D was

not liable on the bill as it was materially altered.

The instrument is deemed to be materially altered in the following cases :

1. Alteration in the date of the instrument.

2. Alteration in the sum payable on the instrument.

3. Alteration in the maturity date of the instrument.

4. Alteration in the rate of interest

5. Alteration by discharge of any party

6. Alteration in the date of endorsement.

Activity Two- Check Your Progress

1. If payment is made in due course, the instrument is ________________

2. If party materially alters date of instrument, other party is __________

3. If holder of instrument cancel the name of any party, such party is ________

4. One who is having possession of bearer instrument is called ____________

5. The person to whom negotiable instrument is indorsed is called ____________

[Hints : 1. Discharged ; 2. Discharged ; 3. Discharged ; 4. Holder ; 5. Indorsee.]

Summary

There can be various parties to negotiable instruments.

Holder is bearer of bearer instrument and endorsee of an order instrument.

A person taking a negotiable instrument in good faith and for value, obtains a valid

title though he takes from one who has a defective title, such a person is known as

‘holder in due course.

Holder in due course has more priviliges than holder.

A negotiable instrument is discharged either by payment or by other modes.

Activity Three – Check Your Progress (Case Studies)

1. On a bill of exchange for Rs. 10,000, X’s acceptance to the bill is forged. A takes the bill

from his customer for value and in good faith before the Bill becomes payable. State with

reasons whether A can be considered as holder in due course and whether A can receive

the amount of the bill from X.

[Hint: Yes, A can be considered as a holder in due course because he became possessor

of the bill for value and in good faith before it became payable. A cannot receive of the

bill because forgery confers no title even to a holder in due course.]

2. Mr. X writes a bill of exchange on Mr. Y and obtains his acceptance by fraud. Mr. X

endorses the bill in favour of Mr. Z who takes it as a holder in due course. Mr. Z again

endorses the bill in favour of Mr. A who has knowledge of the fraud. The bill is

dishonoured on the due date. Can Mr. A recover the amount of the bill?

[Hint: Yes, he can recover the amount because Mr. A has acquired the bill from a holder

in due course having a good title.]

3. Mr. X writes a bill of exchange on Mr. Y and obtains his acceptance by fraud. Mr. X

endorses the bill in favour of Mr. Z who takes it as a holder in due course. The bill is

dishonoured on the due date. Can Mr. Z recover the amount of the bill?

[Hint: Yes, he can recover it because of his privilege as a holder in due course.]

4. Mr. X the maker of a promissory note makes a note payable to Mr. Y who endorses it in

favour of Mr. Z for a consideration. On maturity, Mr. X dishonor the note on the ground

that he had made it for an illegal consideration. Mr Zsues Mr. X on the note. Can be

recover the amount?

[Hint: Yes, Mr. Z can recover the amount because he is a holder in due course and the

plea of illegal consideration can not be accepted.]

5. A cheque was drawn by Mr. X in favour of Mr. Y a minor. He endorses the cheque in

favour of Mr.Z The cheque was dishonoured by the banker. Can Mr.Z claim payment

from Mr. Y?

[Hint: No, he can not claim payament from Mr. Y, because Mr. Y being a minor does not

incur any liability on a dishonoured cheque.]

6. A promissory note did not contain the rate of interest in the space provided for the

purposes. The creditor puts in the rate of interest. The debtor contends that it is material

alteration and, therefore, he is not liable to pay. Decide.

[Hint: Yes, the debtor is not liable to pay due to alternation]

7. H is the holder in due course of bill, of which A is the acceptor. D, the drawer of the bill

is fictitious. Can A escape his liability to H?

[Hint: A cannot escape liability since H is a holder in due course.]

8. A draws a cheque in Chandigarh on a Bank in Kolkata. The bank fails before the cheque

could be presented in the ordinary course. Is A discharged from his liability under the

cheque?

[Hint: No, since the presentment was not delayed, The payee was not at fault. Thus A

will remain liable here.]

