Unformatted text preview: :1: Class : MBA Course Code Subject : Business Legislation Updated by: : CP-302
Dr. M.C. Garg LESSON-1 ESSENTIALS OF A VALID CONTRACT
1.0 Objectives 1.1 Introduction 1.2 Object of the Act 1.3 Definition of Contract 1.4 Classification of Contract 1.5 Essential Elements of a Valid Contract 1.6 Summary 1.7 Keywords 1.8 Self Assessment Questions 1.9 Suggested Readings 1.0 OBJECTIVE
After reading this lesson, you should be able to: 1.1 (a) Define the contract and explain the various types of contract (b) Describe the essentials of a valid contract INTRODUCTION
We enter into contracts day after day. Taking a seat in a bus amounts to entering into a contract. When you put a coin in the slot of a weighing machine, you have entered
into a contract. You go to a restaurant and take meals, you have entered into a contract. In
such cases, we do not even realize that we are making a contract. In the case of people :2: engaged in trade, commerce and industry, they carry on business by entering into
contracts. The law relating to contracts is to be found in the Indian Contract Act, 1872.
The law of contracts differs from other branches of law in a very important
respect. It does not lay down so many precise rights and duties which the law will protect
and enforce; it contains rather a number of limiting principles, subject to which the
parties may create rights and duties for themselves, and the law will uphold those rights
and duties. Thus, we can say that the parties to a contract, in a sense make the law for
themselves. So long as they do not transgress some legal prohibition, they can frame any
rule they like in regard to the subject matter of their contract and the law will give effect
to their contract.
1.2 OBJECT OF THE ACT
The main objective of the Contract Act is to ensure that the rights and obligations arising out of a contract are honoured and that legal remedies are made available to an
aggrieved party against the party failing to honour his part of agreement. The Act is of
great importance to businessmen as it enables them to plan ahead with the knowledge that
what has been promised to them will be performed by the promisors failing which they
will be liable for the loss suffered.
1.3 DEFINITION OF CONTRACT
A contract is a legally binding agreement, that is, an agreement which will be enforced by the courts. Salmond defines contract as, “an agreement creating and defining
obligation between the parties.” Halsbury defines a contract to be, “an agreement
between two or more persons which is intended to be enforceable at law and is
constituted by the acceptance by one party of an offer made to him by the other party to
do or abstain from doing some act.”
The definition of the term ‘contract’ given in the Act is based on the definition
given by Halsbury. Section 2(h) of the Indian Contract Act defines a contract as, “An :3: agreement which is enforceable by law.” This definition has two important components
which constitute the basis for a contract. They are :
1. Agreement : An agreement gives birth to a contract. An agreement is defined as, “every promise and every set of promises forming consideration for each other.” (Section
2(e)). A proposal when accepted becomes a promise. Thus an agreement is an accepted
proposal. An agreement comes into existence only when one party makes a proposal or
offer to the other party and the other party signifies his assent thereto. In short, an
agreement is the sum total of offer and acceptance. The following are the characteristics
of the definition of agreement as given above :
(a) Plurality of persons : There must be two or more persons to make an
agreement because one person cannot enter into an agreement with himself.
(b) Consensus ad idem : An agreement is necessarily the outcome of consenting
minds or consensus ad idem, i.e., the two contracting parties must agree as
regards the subject-matter of the contract at the same time and in the same
2. Legal Obligation : Although every contract is an agreement, there are many kinds of agreements which are not contracts. An agreement to become a contract must give rise
to a legal obligation. Obligation is an undertaking to do or to abstain from doing some
definite act. The obligation must be such as is enforceable by law. In other words, it must
be a legal obligation and not merely moral, social or religious. To take an example,
“Please, come to my house”, says P to D, “and we shall go out for a walk together”. D
came to the house of P but P could not leave the house because of some important
engagement. D cannot sue P in damages for his not fulfilling the promise, the reason
being that there had been no intention between D and P to create any legal obligation by
the engagement as made between them. In the circumstances, there was, in the eye of law
no contract between P and D. Contracts must not be the sports of an idle hour, or mere
matters of pleasantry, never intended by the parties to have any serious effect whatever. :4: Another kind of obligation which does not constitute a contract is the arrangement
made between husband and wife. Such agreements are purely domestic and are not
intended to create legal relationship.
