This article is authored by Miran Ahmed who is a student of BBA.LLB(H) at Amity Law School, Kolkata; and deals with the essentials and fundamentals of contract under the Indian Contract Act, 1872.
What is a contract and what are the essentials of a valid contract?
Section 2(h) of the Indian Contract Act, 1872, defines the term contract as ‘An agreement which is enforceable by law is a contract’. So we can say that a contract is an agreement between two or more parties to do or to abstain from doing something, they decided in exchange for something, that is, a consideration.
General principles in the formation of a Contract involves –
- Intention to create Legal Relations.
- Offer and Acceptance.
- Lawful Consideration.
- Capacity of the involved parties.
- Free Consent.
- Object of the contract must be legal.
- The agreement must also have the elements of certainty and possibility of performance for it to be enforceable by law and it must not be void.
All the above elements must be present for the contract to be valid and gain substance. If any of them is not present, an agreement does not become a contract and therefore, isn’t enforceable by law. This means that every contract is an agreement but not every agreement can be called a contract. Section 10 defines that, “All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void.” This means that all agreements are contracts if the fundamentals of a contract are met.
What is an agreement and what constitutes an agreement?
An Agreement is a promise between two entities creating mutual obligations by law. Section 2(e) of the Indian Contract Act, 1872 defines an agreement as ‘Every promise and every set of promises, forming the consideration for each other, is an agreement’. We understand by the very definition under section 2(e) that the word “agreement” consists of two parts –
- Promise – Promise has been defined under Section 2(b) of the Indian Contract Act, 1872. When one party proposes to do or abstain from doing something, that is, make an offer – and the second party gives his accent, in that case we can say that the offer has been accepted. This then becomes a promise. There are mainly four defined types of promises. Section 9 of the Indian Contract Act, 1872 defines promises.
- Expressed Promises – These are defined under Section 9 of the Indian Contract Act, 1872. When the promise of any offer or acceptance has been conveyed in expressed words be it, orally or in a written fashion, the same are called expressed promises.
- Implied Promises – These are defined under Section 9 of the Indian Contract Act, 1872. When the promise of any offer or acceptance has been made in any other form other than in expressed terms, the same are known as implied promises.
- Reciprocal Promises – These are defined under Section 2(f) of the Indian Contract Act, 1872. When promises form as a consideration for an agreement to be concluded, that is, they form consideration for each other – they are called reciprocal promised.
- Alternative Promises – These are defined under Section 58 of the Indian Contract Act, 1872. Alternative promises are the kind of promises which give the choice of one out of two things.
- Acceptance – The acceptance of a promise can either be expressed by words or actions and must be absolute for the contract to be valid. The acceptance also be implied by actions when dealing with general offers or general offers of continuance. Section 3 deals with acceptance, communication and revocation.
- Consideration – Section 2(d) of the Indian Contract Act, 1872 defines the term consideration, when at the desire of the promisor, the promisee or any other person has done, or abstained from doing something or does or abstains from doing something; or promises to do, or to abstain from doing something; then such act, abstinence or promise is called a consideration for the promise.
In short, the term consideration means ‘something in return’ i.e. ‘QUID PRO QUO’.
Consideration is one of the most important parts of a contract because it states why each party is joining the agreement. Consideration must have value in the eyes of law and can be an exchange of money for products or services, or it can be a trade of one type of product for another type of product. Any consideration must also be lawful and the contract is void ab-initio (from the beginning) of the consideration is unlawful. The rules of consideration include the following:
- It can be past, executory or executed – Consideration provided for any promise must be in relation to that promise. If something has been completed and the promise comes after the completion of such consideration, this is called past consideration. Executory consideration consists of two promises while executed consideration consists of one promise which comes before an action.
- Consideration must be from the promisee – Any consideration must be provided by the promisee in order for it to be enforceable. This means that any party that has not provided any consideration with regards to a promise cannot enforce that promise. And that promise can only be enforced by the party that has provided consideration for it. In the case of Tweddle V. Atkinson, it was held that the son cannot enforce the promise made to his father, as he himself had not given any consideration for it thus, not making is legally binding on him.
- Consideration must have value under law – It must have some economic or material value even if it is negligible in amount. It cannot be of solely sentimental or emotional value. In the case of White V. Bluett, 1853, it was held that a vague promise of being paid compensation for having been treated unfairly cannot be a proper consideration.
