Fundamentals of Contract Law

V.K. Unni
Professor
Indian Institute of Management Calcutta
E-mail: unniv@iimcal.ac.in
 Contract Law
 Law of Contract is the most crucial branch of Business Law.
 It plays a lead role in regulating daily trade, commerce and
industry.
 The Contract Act creates an obligation between the parties to
the contract and not against the whole world.
 In India, the Law of Contracts is contained in the Indian
Contract Act,1872.
 The Act lays down the general principles relating to formation,
performance and enforceability of contracts and the rules
relating to certain special types of contracts like, Indemnity and
Guarantee; Bailment and Pledge, Agency, Negotiable
Instruments etc.
 Contract Law
 The Partnership Act; the Sale of Goods Act; the Negotiable
Instruments Act; though technically belonging to the Law of
Contracts, have been covered by separate enactments
 However, the general principles of the Contract Law are the
basis for all such contracts as well
Difference between Agreements and Contracts
 Though the two terms synonymously but, from a legal
standpoint, there is an important difference.
 All contracts are agreements but all agreements are not
contracts.
 An agreement enforceable by law is a contract
 Contract Law
 All agreements that are made by free consent of the people who are
competent to contract, for a legal object, having a legal
consideration, with an intention to create a legal relationship are
contracts
 Thus, there are five factors that determine whether an agreement can
be legally enforced or not.
1) Free Consent
 Two or more people are said to consent when they agree upon the
same thing in the same sense.
 However, many a times, a consent may not reflect the true intentions
of a party.
 For example, one party may give consent because of being
financially pressured or criminally threatened.
 Thus, such a consent should not make the agreement enforceable
 Contract Law
 Some factors can vitiate a consent
 Consent that is not obtained through coercion, undue influence,
fraud, misrepresentation, or mistake is called free consent
 Coercion means committing or threatening to commit any act
forbidden by law or unlawful detaining or with an intention to cause
that other person to enter into an agreement.
 A good example would be to force someone to consent on gun point
or by hurting or threatening to hurt.
 Undue influence occurs when because of the nature of the
relationship that exists between the parties, one party is able to
dominate the will of the other and uses this dominance to obtain
unfair advantage over the other.
 Contract Law
 A person is in a dominant position when he holds a real or apparent
position of authority for example manager vis a vis an employee
 When a person intentionally tries to cheat another person, it is called
as fraud in a general sense.
 Fraud means and includes any of the following activities done by a
party with an intent to deceive another party or induce the other party
to enter into the contract.
1. the suggestion of a fact which is not true,
2. active concealment of a fact by one who knowledge or belief of the
fact
3. making a promise without an intention to perform.
4. any act intended to deceive
5. any such act or omission that the law declares to be fraudulent.
 Contract Law
 When a person makes an unwarranted statement, however
innocently, which the person believes to be true, and which turns
out to be false, it is misrepresentation.
 Contract induced due to coercion, fraud, or misrepresentation is
voidable at the option or the party whose consent was obtained by
coercion.
 Where both parties to an agreement are under a mistake as to a
matter of fact essential to the agreement, the agreement is void
2) Competence to Contract
The following persons are incompetent to contract
 Minors
 Persons of unsound mind
 Persons disqualified by law to which they are subject to (like
undischarged insolvents, alien enemies)
 Contract Law
Minor's Contract
 According to the Indian law a minor is a person, male or female,
who has not completed the age of 18 years.
 According to the Indian Contract Act, no person is competent to
enter into a contract who has not attained majority.
 In the landmark case of Mohiri Bibee (1903) it was held that a
minor has no capacity to contract and minor's contract is absolutely
void.
 In this case, X, a minor borrowed Rs. 20,000 from Y, a money
lender. As a security for the money advanced, X executed a
mortgage in Y's favour. When sued by Y, the Court held that the
contract by X was void and he cannot be compelled to repay the
amount advanced by him.
 Contract Law
 Indian Courts have applied this decision to those cases where the
minor has incurred any liability and in such cases, the minor is
not liable.