The Leading case on this point is Balfour V. Balfour. The points decided were :
(a) Agreements which do not create legal relations are not contracts. (b) Agreement between husband and wife in domestic affairs is not a contract.
Facts of the case are :
Mr. Balfour was employed in Ceylon. Mrs. Balfour owing to ill health, had to stay in England and could not accompany him to Ceylon. On the occasion of leaving her in
England for medical treatment Mr. Balfour promised to send her £30 per month while he
was abroad. But Mr. Balfour failed to pay that amount. So Mrs. Balfour filed a suit
against her husband for recovering the said amount. The court held that it was a mere
domestic agreement and that the promise made by the husband in this case was not
intended to be a legal obligation. Hence the suit filed by Mrs. Balfour was dismissed
since there was no contract enforceable in a court of law.
In Balfour v. Balfour, the intention not to create a legal obligation was clear from
the conduct of the parties. On the other hand the parties may make this intention clear by
an express statement in the contract.
The main distinction between a legal obligation and a social or religious obligation
is that the former involves money value but the latter does not. In order to constitute a
contract an agreement must create legal obligation. It is this theme which has given rise
to the popular saying : “All contracts are agreements but all agreements need not be
It may be noted that the law of contract deals only with such obligations which
spring from agreements. Obligations which are not contractual in nature are outside the
scope of the law of contract. For example, obligation to maintain wife and children, :5: obligation to comply with the orders of a court and obligation arising from a trust do not
fall within the scope of the Contract Act.
1.4 CLASSIFICATION OF CONTRACT
Before dealing with the various essentials of a valid contract one by one in detail, it is desirable to discuss the “various types of contract,” because we shall be using terms
like ‘voidable contract’, ‘void contract’, ‘void agreement’, ‘unenforceable contract’, etc.,
very often in the course of our discussion. The classification of contracts from the various
points of view may be discussed as follows :
(a) From the point of view of enforceability Contracts may be classified according to their enforceability as (i) valid (ii) void
contracts or agreements (iii) voidable (iv) illegal and (v) unenforceable.
Valid Contract : A valid contract is one which satisfies all the requirements prescribed
by law for the validity of a contract, i.e. the essential elements laid down in Sec.10. A
valid contract creates in favour of one party a legal obligation binding upon the other.
Void Contract : A contract which was legal and enforceable when it was entered into
may subsequently become void due to impossibility of performance, change of law or
other reasons. When it becomes void the contract ceases to have legal effect. In other
words, a void contract is not valid from its inception but subsequent to its formation, it
becomes invalid and destitute of legal effect because of certain reasons. [Sec. 2(j)]
Void Agreement : “An agreement not enforceable by law is said to be void.”— Sec.
2(g). A void agreement has no legal effect. It confers no rights on any person and creates
An agreement made by a minor; agreements made without consideration (except
the cases coming under Sec.25); certain agreements against public policy; agreements in
restraint of trade or in restraint of marriage or in restraint of legal proceedings, etc. are
examples of void agreements. :6: Voidable Contract [Section 2(i)] : A voidable contract is a contract which can be
avoided or set aside at the option of one of the parties to the contract. It can be set aside at
the option of the party defrauded. Until it is avoided or rescinded by the party entitled to
do so by exercising his option in that behalf, it remains valid. But the aggrieved party
must exercise his option of rejecting the contract (i) within a reasonable time and (ii)
before the rights of third parties intervene, otherwise the contract cannot be repudiated.