- Consideration need not be adequate but must be sufficient – Any consideration must have some value to the other party. But the court does not concern on the market price of the topic and thus, the consideration may not be adequate. In the case of Chappell & Co-Limited v Nestlé Co-Limited, it was demonstrated that consideration may have negligible value.
- Payment of a lesser sum is not the satisfaction of the completely agreed upon sum – If a promise involves less than the full amount of debt, it is not enforceable. The part payment of a debt does not extinguish the whole debt even if the other party consents to it. In Pinnel’s Case, it can be observed that an agreement to accept a lesser sum to settle the debt owed even if it is consented to and well-attested, is not a binding obligation because there is no new consideration that supports the new agreement.
- Competence – The parties must be competent to contract for the agreement to be legally binding. This means that they must have reached the age of majority and must be mentally sane or stable at the time of the inception of contract. They also must not be insolvent or financially unable to form a contract.
- Free Consent – This means that consent to enter into a legal relationship by both parties must be freely given and must not have the following elements:
- coercion, as defined in Section 15, or
- undue influence, as defined in Section 16, or
- fraud, as defined in Section 17, or
- misrepresentation, as defined in Section 18, or
- mistake, subject to the provisions of Sections 20, 21 and 22. Consent is said to be so caused when it would not have been given but for the existence of such coercion, undue influence, fraud, misrepresentation or mistake.
What are the key differences between agreements and contracts?
Basis for Comparison
An agreement is made when a proposal by one party is accepted by another lawful consideration.
A contract is made when an agreement becomes enforceable by law.
Offer and Acceptance
Agreement and Enforceability under law
Usually written and registered
There is no legal obligation as long as it is a mere agreement.
Once the agreement becomes a contract, there is a legal obligation by parties involved.
What are Bilateral Relations?
The bilateral contract is the most common kind of binding agreement.”Business contracts are almost always bilateral. Businesses provide a product or service in exchange for financial compensation, so most businesses are constantly entering into bilateral contracts with customers or suppliers. A bilateral contract is an agreement between the two parties in which each side agrees to fulfil his or her side of the bargain.
How are contracts a civil obligation?
Civil obligation is that which is binding under civil law. Agreements become enforceable under law only when it becomes a contract after meeting the requisite fundamentals of a contract such a free consent, offer and acceptance, consideration, etc. Thus, contracts are a civil obligation as they are enforceable under civil law after gaining legal validity.
What are different types of contracts?
There are various types of contracts that are formed voluntarily via civil obligations. They are as follows:
(I) Adhesion Contracts – This type of contracts are those which are formed by the stronger party. It is a sort of, “Opt for it or do not” contract. The stronger party or the one that has the bargaining power leaves the other party with a choice whether to accept or reject the contract.
(II) Aleatory Contracts – This type of contract involves a mutual agreement that comes into being after an unexpected occurrence, accident, or a natural calamity. In this type of contract both the parties have an element of risk. Fire or Car insurances are this type of contract.
(III) Bilateral and Unilateral Contracts – Bilateral contracts involve two parties. Both parties are obliged to one another for performing or abstaining to perform any act. It is also called a two-sided contract as it involves two way promises. Meanwhile, unilateral contracts are those in which the promise is made by only one party. They consist of an offeror and offeree. The offeror makes a promise to perform an action and is bound by the law to do so. The offeree is not bound to the court even if he fails to execute the requested action because he does not promise anything at all.
(IV) Express Contracts – These contracts are those wherein the terms of the contracts are expressed clearly whether in written documents or orally.
(V) Implied Contracts – There is no oral or written terms in this type of contract. The contracts are assumed owing to the facts of the parties. If an individual visits a medical professional, he expects to be diagnosed for a disease or illness and be advised a cure. This is an implied contract and a patient is capable of suing a medical practitioner for malpractice.
(VI) Void and Voidable Contracts – Void contracts are illegal from the very beginning and hold no validity under law. They are thereby un-enforceable. Voidable contracts are unlike void contracts in the sense that one party is bound by the contract and the unbound party is capable to terminate the contract as they are unbound to it.
A quasi-contract is unlike a real contract. Salmond defines quasi contracts as “there are certain obligations which are not in truth contractual in the sense of resting on agreement, but which the law treats as if they were”. It is important to remember that even though it is imposed by law, it is not created by the operation of the contract.
What is Proposal or Offer?