 But if the minor has carried out his part of the contract, then, the
Courts have held, that he can proceed against the other party
 A minor's contract is altogether void in law, and a minor cannot
bind himself by a contract.
 If the minor has obtained any benefit, such as money on a
mortgage, he cannot be asked to repay, nor can his mortgaged
property be made liable to pay
 Contract Law
 Unsound Mind: According to the Law, a person is of sound
mind for the purpose of contracting if at the time of contracting,
he is capable of understanding the contract and capable of
making a rational judgment as to the effects of the contract
upon his interests.
 In India, a contract done by a person of unsound mind is
absolutely void ab initio (invalid from the very beginning).
3) Lawful Object
The object is unlawful if
1. It is forbidden by law,
2. Is of such a nature if permitted it would defeat the provisions of
any law,
 Contract Law
3) It is fraudulent
4) The court regards it immoral,
5) The court regards it opposed to public policy.
 Thus every agreement of which the consideration or object is
unlawful is void.
Void Agreements
 Agreement without consideration is void
 Agreement in restraint of marriage is void.
a) It is the policy of law to discourage agreements, which restrain
freedom of marriage.
b) Where a party is restrained from marrying at all, or for marrying for a
fixed period or from marrying a particular person, or class of persons,
the agreement is void
 Agreement entered between persons not competent to contract are
void
 Contract Law
 Agreement in restraint of trade. Every agreement, by which
one is restrained from exercising a lawful profession, trade or
business of any kind, is to that extent void.
 Agreement in restraint of legal proceedings. Every agreement
by which any party thereto is restricted absolutely from
enforcing his rights under or in respect of any contract, by the
usual legal proceedings in the ordinary tribunals is void to that
extent.
 Agreements by way of wager/ Bet. Agreements by way of
wager are void; and no suit shall be brought for recovering
anything alleged to be won on wager, or entrusted to any person
to abide by the result of any game or other uncertain event on
which any wager is made.
 Contract Law
 Wager contract is one in which parties professing opposing views on
the result of an uncertain event, mutually agree that depending on the
outcome of such event, one will pay or hand over a sum of money or
other stake.
 Neither party has any other interest in the event other than their stake
that they may lose or win.
 Exception - Any amount more than Rs. 500 can be paid to the winner
or winners of any horse race.
 Wagering agreement being void cannot be enforced in any court of
law
 If chance does not play a role and victory is completely dependent on
skill, the competition is not a wager/lottery
 The principle behind treating an agreement by way of wager as void
is that, the law wants to dissuade people from playing games of
chance and make an earning by trying their luck instead of doing
some productive work
 Derivatives: Legal Position
Are Derivatives Contract Void ??
 Derivatives as financial instruments are used to transfer or
hedge the risk
 They are assets, whose values are derived from values of
underlying assets which can be commodities, energy
resources like hydrocarbons, financial assets such as
shares, foreign currencies etc
 There are at least four categories of derivatives, that are
commonly used in transactions called Forwards, Futures,
Swaps,Options.
 Some are traded through exchanges and thus known by the
name Exchange-Traded-Derivatives (ETD).
 Others which are traded directly between the parties are
called as Over-The-Counter (OTC) derivatives.
 Derivatives: Legal Position
 Post liberalization Indian laws also began to accept the
concept of derivatives
 Initially derivatives in securities/shares, were statutorily
recognised
 This was done by the 1999 amendment wherein Section
18A was inserted in the Securities Contracts
(Regulation) Act, 1956
Derivatives Contract
 It states that contracts in derivatives shall be legal and
valid if such contracts are :
 (a) traded on a recognised stock exchange;
 (b) settled on the clearing house of the recognised stock
exchange, in accordance with the rules and bye laws of
such stock exchange
 Derivatives - Legal Position
Landmark Case-law, Rajshree Sugars and Chemicals Ltd.