9. A having a balance of Rs. 1,000 in his bank account draws a cheque of Rs. 5,000 in the

name of P.P presents the cheque for payment. The cheque gets dishonoured. Is notice of

dishonor to A necessary in this case?

[Hint: No, notice of dishonor is not necessary in the case of a cheque.]

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal, Taxmann Allied

Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

Review Questions

Short Questions

1. What is drawee in case of need?

2. What is acceptor for honour?

3. Define holder

4. Who is holder in due course?

5. When a negotiable instrument is discharged?

Long Questions

1. Who are the parties to a negotiable instrument?

2. Discuss the liabilities of various parties to a negotiable instrument.

3. Define the terms (1) Holder, (2) Holder in due course.

4. A holder in due course gets a title free from equities.’ Explain the statement and discuss

the various privileges of a holder in due course.

5. Define a holder of bill and distinguish the holder from holder in due course

6. “Every holder in due course must be a holder but every holder may not be a holder in due

course.” Discuss.

7. What are the circumstances in which a party to a negotiable instrument is discharged

from liability?

8. ‘Any material alteration of a negotiable instrument renders the same void.’ Discuss.

Chapter – 15

Consumer Protection Act, 1986

There was nothing to protect the consumers against the exploitation by the business

establishments. More or less they were at the mercy of businessmen. Sometimes, they had to

accept whatever was supplied to them irrespective of the fact whether that corresponded to

the terms of the contract or not. The position of the consumers was more vulnerable

particularly in the service sector such as banking, insurance, transport, corporate bodies,

semi-government establishments etc. therefore, it became necessary to protect the consumers

against the wrong doings of the business establishment. So, the Consumer Protection Act

came into force on 26th

December, 1986

Application of the Act

The Consumer Protection Act, 1986 extends to the whole of India except the State of Jammu

and Kashmir. It is applicable to all the consumers defined under the Act since it came into

effect with effect from 26th

December, 1986. It is applicable to all goods and services except

as otherwise provided by the Central Government by notification.

Learning Objectives:

After going through the chapter, students will be able to learn

What is consumer

What is the remedy to consumer if seller uses unfair trade practices

How to file complaint under the act

Redressal machinery under the act

OBJECTS OF THE ACT

The objects of the Act are as follows:

1. Better protection of interests of consumers

The Act aims at better protection of the interests of consumers. For this purpose, the

act makes provision for the establishment of Consumer Councils and other authorities

so as to resolve consumer disputes.

2. Protection of rights of consumers

The act came to existence with an objective to promote and protect the rights of

consumers which are as follows:

i) Right to safety:

It is the right of the consumers to be protected against marketing of goods which

are injurious to health and life. A consumer has a right to complain against the

dealer if any injury is caused to him due to defect of goods. Moreover he can claim

compensation. For example, if a person buys any medicine, the pharmacy selling it

can be held responsible if the medicine proves harmful.

ii) Right to be informed:

Consumers also have the right to be informed about the quantity, quality, purity,

standard or grade and price of the goods available so that they can make rational

choice before buying any product or service. The consumer must also be informed

about the safety precautions to be taken while using the product to avoid any loss

or injury.

iii) Right to choose:

Every consumer has the right to choose the goods needed from a wide variety of

similar goods. Sometimes, consumers are misguided by advertisements on the TV.

Dealers can also use pressure tactics on consumers to buy their products. These

things can be avoided if consumers are conscious of this right.

iv) Right to be heard :

This right has three interpretations. Broadly speaking, this right means that

consumers have a right to be consulted by Government and public bodies when

decisions and policies are made affecting consumer interests. Also, consumers

have a right to be heard by manufactures, dealers and advertisers about their

opinion on production and marketing decisions. Thirdly, consumers have the right

to be heard in legal proceedings in law courts dealing with consumer complaints.

v) Right to seek redressal :

If any consumer has a complaint or grievance due to unfair trade practices or if he

has suffered any loss or injury due to defective or adulterated products, he has the

right to seek remedies. He can go to consumer forums and file a complaint. He can

get the defective goods replaced or can also demand money refund from the seller

or dealer.

vi) Right to consumer education :

To protect consumers from exploitation, consumer awareness and education are

essentially required. For this purpose, consumer associations, educational

institutions and Government policy makers are making efforts to make consumers

informed and educated about

(a) the relevant laws which are aimed at preventing unfair trade practice;

(b) the ways in which dishonest traders and producers may try to manipulate

market practices to deceive consumers;

(c) how consumers can protect their own interest; and

(d) the procedure to be adopted by consumers while making complain.