Proposals are commonly referred to as an offer. The entire process of entering into a contract takes form when an offer has been made.
According to Section 2(a) of the Indian Contract Act, 1872 proposal has been defined as “when one person will signify to another person his willingness to do or not do something (abstain) with a view to obtain the assent of such person to such an act or abstinence, he is said to make a proposal or an offer.”
The person making the offer/proposal is known as the “promisor” or the “offeror”. And the person who may accept such an offer will be the “promisee” or the “acceptor”.
What is a General Offer?
A general offer is any offer which is not made to a definitive person but rather to the public at large or the entire world which includes any individual that may understand the offer and accept it. It is however different from invitation to an offer which is also made to the public at large but merely invites individuals to make an offer which may or may not be accepted by the offeree owing to the consideration of other factors. Like a bookseller advertising new books on a window of his shop is merely inviting offer and not making an offer. But a general offer can be accepted by any individual willing to fulfill the terms of the offer. A contract can be made with any individual who possesses the knowledge of the offer and accepts it by fulfilling the terms of the offer. For example, a reward offered to any individual to help find a lost pet can be accepted by anyone. But the reward is binding only if the acceptor had knowledge of the offer and completed the terms of the offer as requested by the offeror. If a person found the pet and reunited it with the owner but did not know anything about the reward. Then he cannot be said to have accepted the offer and therefore, is not owed the reward.
How can a proposal be acceptable by conduct?
Section 2(b) of the Indian Contract Act, deals with acceptance of proposals. It also recognizes that in certain cases the offeror invites acceptance by doing an act, “it is sometimes impossible for the offeree to express his acceptance otherwise than by performing of his part of the contract.” For example, if a reward is publicly offered for the fulfilment of any terms or the completion of an act, then any individual who fulfils the terms of the contract by completing those acts is owed the reward, considering he possessed knowledge of the offer and accepted it by completing the acts required in the offer. In the case of Carlill v Carbolic Smoke Ball Co., the court held that there was an offer to anyone who performed the conditions mentioned in the advertisement faithfully and by such performance the offer became a legally binding contract. Also, in the case of State of Bihar vs Bengal Chemical and Pharmaceutical Works, it can be observed that the mere performance of the act prescribed in the proposal converts it into a promise even without further communication of acceptance as it is a general offer.
What is a general offer of continuing nature?
A general offer of continuing nature is much like a general offer but differs in the way that it does not end when the terms of the offer are accepted and met by any individual but continues to exist and apply to any other individual that may complete the set terms. A general offer to locate someone’s pet comes to an end when another individual finds the pet and gets the reward. But a general offer of continuing nature would not end when the terms are accepted and completed by one party. For example, if a restaurant offers a sum of money to any individual who can eat a particular meal within a stipulated time period as a challenge. And one individual finishes the challenge successfully, then the contract does not end. Another individual can compete the same challenge and still earn the reward. The general offer of continuing nature does not end when one party meets the terms and the reward is owed to all parties that complete the terms until the offer is revoked. And sufficient approach is taken to make the general public aware of the revocation of offer in a general manner.
What is communication of a proposal and acceptance and how is it done?
According to the Indian Contract Act, 1872, the communication of the proposal is deemed by an act of the party proposing or accepting an agreement by which he intends to communicate such proposal and agreement to the other party or which has the effect of communicating it.
The acceptance of the offer must be absolute and cannot be arbitrary or open to interpretation of the reader. If ‘A’ wishes to purchase a black horse from ‘B’ who has two horses a white and a black one, then he must mention in his acceptance that he wishes to purchase the black horse. This would make the acceptance absolute.
In a valid contract, the communication of acceptance must be in a manner specified by the proposer. If the proposer requires an acceptance of the offer by email, then the acceptance must be conducted via an email for it to be a valid contract.
What are Implied Proposals?
An implied offer is one that’s implied rather than overtly stated. For instance, a person who buys a product from a seller assumes that the product functions properly without a seller explicitly claiming that the product works. An agreement stems from the offer, and the offer is then construed as the proposal. According to the Contract Act, a person who makes an offer, when he or she implies to another party regarding the validity of a product or service, has officially entered into an implied offer agreement.
When is communication completed?
The communication of a proposal is complete when it comes to the knowledge of the party to whom it is made or when the other party is made aware of it.