(RSCL) vs. Axis Bank, 2008, Madras High Court
 Issue before the court was whether the RSCL was liable to
pay dues to the bank arising out of a derivatives contract
 RSCL contended that the derivatives contract (OTC forex
swap) the company entered into with Axis Bank was a wager
and speculative in nature and thus it could not be enforced
 RSCL entered into contract with bank to protect from
fluctuations in the forex market and found itself at the wrong
end of the deal after the dollar depreciated sharply against
the rupee and also against other currencies in 2007
 Derivatives - Legal Position
 Court rejected the argument of RSCL and held that
the prices of derivatives are now scientifically
determined on the basis of a mathematical model
(or formulae) called Black-Scholes Model and
similar models derived from it
 Court noted that the pricing of the deals, follows a
scientific pattern on the basis of Financial
Mathematics and they cannot be termed as wagers.
 Finally the court held that the contract was not void
and thus the arguments raised by Axis Bank was
held valid
 Contract Law
4) Consideration: When, at the desire of the Promisor, the Promisee had
done or abstained from doing, something, such act or abstinence is
called a consideration for the promise.
 Consideration is nothing but the price paid by one party for the
promise of the other.
 It can be in the nature of a positive act or the forbearance of a
certain act, it can be past, present or future.
 Thus, consideration forms an essential part of an agreement without
which the agreement is void.
 This is because, in the absence of consideration, there is no legal
obligation formed between the parties and, therefore, in such a
scenario, they are not bound by the terms of the agreement.
 Contract Law
There are three exceptions for consideration
 Mutual love and affection- Any agreement, made without
consideration, is valid if it is made on account of natural love
and affection between the parties, standing in near relation to
each other, provided it is expressed in writing and it is
registered under the law.
 Promise to compensate for something done: Any
agreement, made without consideration, is valid if it is a
promise to compensate a person, who has already voluntarily
done something for the person making the promise.
 Promise to pay a debt, barred by Limitation law: Any
promise, made in writing and signed to pay a debt, is binding
on the person signing it even though it may be barred by the
law of limitation.
 Contract Law
5) Intention to Create a Legal Relationship
 The intention to create legal relation is an essential
requirement of contract
 Normally the intention to create legal relations is
expressly stated by the contracting parties
 In other scenarios the law will presume the intention,
because of the nature of the commercial dealings
between the parties
 In many domestic agreements, like the kind of
agreements made between parents and children, there is
no intention to create legal relations and no intention that
the agreement should be subject to litigation
 Family relationships do not preclude the formation of a
binding contract, but to create contractual relations, there
must be a clear intention on either party to be bound
 Voidable Contract
 Voidable Contract :- Voidable Contract are valid unless
one of the parties has decided to set it aside
 Voidable Contract generally happens when one side of
the party is tricked into entering a contract by other party
 Voidability of contract without free consent :- when
consent to a contract is caused by coercion , fraud or
misrepresentation the agreement is voidable at the
option of the party whose consent was so caused.
 However , A party to a contract , whose consent was
obtained by fraud or misrepresentation, may if he thinks
fit insist that the contract shall be performed.
 Contract Law
 Difference between Void and Voidable Contract :-
A void contract is considered to be a contract that is invalid, even
from the start of signing the contract.
 On the other hand, a voidable contract is also a legal contract
which is declared invalid by one of the two parties, for certain
legal reasons
 While a void contract becomes invalid at the time of its creation, a
voidable contract only becomes invalid if it is cancelled by one of
the two parties who are engaged in the contract
 In the case of a void contract, no performance is possible, whereas
it is possible in a voidable contract.
 Contract Law
Privity of Contract: A contract is an agreement between two or
more parties that creates an obligation to do or not to do something
 The parties to the contract are under an obligation to perform the
terms and conditions as provided in the contract.
 The contract can confer rights or impose obligations arising under
the contract only on the parties to the contract.
 Third parties cannot be under such an obligation to perform or
demand performance under a contract.
 This is generally called as Privity of contract
There are two aspects of this doctrine.