3. Consumer Protection Councils

The above objectives are promoted and protected by the Consumer Protection

Councils established at the Central and State levels.

4. Quast-judicial machinery for speedy redressal of consumer disputes

The act seeks to provide speedy and simple redressal to consumer disputes. For this

purpose, a quasi-judicial machinery at the district, State and Central levels havce been

set up.

DEFINITIONS

1. Complaint

It means nay allegation in writing made by complainant regarding:

(i) Unfair or restrictive trade practice,

(ii) Defect in the goods,

(iii) Deficiency in service agreed to,

(iv) Price charged in excess of the fixed or displayed price under any law.

(v) Goods which are hazardous to life and safety.

2. Consumer

A consumer means any person who

(i) Buys the goods for consideration and it also includes any user of such goods

other than the buyer who uses them for consideration ; or

(ii) Hires or avails of any service for consideration and it also includes beneficiary

of such services other than hirer, who take benefit of them for consideration.

It is immaterial whether consideration is paid or not. It may be noted that the

person who buys the goods for resale or any other commercial purpose, is not

a consumer. If a person buys the goods and exclusively uses them for the

purpose of earning livelihood, by self-employment, such a person is a

consumer.

VINAYAKA AGENCIES vs. D N SRIDHAR

A person registered himself for an LPG connection without any registration fee i.e. without

consideration. It was held that he was not a consumer under the Consumer Protection Act,

1986.

MOTOR SALES AND SERVICES vs. RENJI SEBASTIAN (1991)

A person booked a Hero Honda motorcycle with an agency for a consideration. He was

ignored when his turn came. On his complaint, the dealer was asked to deliver him the

motorcycle at that day’s price and a compensation of Rs. 500.

3. Service

According to section 2(1) (o) of the Act, service means-

(a) Service of any description which is made available to potential users, and

(b) includes, but is not limited to, the provision of facilities in connection with banking,

financing, insurance, transport, processing, supply of electrical or other energy, board or

lodging or both, housing construction, entertainment, amusement of the purveying of

news or other information, but

(c) does not include rendering of any service free of charge or under a contract of

personal service.

Service under section 2(1) (o) means only such service which is commercial in nature and is

rendered against payment. Agreement to supply water as part of a contract of tenancy is not

in the nature of a commercial transaction.

4. Complainant [Sec. 2 (1) (b)]

Complainant means:

i) A consumer , or

ii) Any voluntary consumer association registered under the Indian Companies Act, 1956 or

under any other law for the time being in force ; or

iii) The Central Government or any State Government ; or

iv) One or more consumers, where there are numerous consumers having the same interest

who or which make a complaint.

5. Consumer dispute [Sec. 2 (1) (e)]

It means a dispute where the person against whom a complaint has been made, denies or

disputes the allegations contained in the complaint.

6. Defect [Sec. 2 (1) (f)]

It means any fault, imperfection, shortcoming in the quality, quantity, potency, purity or

standard which is required to be maintained by or under any law for the time being in

force or claimed by the trade in any manner whatsoever in relation to any goods.

7. Deficiency [Sec. 2 (1) (g)]

Deficiency means any fault, imperfection or shortcoming or inadequacy in the quality,

nature and manner of performance which is required to be maintained by or under any

law for the time being in force or has been undertaken to be performed by a person in

pursuance of a contract or otherwise in relation to any service.