The communication of acceptance is completed, as against the proposer as soon as the same has been set in the course of transmission and is beyond the control of the acceptor. Whereas, the communication of acceptance is completed, as against the acceptor as soon as the acceptance has come to the knowledge of the proposer.
‘A’ proposes, by letter, to sell a car to ‘B’ at a certain price. The communication of the proposal is complete when ‘B’ receives the letter.
‘B’ accepts the proposal of ‘A’ by a letter sent by post. The communication is complete as against ‘A’ when the letter is posted; and as against ‘B’ when the letter is received by A.
How can proposals and acceptances be revoked?
A proposal can only be revoked at any time before the communication of acceptance is complete as against the proposer and not afterwards.
An acceptance can be revoked at any time before the communication of acceptance is complete as against the acceptor and not after that.
‘A’ proposes, by a letter posted, to buy a computer from ‘B’. ‘B’ accepts the proposal to sell the computer.
‘A’ can revoke his proposal at any time before or at the moment ‘B’ posts his letter but cannot do so after he has posted it.
‘B’ can revoke his acceptance at any time before or at the moment when ‘B’ posts his letter of acceptance but not after that.
What is the intention to contract and what is its significance?
The intention to contract is the mental capacity and intents to create and enter legal relations with respect to a contract. It is the intention to enter a legally binding agreement or contract and is one of the fundamental elements in the formation of a contract. It implies readiness of a party put oneself in the position of having entered into a legally binding agreement or contract. It holds significance because:
- It shows the contracting parties are in an obvious state of mind to enter into a serious contract. And the agreement is freely consented to.
- If there is no intention to create legal relations, the contract would not be legally binding.
- Without intention to enter into a legal relationship, the parties cannot sue each other. Thus, it may become a mere promise and not a valid contract.
How does intention to enter into a contract apply to family and social matters?
In relations of social friends there is no presumption for an agreement to be considered a contract and to make it legally binding or enforceable under law. Or in cases of exception, the presumption is rebuttable.
In the case of Simpkins V. Pays, 1955, the case shows mutuality. In this case the defendant, her granddaughter and the plaintiff who is a paying lodger regularly took part in a newspaper competition. All contributed but entered in defendant’s name. There are no arrangements that state payment of postage, etc. When the entry of the competition is successful, the defendant refused to share with plaintiff, the winnings of said competition. The plaintiff sued for his share of the rewards. Court after applying the objective test ruled legally binding relationship as sufficient mutuality in the arrangements between the parties and the grandmother was ordered to pay one-third of the winnings to the lodger.
Similarly, in family or domestic relations, there is no presumption for any agreement to be legally binding. In cases of exception, the presumption is rebuttable.
In the case of Balfour V. Balfour, 1919, the husband brought his wife to England from Sri Lanka to live with him. The husband had to return to Sri-Lanka but the wife stayed for medical reasons. He promised to pay her £30 each month until his return. On failure to pay, the wife sued the husband for breach of contract. Wife’s action failed because there is no consideration from her and no intention to create a legally binding agreement was found. The court stated that in husband and wife cases, the burden of proof is on the plaintiff to prove the intention to create a legally binding agreement.
How does intention to enter into a contract apply to business matters?
In business or commercial relations, there is a presumption for intention to be legally binding, unlike family and social relations. However, in terms of exception the presumption is rebuttable. In the case of Kleinwort Benson V. Malaysian Mining Corporation, the court observed that no intention to create a legally binding statement cannot be meant to act as guarantee stating on current position and not future intention.
What is a test of contractual intent and its significance?
There are two tests to determine contractual intent or the intention to enter into a legally binding agreement. One is the objective approach wherein the court uses this approach to look at any case from the point of view of any rational individual. While the other is a subjective approach which requires the court to consider the party’s state of mind while entering into a contract to determine whether the contract is legally enforceable. Many legal experts reject the subjective approach but some observe it should play a more important role in contract law as intention to enter into a contract is fundamental to the creation of any contract.
Intent is fundamental to any contract and can be defined as an individual’s state of mind while performing an act or behaving in a particular way. It is the cause or aim behind the activity or the sequence of activities that an individual wishes to perform. And any contract is only enforceable of both parties show intention to be legally bound. Thus, the tests to determine intent holds great significance in contract law.
Intent must be expressed through clear and unambiguous words or actions. And the other party must understand the words or actions as the previous party had intended to be understood. Sometimes there may be miscommunication owing to the method of communication or similar factors such as:
- Wrong selection of words or actions than can be expected by any rational individual.
