The article has been written by Varnik Yadav, a student of Gujarat National Law University, Gandhinagar. The author has discussed the intricacies of the hire purchase transactions.
Introduction
The important role that contract law plays in our lives has given rise to a number of need-based contracts, such as that of bailment. A modern species of the contract of bailment is the hire-purchase agreement. It is a contract of hire with the option to purchase available at the inception.
Chitty defines characterizes a hire-purchase agreement as an agreement under which an owner lets chattels of any depiction out on hire and further concurs that the hirer may either restore the products and end the procuring or choose to purchase the merchandise when the instalments for hire have achieved an entirety equivalent to the measure of the purchase cost expressed in the agreement endless supply of an expressed total of the agreement. The hire-purchase agreement is therefore related to, but distinct from, a contract of bailment. It contains not only the element of bailment but also the element of the sale.
Hire-purchase agreements originated in England and were thereafter brought to India by the British. Such transactions were initially governed by English law and the major judicial precedents. A specialized act to govern the same, viz. the Hire Purchase Act was passed in 1972 but was never enforced, and was finally repealed in 2005. This gives rise to a most interesting March of Law that begs examination.
This term paper is aimed at a thorough examination of hire purchase agreements with specific reference to the Indian context. Therefore, it would begin with an examination of the history and nature of such transactions, followed by a comparative analysis between the relevant position at Common law and in Indian law. Relevant case laws have been relied upon wherever possible.
Historical Perspective: Development of Hire Purchase Transactions
Hire-purchase transactions originated in England during the mid-19th century when, against the backdrop of the Industrial Revolution, sewing machines were sold under a formal agreement to hire with an option to purchase. Subsequently, other consumer durable goods began to come under the purview of such agreements.
The advent of automobiles provided a great fillip to the proliferation of hire-purchase transactions. Initially, there were only two parties to such agreements, viz. the owner and the hirer. After World War I, the transactions assumed a triangular form with the establishment of large scale financing companies. The new form that became popular was one in which the owner, instead of dealing directly with the hirer, sold his goods to the financing companies, which then let them out to the hirers/intended purchasers under hire-purchase transactions.
In India, hire-purchase transactions were introduced at the beginning of the twentieth century. The pioneering hire-purchase company was the Madras-based Auto Supply Company Ltd. (1920), later known as Commercial Credit Corporation. Other prominent companies included the Motor and General Finance Company and the Instalment Supply Company (c. 1925), based in the north.
In the post-war years, hire-purchase agreements gained popularity, proving particularly useful in the road transport industry and the automobile industry, viz. financing on commercial vehicles. Various government-constituted committees such as the Masani and James Raj Committees have recognised role of hire-purchase agreements in the development of the road transport industry.
With the proliferation of hire-purchase transaction, there has also been a fair amount of litigation with respect to the same. The Courts have been active in expounding the various aspects and characteristics of hire-purchase agreements.
Nature of Hire Purchase Agreements
Overview
According to Chitty, a hire-purchase agreement might be characterized as an agreement under which an owner lets chattels of any depiction out on hire and further concurs that the hirer may either restore the products and end the contracting or choose to purchase the merchandise when the instalments for hire have achieved an aggregate equivalent to the measure of the purchase cost expressed in the agreement endless supply of an expressed total. It is one of the varieties of the agreement of bailment, yet it is an advanced improvement and the guidelines concerning bailment can’t be connected without modification in light of the fact that such an agreement has the component of bailment as well as of the sale.
Such transaction is, therefore, a contract of hire with an option to purchase, and until the option is exercised, property in the goods does not pass to the hirer/vendee. This definition has been comprehensively codified by Section 2 (c) of the Hire Purchase Act, 1972. The purpose of hire-purchase transactions is to assist those borrowers who have problems in furnishing security for lending institutions in purchasing goods: here goods themselves are security because property or title in the goods is retained by the lender until all payments are made. The law of hire-purchase is comparatively modern in origin and is designed to serve the needs of credit buying while at the same time protecting the vendor from being caught in the meshes of the law relating to sales strict sensu.
Hire Purchase: A distinct transaction
In addition to laying down general principles governing hire-purchase transactions, the judiciary has also helped to clarify the distinct nature of such transactions with respect to others, in particular those of sale. The relevant distinctions have been discussed below.
Hire-purchase itself contains an element of the sale. The distinguishing feature of a typical hire-purchase agreement, therefore, is that property in the goods does not pass when the agreement is made but only passes when the option to purchase is finally exercised in compliance with all the terms of the agreement.
The essence of a transaction of the sale is that property in the goods is transferred immediately from seller to purchaser. This is the crux of the definition of ‘sale’ as per Section 4 of the Sale of Goods Act, 1930, which requires that the seller transfers the property in the goods to the buyer for a price. It has been held that it is immaterial whether this price is paid in full or in instalments: if the transfer of possession is accompanied by the transfer of property in the chattels then the transaction is one of sale, whether immediately or in instalments.