8. Person [Sec. 2 (1) (m)]

The terms “person” includes the following:-

i) A firm whether registered or not;

ii) A hindu undivided family;

iii) A co-operative society;

iv) Every other association of person whether registered under the Societies Registration Act,

1860 or not.

9. Restrictive Trade Practice

Restrictive trade practice means a practice according to which a consumer has to buy or

hire or avail of any goods or services as a condition before buying or hiring or availing of

those goods or services which he actually wishes to have.

10. Unfair Trade Practice

Unfair trade practice is an unfair method or unfair or deceptive practice which a trader adopts

for promotion of sales, use or supply of any goods or for rendering any service. It includes

the following:

The practice of making any statement, whether orally or in writing or by visible

representation which –

(i) Falsely represents that the goods are of a particular standard, quality, quantity, grade,

composition, style or model ;

(ii) Falsely represents that the services are of a particular standard, quality or grade;

(iii) Falsely represents any re-built, second-hand, renovated, reconditioned or old goods as new

goods ;

(iv) Represents that the goods or services have sponsorship, approval, performance,

characteristics, accessories, uses or benefits which such goods or services do not have ;

(v) Represents that the seller or the supplier has a sponsorship or approval or affiliation which

such seller or supplier does not have ;

(vi) Makes a false or misleading representation concerning the need for, or the usefulness of,

any goods or services ;

(vii) Gives to the public any warranty or guarantee of the performance or length of life of a

product without any sound basis or test;

(viii) A representation to the public regarding warranty or guarantee of a product without

reasonable prospect that such warranty, guarantee or promise will be carried out ;

(ix) Misleading the public concerning the price of goods or services which have been sold;

(x) Gives false or misleading facts disparaging the goods, services or trade of another person.

CONSUMER PROTECTION COUNCIL (SECTION 4-8)

Consumer Protection Councils are the advisory bodies which have been established at three

levels-Central, State & District levels. These bodies have been set up for promoting and

protecting the interests of the consumers. These councils have been entrusted the task of

protecting the rights of the consumers.

(U/S 4-6) (U/S 7&8) (U/S 8A & 8B)

Consumer Protection Council

Central Consumer

Protection Council

State Consumer

Protection Council

District Consumer

Protection Council

The Central Consumer Protection Council

The Central Government shall establish Central Consumer Protection Council (Central

Council) by notification with effect from such date as may be specified in such notification.

The establishment of such Councils has been made mandatory by the Consumer Protection

(Amendment) Act, 2002.

The State Consumer Protection Council

The State Government has been empowered to establish the State Consumer Protection

Council by notification in the official Gazette. The council shall be established form such

date as may be specified in the notification. However, the establishment of such councils has

been made mandatory by the Consumer Protection (Amendment) Act, 2002.

The District Consumer Protection Council

Section 8 A as inserted by the Consumer Protection (Amendment) Act, 2002 provides for the

establishment of the District Consumer Protection Council by the State Government at every

district by notification. It is mandatory to establish the District Consumer Protection Council.

CONSUMER DISPUTE REDRESSAL MACHINERY (SECTION 9-27)

The Consumer Dispute Redressal Machinery is a THREE-TIER, QUASI-JUDICAL

MACHINERY for speedy and inexpensive redressal of consumer grievances and disputes.

The Consumer Dispute Redressal Machinery is an easy redressal alternative for the

consumers than the ordinary process of the civil court which is a very expensive and time

consuming litigation process.

(I) (II) (III)

U/S 9(a) U/S 9(b) U/S 9(c)

I. DISTRICT FORUM

1. Establishment: [U/S 9(a)] The State Government is under statutory obligation to

establish a Consumer Disputes Redressal Forum to be called as “District Forum” in

each district of the State by notification. It is clear that the “District Forum” is an

establishment at District level.

2. Composition: (U/S 10):- Each District Forum shall consist of –

(a) A person who is, or has been, or is qualified to be a District Judge, who shall be its

President ;

(b) Two other members, one of whom shall be a woman.

3. Method of Appointment (U/S 10(1A))

Every appointment must be made (of President & Members of the District Forum) by the

State Government on the recommendations of the selection committee.