- Misunderstanding or alternate interpretation of words or actions.
- Intentional concealment of facts or secrets.
The tests help determine the legal validity of any contract and help judges decide on cases to determine if a contract is enforceable under law or void from the very beginning. Contract law seeks to differentiate between contracts with intention to create a legally binding and those with no intention to do so. Therefore, it holds great significance while determining the facts of any case dealing with contract law.
What do objectivity and subjectivity mean as a test in contracts?
Joseph Dance observes objectivity as words which are reasonably understood by the party to whom they were spoken. And subjectivity as the fundamental intent one’s mind. The intention to create legal relations is often observed as a barrier in avoiding the subjective intent of the parties. The courts attempt not to use a subjective approach while delivering judgements but this poses a difficulty as any contract requires the establishment of intent. When observing cases like Balfour V. Balfour, 1919, and Carlill V. Carbolic Smoke Ball Co, it becomes clear that the courts look objectively to identify the intent behind the formation of contracts. The case of Balfour was used to establish removal of intent while dealing with cases of social and domestic disagreements. But inferring intention in commercial cases like Carlill due to conduct. Therefore, actions taken by the courts remove the doubts that subjective view contributes to, and provides certainty which is desired when intention to create legal relationships is concerned. Neither the objective or subjective tests are better than the other, as they combine effectively to provide certainty in contracts. There is a preference for the objective test as it has the benefit of providing the judges with direction within the application of case laws to the basic requirements of any valid contract. It is also a consistent approach usually practiced all over the world.
What is the Supreme Court’s view on the requirement of intention?
A Supreme Court bench comprising of Justices Rohintan F. Nariman and Sanjay Kishan Kaul held that:
- A contract should be read as it reads, as per its express terms.
- The concept of implied terms must come into play only when there is a strict necessity for it.
- Commercial courts ought to be mindful of the contemporary technical expertise of legal drafting and must not endeavour to imply terms into a contract.
In the case of Nabha Power Limited V. Punjab State Power Corporation Limited, the Supreme Court dealt with the issue of interpreting provisions of an agreement and implying terms. The court performed an analysis of domestic and international jurisprudence on the concept of implied terms in contracts. The court stated that standardized principles cannot substitute the court’s independent view while dealing with presumed understanding of the commercial terms.
What is a letter of intent and is it legally binding?
A letter of intent is a letter between two parties or businesses, which provides the fundamentals for a future or proposed agreement. It can also be called an agreement between two businesses or terms rather than a letter. It can record negotiations and discussions where the outline or details of a future term have been agreed upon. It may not necessarily deal with negotiations that have been completed or may be on-going. It is not a substitute to contract.
A letter of intent usually deals with issues like, details of proposed agreement, target date, obligations of parties, and which party shall produce the initial draft of the agreement. It also covers the pre-conditions or initial terms discussed by businesses before the actual agreement is signed and may include certain important documents that require approval by an external agency like a safety certificate. Satisfaction of due diligence is by both parties is an important part of the letter of intent to investigate the key risks in any proposed transaction.
The key advantage to a letter of intent is that neither party is bound by any negotiations. Either party can decide to pull out before the agreement proceeds without any consequences. This is why a letter of intent contains terms like, “Subject to contract”. However, some terms are legally enforceable like:
- Confidentiality – If the parties involved do not sign a confidentiality agreement, the agreement will create legally enforceable obligations of confidentiality between the parties.
- Non-Solicitation Provision – This prevents parties from poaching employees and customers from one another. It must be reasonable in scope and time.
- Exclusivity – This prevents parties from negotiating with a third party for a period of time. Time limit is a way of putting pressure on parties to progress negotiations. The time limit cannot be unreasonable given the nature of any transaction.
A contract is a legally binding agreement between two parties while there is a presence of consideration and the object of the agreement is legal. Otherwise, the contract is void from the start. The Indian Contract Act, 1872 comprehensively deals with contracts and explains what constitutes a valid contract and what the essentials of the contracts are. This document deals with several parts of contracts and how it is applied with respect to personal and business relationships. And how contracts are tested by courts objectively and subjectively to determine the intention behind the formation of contract and test their legality or legal validity. The document also covers several types of contracts and other relevant parts of a contract like letters of intent, general offers, etc.