1. Only the parties to the contract are entitled under it.
 Rights or benefits may be conferred upon a third party but such a
third party can neither sue under the contract nor rely on defenses
based on the contract.
2. Secondly the parties to a contract cannot impose liabilities on a third
party
 Contract Law
Exceptions to the principle
 Over a period of time the Courts have through the various
judgments laid down few exceptions to the principle. The
exceptions are as follows:
1. Trust : Where a person acts as a trustee and enters into a
contract the beneficiary of the contract can sue if the promise
has not been performed by the trustee
2. Third-party Insurance: Third party may claim under an
insurance policy made for their benefit, even though that party
did not pay the premiums
3. Collateral Contracts : Between the third party and one of the
contracting parties like Contracts involving Project Finance
 Contract Law
Breach of Contract
 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 the Act,
or any other law.
 Promises bind the legal representatives of the promisor in
the case of death of such promisor before performance,
unless a contrary intention appears from a contract.
 In a contract each party to the contract is legally bound to
perform his part of the obligation.
 Non-performance of the duty undertaken by a party in a
contract amounts to breach of contract, for which he can be
made liable.
 Contract Law
REMEDIES
 When a party to the contract makes a breach of contract, there are
two possible alternatives available to the other party.
1. To bring an action for the breach of contract
2. To bring an action for specific performance of the contract.
DAMAGES IN CASE OF BREACH
 For the breach of contract damages is the most appropriate
remedy.
 When a contract has been broken, the party who suffers by such
breach is entitled to receive, from the party who has broken the
contract, compensation for any loss or damage caused to him
 Such compensation is not to be given for any remote or indirect
loss or damage sustained by reason of the breach
 Contract Law
 Damages are compensatory and not penal and one who
has suffered loss from breach of contract must take every
reasonable step that is available to him to mitigate the
extent of damages caused by the breach
 Loss of damages must be actual and not by way of
punishment.
 The basic principle of law of damages is that the person
affected by breach of contract shall have fair and just
compensation proportional to the loss sustained in
consequence of the defendant’s breach of contract which
gives rise to the action
 Contract Law
 For e.g. under a contract for the sale of goods, the measure of
damages upon a breach by the buyer is the difference between the
contract price and the market price at the date of breach.
 On a breach of contract to supply goods by the seller, the buyer is
entitled to recover all the expenses of procuring same or similar
goods
 In case of breach of contract, the aggrieved party is only entitled to
recover such part of the loss actually resulting as was at the time of
the contract reasonably foreseeable as liable to result from the breach
 What was at that time reasonably so foreseeable depends on the
knowledge then possessed by the party who later commits the breach
 Contract Law
Compensation for breach of contract where Damages are stipulated
for (Liquidated Damages)
 When a contract has been broken and a sum has been named in the
contract as the amount to be paid in case of such breach, the party
complaining of the breach is entitled, to receive from the party
reasonable compensation not exceeding the amount so named,
whether or not actual damage or loss is proved
 This is beneficial for the aggrieved party as it will get a pre-
determined sum of money without proving any actual damage
 Jurisdiction of the Court to award compensation in case of breach of
contract is unqualified except as to the maximum stipulated
 But compensation has to be reasonable, and that imposes upon the
court a duty to award compensation
 Contract Law
Specific Performance
 Specific performance means actual execution of the contract
as agreed between the parties.
Specific Performance of any contract may, in the discretion of the
court be enforced in the following situations
 When there exists no standard for ascertaining the actual
damage caused by the non-performance of the act agreed to
be done; or
 When the act agreed to be done is such that compensation in
money for its non-performance would not afford adequate
relief.
Contracts which cannot be specifically enforced
1. When compensation in money is an adequate relief.
 Contract Law
2. When a contract runs into such minute and complex details or
is dependent on personal qualifications
3. when a contract is in its nature determinable (containing a
termination clause)
4. when a contract, the performance of which involves
performance of continuous nature, which the court cannot
supervise.