The selection committee shall consist of :

(a) The chairman ; who shall be President of the State Commission ;

(b) Members; who shall be Secretary of the Law Department of State and the Secretary

incharge of the Department dealing with consumer affairs in the State.

4. Term of Office (U/S 10(2))

Every member of the District Forum shall hold office for a term of five years or up to the

age of sixty-five years, whichever is earlier.

At Central Level At State Level

National Commission State Commission District Forum

Consumer Dispute Redressal machinery

At District Level

(1) A member shall be eligible for re-appointment for another term of five years of up to

the age of sixty-five years, whichever is earlier subject to the condition that he fulfills

the qualification and other conditions for appointment.

5. Salary and honorarium [Section 10(3)]

The salary or honorarium and other allowances payable to, and the other terms and

conditions of service the members of the District Forum shall be such as may be prescribed

by the State Government.

II. STATE COMMISSION

1. Establishment: The State Government is under statutory obligation to establish a

Consumer Disputes Redressal Commission to be known as the State Commission. The

State Government is required to establish State Commission at State level by notification

in the official Gazette.

2. Composition [U/S 16]

Section 16 prescribes composition of the State Commission. According to Section 16(1), the

State Commission shall consist of :

(i) President. Who is or has been a Judge of a High Court, he will be appointed by the State

Government after consultation with the Chief Justice of the High Court concerned.

(ii) Two members. There shall be atleast two members, however, one member shall be a

woman.

3. Method of Appointment [U/S 16(1A)]

Every appointment must be made (of President & Members of the state commission) by the

State Government on the recommendations of the selection committee.

The Selection Committee shall consist of :

(a) The chairman ; who shall be President of the state commission ;

(b) Members ; who shall be Secretary of the Law Department of State and the Secretary

incharge of the Department dealing with consumer affairs in the state.

4. Salary [Section 16(2)]

The salary or honorarium and other allowances payable to and the other terms and conditions

of service, of the members of the State commission shall be such as may be prescribed

by the State Government.

5. Term of office [Section 16(3)]

(1) Every member of the State Commission shall hold office for a term of five years or up to

the age of sixty-seven years, whichever is earlier.

(2) A member shall be eligible for re-appointment for another term of five years or up to the

age of sixty-seven years, whichever is earlier provided that he fulfills the qualifications

and other conditions for appointment.

II. NATIONAL COMMISSION

1. Establishment: Under Section 9(c) of the Act the Central Government is required to

establish by notification a National Consumer Disputes Redressal Commission to be

known as the National Commission.

2. Composition [U/S 20]

(a) The National Commission shall consist of a person who is or has been a judge of the

Supreme Court, to be appointed by the Central Government, who shall be its President.

The president shall be appointed after consultation with the Chief Justice of India.

(b) The National commission shall consist of minimum four members and one of whom shall

be a woman.

3. Method of Appointment

Every appointment under this clause shall be made by the Central Government on the

recommendation of a Selection Committee consisting of the following namely :

(a) The chairman who shall be the Judge of the Supreme Court to be nominated by the Chief

Justice of India.

(b) The Secretary in the Department of Legal Affairs in the Government of India as member.

(c) Secretary of the Department dealing with consumer affairs in the Government of India as

member.

4. Term of Office

(a) Every member of the National Commission shall hold office for a term of five years or up

to the age of seventy years, whichever is earlier.

(b) A member shall be eligible for re-appointment for another term of five years or up to the

age of seventy years, whichever is earlier, provided that he fulfills the qualifications and

other conditions for appointment.

5. Salary

The salary or honorarium and other allowances payable to and the other terms and

conditions of service of the members of the national commission shall be such as may be

prescribed by the Central Government.