1. X threatens to kill Y if he does not sell his new Ambassador car to X for
Rs.12,000. Y agrees. The contract has been brought about by coercion and is
voidable at the option of Y, i.e. the aggrieved party. 2. A, with the intention to deceive B, falsely represents that fifty lakh bulbs are
made annually at A’s factory, and thereby induces B to buy the factory. The
contract has been caused by fraud and as such is voidable at the option of B. The Indian Contract Act has laid down certain other situations also under which a
contract becomes voidable. They are :
1. When a contract contains reciprocal promises, and one party to the contract
prevents the other from performing his promise, then the contract becomes
voidable at the option of the party so prevented (Sec.53).
Example : A, contracts with B that A shall repair B’s house for Rs.1000. A is
ready and willing to execute the work accordingly, but B does not supply him
material and thus prevents him from doing so. The contract is voidable at the
option of A. 2. When a party to the contract promises to do a certain thing within a specified time,
but fails to do it, then the contract becomes voidable at the option of the promises,
provided at the time of entering into contract, the intention of the parties was that
the time would be the essence of the contract (Sec.55). :7: Example: A contracts with B that A shall whitewash B’s house for Rs.1000
within fifteen day. But A does not turn up within the specified time. The contract
is voidable at the option of B.
Consequences of Recession of Voidable Contract : Section 64 lays down the rights and obligations of the parties to a voidable contract after it has been rescinded. The
section states that when a person at whose option a contract is voidable rescinds it, the
other party thereto need not perform any promise therein contained in which he is a
promisor. If the party rescinding a voidable contract has received any benefit under the
contract, he must restore such benefit to the person from whom it was received. For
example, when a contract for the sale of a car is avoided on the ground of coercion, any
advance received on account of the price must be refunded. The object of this refund of
money is to ensure that the parties are placed on the same footing in which they would
have been without the contract. However, it must be remembered that the benefit which is
to be restored must have been received under the contact. If a certain amount has been
received as a security or as an earnest money for the due performance of the contract,
such deposit is not to be returned if the promisor fails to fulfill the promise because it is
not a benefit received under the contract.
Illegal or Unlawful Contract : The word illegal means ‘contrary to law’ and the term
contract refers to an agreement enforceable by law. Therefore to speak of an ‘illegal
contract’ involves a contradiction in terms as it amounts to saying that an agreement
contrary to law is enforceable by law. Thus it will be appropriate to use the term illegal
agreement in place of illegal contract. An illegal agreement is one which is against the
law enforceable in India. The term ‘illegal agreement’ has a wider conception than ‘void
agreement.’ All illegal agreements are void but all void agreements are not necessarily
illegal, e.g., an agreement with a minors is void but not illegal.
Unenforceable Contract : A contract may be valid, but it may not, at the same time, be
given effect to in a court of law. The statement is paradoxical; but it is nonetheless true.
The contract is valid, because judged by the canons of law which are applied to test the :8: validity of a contract, the contract is flawless; but it cannot be enforced because of certain
technical defects such as absence of writing, registration, requisite stamp, etc., or time
barred by the law of limitation. Suppose A gives a loan of Rs.1000 to B. The contract of
loan, let us assume, is valid in this case; but if A does not sue on the contract within the
period prescribed by law and allows his claim to be barred by time, he cannot afterwards
recover it from B. He cannot recover it, not because the contract was invalid, but because
the Statute of Limitation bars the suit. Similarly, an oral arbitration agreement is
unenforceable, because the law requires an arbitration agreement to be in writing. It is
important to remember here that some of the contracts can be enforced if the technical
defect is removed. For example, if a document embodying a contract is under stamped,
the contract is unenforceable, but if the requisite stamp is affixed (if allowed), the
contract becomes enforceable.
Difference between void and voidable contracts : A void contract is one which is
unenforceable by law. It has no legal existence and, therefore, is destitute of legal effect,
whereas a voidable contract is that agreement which is enforceable by law at the option
of aggrieved party thereto, but not at the option of the other or others. It is valid so long
as it is not rescinded or impeached by the party entitled to do so, i.e. the aggrieved party.
If the party fails to use his right of avoidance within a reasonable time, the agreement
would be binding.