 Thus in other words, specific performance is equitable relief
granted by the courts in case of breach of contract in the form
of a judgment that the defendant must actually perform the
contract according to its terms and stipulations.
 Contract Law
Contract: The elements of a contract
 There are certain elements that must be present for a
legally binding contract to be in place.
The first two are the most obvious:
 An offer: an expression of willingness to contract on a
specific set of terms, made by the offeror with the
intention that, if the offer is accepted, he or she will be
bound by a contract.
 Acceptance: an expression of absolute and unconditional
agreement to all the terms set out in the offer.
 It can be oral or in writing.
 The acceptance must exactly mirror the original offer
made.
 Contract Law
 Thus, a promise cannot come into existence unless the willingness or
assent is communicated to the other party.
 Further, even the revocation, if any, must be communicated to the
other party for it to take effect.
 Therefore, communication is the most critical aspect in the making of
a contract.
Communication
 Thus, a proposal may be made in any way, which has the effect of
laying before another person his willingness to do or not do
something and the acceptance can be signified similarly.
 A promise (i.e. a proposal and its acceptance) can be formed either
by words, written or oral, is which case it is called express or by
action, in which case it is called implied.
 Contract Law
Completion of communication
 Communication of a proposal is complete when it comes to the
knowledge of the party to whom the proposal is made.
 For example, if X sends a proposal in the mail to Y and if the mail
is lost, then the communication of the proposal is not complete.
 Thus there was no contract between the two in the first place
because X’s proposal never came to the knowledge of Y and thus
he could never accept it.
 The communication of an acceptance is complete, — as against the
proposer, when it is put in a course of transmission to him, so as to
be out of the power of the acceptor;
 Contract Law
 The communication of an acceptance is complete as against
the acceptor, when it comes to the knowledge of the proposer
 A proposal can be revoked anytime before the communication
of its acceptance is complete as against the proposer but not
afterwards.
 The communication of a revocation is complete as against the
person who makes it, when it is put into a course of
transmission to the person to whom it is made, so as to be out of
the power of the person who makes it;
 The communication of a revocation is complete as against the
person to whom it is made, when it comes to his knowledge
 Contract Law
 If X makes an offer to Y to sell his car for Rs. 500000
and sends Y a letter at Y’s office address on 1st January
2007 and Y accepts that offer and sends back X an
acceptance letter on 2nd January 2007
 The communication of acceptance is complete — as
against X when Y’s letter is posted
 The communication of acceptance would be complete -
as against Y , when Y’s letter reaches X’s address.
 Thus any revocation of the offer by X should be done
before Y’s letter is posted to X, i.e 2nd January 2007
 Thus any revocation of the acceptance by Y should be
done before Y’s acceptance letter reaches X’s address.
 Tenders as Invitations to Treat
Offers and Invitations to Treat:
 It is sometimes difficult to distinguish statements of intention which
cannot, result in any binding obligation from offers which admit of
acceptance, and so become binding promises.
 A person advertises goods for sale in a newspaper, or announces that
he will sell them by tender or by auction; a shopkeeper displays
goods in a shop window at a certain price etc
 In such cases it may be asked whether the statement made is an offer
capable of acceptance or merely an invitation to make offers, and do
business.
 An invitation of this nature, if it is not intended to be binding, is
known as an 'invitation to treat."
 Contract Law : Tenders
 Tenders: A statement that goods are to be sold by tender is not
normally an offer to sell to the person making the highest tender; it
merely indicates a readiness to receive offers
 Similarly, an invitation for tenders for the supply of goods or for
the execution of works is, generally, not an offer, even though the
preparation of the tender may involve very considerable expense
 The offer comes from the person who submits the tender and
there is no contract until the person asking for the tenders
accepts one of them
 These rules, may be excluded by evidence of contrary
intention: e.g. where the person who invites the tenders
states in the invitation that he binds himself to accept the
highest offer to buy
 Contract Law : Tenders
 In such cases, the invitation for tenders may be regarded either as
itself an offer or as an invitation to submit offers coupled with an
undertaking to accept the highest
 When parties negotiate with a view to making a contract, many
preliminary communications may pass between them before a
definite offer is made
 One party may simply respond to a request for information or he
may invite the other to make an offer; he is then said to make an
"invitation to treat”
 The question whether a statement is an offer or an invitation to
treat depends primarily on the intention with which it was made
 Contract Law: Tenders
 How a Tender differs from an ‘Offer’?