Activity One – Check Your Progress

1. Can complaint be filed against unrestrictive grade practice?

2. One who hires any seen for consideration is called _______________

3. At district level, disparate redressal machinery is _________

4. Every member of redressal machinery can hold office up to __________ years.

5. The consumer dispute redressal machinery is a ________ quasi judicial machinery.

[Hints : 1. Yes ; 2. Consumer ; 3. District Forum ; 4. Five years ; 5. Three tier]

PROCEDURE TO SETTLE COMPAINT

A Consumer may file a complaint with the District Forum, or, State Commission or, the

National Commission depending on the jurisdiction of these. Both pecuniary and territorial

jurisdiction must be considered by the consumer before he files a complaint.

There is a concrete procedure that is to followed when a complaint is filed by the consumer.

The procedure to settle complaint is governed under section 12,13,14,18 and 22 of the

Consumer Protection Act.

(I) (II) (III)

U/S 12, Manner in U/S 18, the same U/S 22, the same

Which Complaint is Procedure is followed Procedure is

followed

Filed as is followed as is followed

U/S 13, Procedure U/S 12,13,14 for U/S 12,13,14 for

on Admission of District Forum District Forum

Complaint

U/S 14, Relief to

The Consumer

Procedure to Settle Complaint

When a Complaint is filed

with State Commission

When a Complaint is filed

with State Commission

When a Complaint is

filed with District Forum

Procedure Procedure Procedure

A. WHEN COMPLAINT IS FILED WITH DISTRICT FORUM

I. Manner in which complaint is filed (Section 12)

The manner in which complaint can be filed covers three precise questions namely:

(i) Who can file a complaint?

(ii) Where to file a complaint?

(iii) How to file a complaint?

(iv) Decision of Forum to accept or reject the complaint.

a) Who can file a complaint?

A complaint relating to any goods sold or delivered or agreed to be sold or delivered or

any service hired or agreed to be hired may be filed with a District Forum by the

following :

(i) A person who is a consumer, or

(ii) Any recognized consumer association, or

(iii) One or more consumers having common interest, with the permission of the District

Forum, or

(iv) The central Government or the State Government.

b) Where to file a complaint?

The answer to this question depends upon the jurisdiction of the District Forum, State

Commission & National Commission.

Value of Goods or Services

(Pecuniary Jurisdiction)

Where to file complaint

(a) If value of Goods or services < Rs. 20

Lakhs

File complaint in District Forum

(b) If value of goods or services > Rs. 20

Lakhs < 1 crore

File complaint in State commission

(c) If value of goods or services > Rs. 1 crore File complaint in National Commission

c) How to file a complaint?

After deciding upon the jurisdiction of the Consumer Dispute Redressal Machinery, the

next step is to proceed with the filing the complaint for which following issues need

attention :

1. Fee :- A prescribe fee is payable for filing a complaint before District Forum, State

Commission or National Commission.

Value of goods or services OR Relief

claimed

Prescribe Fee

Upto Rs. 1 lakh Rs. 100/-

Rs. 1 lakh to Rs. 5 lakhs Rs.200/-

Rs. 5 lakhs to Rs. 10 lakhs Rs.400/-

Rs. 10 lakhs to Rs. 20 lakhs Rs.500/-

The fee can be paid by Demand Draft.

2. Information contained in the Complaint

The complaint must contain the following information :

A cause-title before the main heading.

A Heading

3. Signatures on the complaint

The complaint must be signed by the

The complainant himself; or

When the complainant has authorized someone to represent him, then the complainant must

give the authorized person a signed authorization letter.

In event of the death of the complainant, the legal representative of the complainant can

continue as the complainant.

4. Number of copies of the complaint

A minimum of five copies of the complaint have to be filed. This includes three copies for

the Forum, one copy for the office of the Forum and one copy for the opposite party.

However, the complainant may keep one copy for his own records.

d) Decision of the Forum

On receipt of complaint made, the District Forum may, by order, allow the complaint to be

proceeded with or rejected. However, that a complaint shall not be rejected unless an

opportunity of being heard has been given to the complaint. The admissibility of the

complaint shall ordinary be decided within 21 days from the date on which the complaint

was received.