Difference between void and illegal contracts : In all contracts there must be legality,
otherwise they are void and hence destitute of legal effect. Some contracts are illegal in
themselves, e.g., contracts of immoral nature, contracts against public policy, contracts in
restraint of trade. All illegal contracts are void but all void contracts are not illegal. An
illegal contract or agreement is destitute of legal effect ab-initio. The difference between
void and illegal contracts is significant in cases of collateral transactions, e.g. A, a person,
who lent money to another to pay bets already made or lost is not precluded from
recovering it; but money advanced for illegal transactions cannot be recovered. Thus the :9: term ‘illegal’ is narrower in meaning than ‘void’ or ‘voidable’. All illegal contracts are
void, but all contracts which are void are not necessarily illegal.
(b) From the point of view of creation : From the point of view of creation, contracts may be two types : (i) express contracts, and (ii) implied contracts.
Express Contract : Contracts entered into between the parties by words spoken or
written, are termed as express contracts. For example, if X tells Y on telephone that he
offers to sell his house for Rs.20,000 and Y in reply informs X that he accepts the offer,
there is an express contract.
Implied Contract : Where the offer or acceptance is made not by words, written or
spoken, but by acts and conduct of parties, it is termed as an implied contract. Thus,
where X, a coolie, in uniform takes up the luggage of Y to be carried out of a railway
station without being asked by Y, and Y allows the coolie to do so, the law implied here
that Y agreed to pay for the services of X, and there is an implied contract between X and
Y. Similarly, when A takes a seat in a bus, an implied contract comes into being—a
contract according to which A will pay the prescribed fare to the conductor (i.e., the agent
of the bus company) for taking him to his destination.
(c) From the point of view of extent of execution or classification according to performance : On the basis of extent to which the contracts have been performed, we
may classify them as (i) executed contract, and (ii) executory contracts.
Executed Contract : An executed contract refers to that contract in which both the
parties have fulfilled their respective obligations. In other words, an executed contract is
one where nothing remains to be done by either party.
Example: X agrees to paint a picture for Y for Rs.20. When X paints the picture and Y
pays the price, it becomes an executed contract.
Sometimes though the contract may appear to be completed at once yet the effects
of it may continue, e.g., when a person buys a bun for a penny and subsequently breaks
his tooth due to a stone in it, he has a right to recover damages from the seller. : 10 : Executory Contract : An executory contract refers to that contract in which both the
parties to the contract have yet to perform their respective obligations. In the example
referred to above, the contract is executory, if X has not yet painted the picture and Y has
not paid the price. Similarly, if A agrees to engage M as his servant from the next month,
the contract is executory.
A contract may sometimes be partly executed and partly executory. Thus if Y has
paid the price to X and X has not yet painted the picture, the contract is executed as to Y
and executory as to X.
On the basis of execution, the contracts may also be classified as (i) unilateral
contracts, and (ii) bilateral contracts.
Unilateral Contract : A contract is said to be unilateral where one party to a contract
has performed his share of obligation either before or at the time when the contract comes
into existence. It is only the obligation of the other party which remains outstanding at the
time of formation of the contract. Such contracts are also termed as contract with
executed consideration. Thus, a contract of loan, where money has been advanced by the
creditor is an example of unilateral contract, because the creditor has done what he was to
do under the contract, it remains for the debtor to repay the debt.
Bilateral Contract : In a bilateral contract obligations of both the parties are outstanding
at the time of the formation of the contract. They are, executory contracts or contracts
with executory consideration. In other words, in a bilateral contract, there is only a
promise for a promise. For example, where X promises to sell his car to Y after 15 days
and Y promises to pay the price on the delivery of the car, the contract is bilateral as
obligations of both the parties are outstanding at the time of formation on the contract.
It is to be remembered that a contract comes into being on the date on which it is
entered into between the parties. The date of its execution is immaterial for determining
the validity of the contract. In other words, a contract is a contract from the time it is
made and not from the time its performance is due. : 11 : (d) From the point of view of form or mode of the contract : There are four kinds of contracts : formal contracts, contracts under seal or specialty contracts, simple
contracts and quasi-contracts.
Formal Contracts : These are in vogue in England. These have not received recognit...
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