A hire-purchase agreement, however, is distinct from a sale and sale by instalments by virtue of the question of passage of property in the chattels. It is an agreement of hire with an option to purchase. There is no immediate passage of property in the chattels as in the transaction of sale. The property does not pass at the time of the agreement but remains in the intending seller and only passes when the option to purchase is exercised after complying with all the terms of the agreement.
Hire-purchase can be further distinguished as against sale by instalments. In Sundaram Finance v. State of Kerala, it was held that a hire-purchase transaction is more complex than that of sale. In the former, the hirer is under no legal obligation to buy the goods; he has an option either to return the goods, thus terminating payment of instalments and forfeiting the amount already paid; or to become their owner by payment in full of the stipulated hire and the price for exercising the option to purchase.
However, in the sale by instalments, the purchaser cannot return the goods once the sale is affected because property in the goods has already been transferred to him. He may not terminate payment of instalments and is legally obligated to complete the purchase by payment of the requisite instalments. In doing so, he would be in breach of contract and would be liable to payment of damages, vide Lee v. Butler and Helby v. Matthews.
In Damodar Valley Corporation v. State of Bihar, the Supreme Court laid down certain tests to determine whether an agreement to be one of hire-purchase as opposed to sale:-
- Whether there is a binding obligation upon the hirer to purchase the goods.
- Whether there is a right reserved to the hirer to return the goods at any time during the subsistence of the contract.
It was held that if there was no binding obligation and such right was reserved, then there was no contract of sale but rather, a hire-purchase agreement. In the same case, it was stated that such an agreement confers no title upon the hirer, but a mere option to purchase based on the fulfilment of certain conditions.
The term ‘hire-purchase’ itself has two meanings. The term is often used to describe contracts that in reality represent agreements to purchase by instalments, subject to the condition that property passes only when all instalments have been paid (hence distinct from sale by instalments). These transactions can perhaps more accurately be described as contracts of conditional sale or credit sale.
In such transactions, there is again a binding legal obligation to purchase the goods and therefore the hirer can pass good title to any purchaser or pledgee dealing with him in good faith, without notice to the original owner. Moreover, termination of a credit sale by the intended purchaser would find him in breach of contract and make him liable for damages. However, in pure hire-purchase transactions, such a legal obligation is absent and so is a transfer of property in the goods. Hence a further purchaser or pledgee can obtain no better title than the hirer had. Credit sale agreements, being distinct themselves, are governed by the Sale of Goods Act, 1930.
Pure hire-purchase agreements must also be distinguished from transactions in which the customer is the owner of the goods and with a view to financing his purchase he enters into an arrangement which is in the form of a hire-purchase agreement with the financier, but in substance evidences a loan transaction, subject to a hiring agreement under which the lender is given the license to seize the goods.
Thus we see that a hire-purchase transaction is distinct and unique.
Modern Trends
Initially, hire-purchase represented a two-party transaction between the owner and the hirer or intended purchaser. However, in modern times, there are variations when a financier is interposed between the owner of the goods and the customer. Many retailers have no wish to act as financiers themselves supplying credit to customers. Consequently, a hire-purchase transaction often involves first, a sale under which the retailer sells the goods to a finance company, and then secondly, a hire-purchase contract under which the finance company lets the goods on hire-purchase terms to the hirer (intended purchaser).
In modern times, therefore, the owner has no real contractual relations with the seller. Similarly, if the owner is unwilling to look to the purchaser of goods to recover the balance of the price, a financier may pay the balance and undertake recovery. In this form, goods are purchased by the financier from the dealer, who then obtains a hire-purchase agreement from the customer under which the latter becomes the owner of the goods on payment of all the instalments of the stipulated hire and exercising his option to purchase the goods on payment of a nominal price.
Hire Purchase and Sales Tax Liability
One of the major questions related to hire-purchase transactions is related to sales tax liability. The basic question is, whether hire-purchase can be classified as sales and thereby attracts sales tax. It appears that initially, the Supreme Court observed that the hire-purchase agreement does not only contain the element of bailment but also the element of sale and hence should also be included as a sale transaction. This was the ruling of the Madras High Court in Commercial Credit Corporation v. Deputy Income Tax Officer.
However, in the landmark judgment of K.L. Johar& Co. v. Deputy Commercial Tax Officer, it was held that a hire-purchase transaction would be liable to sales tax only when it fructifies into a sale at the option of the hirer. Where, however, the option is not exercised or cannot be exercised because of the inability of the purchaser to fulfil all the terms of the agreement, there is no sale and thus the transaction is not liable to sales tax, as the taxable event, which is the taking place of the sale, is not taking place.
Following this judgment (1965), the Law Commission in its 61st Report (1974) on “Certain problems connected with power of the States to levy a tax on the sale of goods and with the Central Sales Tax Act, 1956”, recommended that hire-purchase transactions should not be liable to sales tax unless the impugned sale actually takes place.
Consequently, the 46th Amendment was passed in 1982, thus inserting Clause 29A into Article 366 of the Constitution. With respect to hire-purchase agreements, the Amendment Act stated that since there is sale only when the hirer exercises his option to purchase, only the depreciated value of the goods involved in such transaction at the time the option is exercised becomes assessable to sales tax.
Hence, the present position of tax liability under hire-purchase transactions has been discussed.