II. Procedure on Admission of Complaint (Section 13)

(i) When the complaint relates to goods. [U/S 13 (1)]

Where the complaint relates to goods, on admission of a complaint, the District Forum shall :

(a) Refer a copy of the admitted complaint, within 21 days from the date of its admission

to the Opposite Party mentioned in the complaint directing him to give his version of

the case within a period of 30 days or such extended period not exceeding 15 days as

may be granted by the District Forum.

(b) Where the Opposite party on receipt of a complaint referred to him under clause (a)

denies or disputes the allegations contained in the complaint, or omits or fails to take

any action to represent his case within the time given by the District Forum, the

District Forum shall proceed to settle the consumer dispute in the manner specified in

clauses (c) to (g) under the Act.

Manner specified under clauses (c) to (g) of Section 13 (1)

(c) Where the complaint alleges a defect in the goods which cannot be determined

without proper analysis or test of the goods, the District Forum shall obtain a sample

of the goods from the complainant, seal it and authenticate it and refer the sample so

sealed to the appropriate laboratory.

(d) Before any sample of the goods is referred to any appropriate laboratory under clause

(c), the District Forum may require the complainant to deposit to the credit of the

Forum such fees as may be specified.

(e) The District Forum shall remit the amount deposited to its credit under clause (d) to

the appropriate laboratory to enable it to carry out the analysis or test

(f) If any of the parties disputes the correctness of the findings of the appropriate

laboratory, the District Forum shall require the opposite party or the complainant to

submit in writing his objections.

(g) The district Forum shall thereafter give a reasonable opportunity to the complainant

as well as the opposite party of being heard as to the correctness of the report made

by the appropriate laboratory.

Expeditious hearing of complaint

(i) A complaint shall be decided upon within a period of 3 months from the date of

receipt of notice by opposite party where the complaint does not require analysis or

testing of commodities and within 5 months if it requires analysis or testing of

commodities.

(ii) No adjournment shall be ordinarily granted by the District Forum unless sufficient

cause is shown and the reasons for grant of adjournment have been recorded in

writing by the Forum.

(iii)In the event of a complaint being disposed off after the period so specified then

District Forum shall record in writing the reasons for the same at the time of

disposing of the said complaint.

(iv) Passing of interim order. Where during the pendency of any proceeding before the

District Forum, it appears to it necessary, it may pass such interim order as is just

and proper in the facts and circumstances of the case.

III. RELIEF GRANTED TO THE CONSUMER (Section 14)

Under Section 14(1) of the Consumer Protection Act, the District Forum may provide relief

to a consumer by one or more of the following ways:

(i) The opposite party may be directed to remove the defect pointed out by the

appropriate laboratory from the goods in question;

(ii) Replacement of goods of similar description, with new goods which is having no such

defects.

(iii)Return of sum paid by the complainant or any charge paid by the complainant;

(iv) Award compensation to the consumer for any loss or injury suffered due to the

negligence of the opposite party. However, in terms of the Amendment Act, 2002 the

District Forum shall have the power to grant punitive damages by means of

compensation;

(v) Removal of the defects or deficiencies in the services in question;

(vi) Make order to discontinue the unfair trade practice or the restrictive trade practice,

then not to be repeated;

(vii) Make order not to offer hazardous goods for sale;

(viii) Make order to cease the manufacturing process of hazardous goods and also to

abstain from offering services if such services are hazardous in nature;

(ix) In case a large number of consumers are affected whether on account of goods or

services, the Forum may work out the amount so payable, but shall not be less than

five per cent of the value of such defective goods sold or services rendered.

(x) In case of misleading advertisement causing damages, the opposite party responsible

for issuing such advertisement may be directed to issue corrective advertisement;

(xi) Make order for sufficient costs to the parties affected.

Issues to be taken care of while granting relief :

(i) It is necessary that every proceeding held U/S 14(1) of the Consumer Protection Act

will be conducted by the President of the District Forum and at least one member

thereof sitting together.

(ii) According to Section 14(2-A), every order passed by the District Consumer Forum

must be signed by its President and by the member/members who have conducted the

proceedings.