 ‘Offer’ in Section 2(a) of Indian Contract Act, 1872, is defined as
 “When one person signifies to another his willingness to do or to
abstain from doing anything, with a view to obtaining the assent of
that other to such act or abstinence, he is said to make a proposal”
 It is the willingness of a person to act or abstain from an act which
differentiates an ‘Offer’ from a mere ‘Invitation to Treat’ or an
“Invitation to Offer”.
 In a ‘Invitation to Treat’ this willingness is missing
 ‘Tenders’, advertised mainly by government / public companies in
India, who ask Contractors to submit their best offers on the pre-
specified terms also fall within the category of invitation to treat
 Contract Law: Tenders
 Due to their bargaining advantage, these government
companies are able to get a good product/ service at a great
price.
 The agreement in such a scenario comes into effect with one
of the many Contractors whose bid is accepted, out of many
bids (‘offers’).
 Maximum that an unsuccessful Contractor can ask is for a fair
competition between the fellow Contractors, as “State” is
defined to include the government bodies (Article 12 of Indian
Constitution)
 Contractors can seek this remedy through Writs.
Carlill v Carbolic Smoke Ball Company
 Carlill v Carbolic Smoke Ball
Company
 The Carbolic Smoke Ball Company made a product called the
"smoke ball“, it claimed to be a cure for influenza and a number of
other diseases
 The Company published advertisements in newspapers in 1891 and
claimed that it would pay £100 to anyone who got sick with influenza
after using its product according to the instructions set out in the
advertisement
 Mrs Carlill saw the advertisement, bought and used three times daily
for nearly two months and finally she contracted the flu in 1892.
 She claimed £100 from the Carbolic Smoke Ball Company
 Carlill v Carbolic Smoke Ball
Company
 Company did not pay saying that it was not a serious contract
and finally the case was filed
 The Court rejected the company's arguments and held that there
was a fully binding contract for £100 with Mrs Carlill.
Among the reasons given by the three judges were
 that the advertisement was a unilateral offer to all the world

 that satisfying conditions for using the smokeball constituted

acceptance of the offer that the company's claim
 that £100 was deposited at the Alliance Bank showed the serious
intention to be legally bound
 Tenders
 An auction generally is seen as an invitation to
treat, with the property owner asking for
offers of a certain amount and then selecting
which to accept.
 However, if it is stated by the owner that there
is no reserve price or that there is a reserve
price beyond which offers will be accepted
then the auction is most likely a contractual
offer which is accepted by the highest bidder
 Discharge of a Contract
 Discharge of a valid contract involves the process under
which the primary (performance) obligations come to an end.
 Discharge can be by way of a) Agreement b) Performance c)
Breach d) Frustration
 Since contractual obligations are created by an agreement it
can also be discharged by agreement between the parties
 Discharge by performance will not give rise to secondary
obligations, as the contract has been successfully completed
 Discharge by breach gives rise to secondary obligations to
pay damages
 Discharge by frustration happens when the performance
becomes impossible or illegal
 Discharge of a Contract
 This will only happen when the circumstances are so different
that performance in the changed circumstance would be
totally different from what the parties originally intended
 A contract will only be frustrated by events which were totally
unforeseeable at the time
 This means that performance must not merely be
cumbersome or unexpectedly costly for one party; there must
be no way for it to actually be accomplished.
Contract Law………

V.K. Unni
Professor
Indian Institute of Management Calcutta
E-mail: unniv@iimcal.ac.in