(iii)The minimum amount of sum so payable shall not be less than five percent of the

value of such defective goods sold or services provided, as the case may be, to such

consumers.

(iv) The amount so obtained shall be credited in favour of such person and utilized in such

manner as may be prescribed.

B. WHEN COMPLAINT IS FILED WITH STATE COMMISSION (U/S 18)

Section 18 of the Consumer Protection Act, 1986 states that the provisions of Sections 12, 13

and 14 and the rules made there under will be applicable to the disposal of disputes by the

State Commission. It means that under the Consumer Protection Act, the State Commission

would follow the same procedure for the disposal of complaints as by the District Forum.

Thus, there is procedural similarity between the District Forum and the State Commission for

the disposal of complaints under the said Act, However, necessary modifications may be

made in the procedure by the State Commission with the object to meet the ends of justice.

C. WHEN COMPLAINT IS FILED WITH NATIONAL COMISSION (U/S

22)

Section 22 of the Consumer Protection Act, 1986 states that the provisions of Sections 12,13

and 14 and the rules made thereunder will be applicable to the disposal of disputes by the

Natioanl Commission. It means that under the Consumer Protection Act, the National

Commission would follow the same procedure for the disposal of complaints as by the

District Forum. Thus, there is procedural similarity between the District Forum and the

National Commission for the disposal of complaints under the said Act. However, necessary

modifications may be made in the procedure by the National Commission with the object to

meet the ends of justice.

Activity Two – Check your progress

1. Complaint can be filed with state commission if value of goods is between ________

2. If value of goods is between 5 to 10 lakh then fee for filling complaint is _________

3. Minimum __________ copies of complaint are to be filed

4. Can consumer be awarded compensation for loss or injury?

5. Can redressal machinery reject the complaint?

[Hints: 1. 20 Lakhs to 1 Crore ; 2. Rs. 400 ; 3. Five ; 4. Yes ; 5. Yes]

REFERENCE BOOKS

i) Students’ Guide to Mercantile Laws and Commercial Laws, Rohini Aggarwal, Taxmann Allied

Services Pvt. Ltd.

ii) Elements of Mercantile Law- N.D. Kapoor, Sultan Chand & Sons

iii) A Textbook of Mercantile Law, P P S Gogna, S.Chand& Co. Ltd.

Summary

The Act seeks to provide for better protection of the interests of consumers. For this

purpose, the act makes provision for the establishment of Consumer Councils and

other authorities for the settlement of consumer disputes and for matters connected

therewith.

Consumer Protection Councils are the advisory bodies which have been established

at three levels-Central, State & District levels. These bodies have been set up for

promoting and protecting the interests of the consumers.

The Consumer Dispute Redressal Machinery is a THREE-TIER, QUASI-JUDICAL

MACHINERY for speedy and inexpensive redressal of consumer grievances and

disputes.

A Consumer may file a complaint with the District Forum, or, State Commission or,

the National Commission depending on the jurisdiction of these.

Review Questions

Short Questions

1. Write a note on scope of the Consumer Protection Act 2002.

2. State the objectives of the Act?

3. Who, under the Act, can file a complaint?

4. Define the following terms:

(a) Complainant (b) complaint (c) Consumer

5. Explain the rights of the consumers.

6. How are the members of State commission appointed?

7. When can an appeal be made by consumer?

Long Questions

1. What is the jurisdiction of the various Forums/Commissions for the purpose of the

Consumer Protection Act, 1986?

2. What is the procedure for filing complaints?

3. Explain the manner in which complaint is made.

4. What are the objects of the Consumer Protection Act, 1986?

5. Write a note on the procedure to be followed on admission of a complaint.

6. Explain the term ‘consumer’ under the Consumer Protection Act, 1986. Explain the

rights of the consumers under the Act.

7. What is the procedure for making compliant under the Consumer Protection Act

1986, and procedure after the complaint is made.

8. Define consumer. Explain the objects & Scope of the Consumer Protection Act.