Master in Business Laws - Part I Law of Contract Course No: I Module No: I-IX
CONTRACT LAW
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 1
CONTENTS TOPICS 1.
Contract: Concept and its Role in Developing Society (Module I) .............................................. 3
2.
Capacity and Consideration (Module II)........................................................................................41
3.
Free Consent and Public Policy (Module III).................................................................................75
4.
Public and Government Contract Engineering Contract and Quasi Contract (Module IV)...............................................................
108
5.
Discharge of Contract (Module V) .................................................................................................
142
6.
Breach of Contract and Remedies (Module VI) ............................................................................
181
7.
Representative Contracts (Module VII) .........................................................................................
212
8.
Special Contracts (Module VIII)............................................................................................
268
9.
Digital Contract (Module IX) ...............................................................................................
326
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Master in Business Laws Law of Contract Course No: I Module No: I
Contract: Concept & Its Role in a Developing Society
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 3
Materials Prepared By : 1. Prof. N.L. Mitra M.Com., LL.M., Ph.D. 2. Mr. S.V. Joga Rao B.Com., LL.M., M.Phil. Materials Checked By : 1. Mr. T. Devidas LL.M. 2. Ms. Sudha Peri LL.M. Materials Edited By : 1. Dr. P.C. Bedwa LL.M., Ph.D. 2. Mr. V. Vijaykumar M.A., LL.M., M.Phil. 3. Mr. Harihara Ayyar LL.M. 4. Mr. P.P.R. Nair
© National Law School of India University
Published by Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore - 560 072.
Printed at
National Printing Press, Koramangala, Bangalore - 95 Ph: 5710658
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INSTRUCTIONS Basic Readings The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics included in the course. Experts in the area have collected the basic information and thoroughly analysed the same in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative provisions are also included. Care has been taken to communicate basic information required for decision making in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading information provided are to be selected by making marginal notes using markers. The first reading, therefore, necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the implications of those informations. In the second reading the reader has to critically analyse the material supplied and jot down in a separate note book points stated in the material as well as the critical comments on the same. A third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections at every stage.) Supplementary Reading Several supplementary readings are suggested in the materials. It is suggested that the reader should register with a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the National Library, any University Library where externals are registered for the purpose of library reading, any commercial library or any other public library run by Government or any private institution. Readers in Metropolitan and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary, and kept in the course file. Supplementary readings are also required to be read more than once and marginal notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the payment. Case Law The course material includes some case materials generally based upon decided cases. These cases are to be studied several times for, (a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/ appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence. Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the experts’ comment to the students. Through these exercises one can build up an effective dialogue with the experts of the Distance Education Department (DED). Problems and Responses After reading the whole module which is divided into several topics and sub-topics the reader has to solve the problems specified at the end of the module. The module is designed in such a manner that a reader can take about a week’s time for completing one module in each of the four courses. It is expected that after finishing the module over a period of a week the student solves these problems from all possible dimensions to the issue. No time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has already prepared. After completing the exercise the student is directed to send the same to Course Coordinator for evaluation. Though there is no time stipulation for sending these responses a student is required to complete these exercises before he/she can be given the certificate of completion to appear for final examination. 5
Contract : Concept and its Role in a Developing Society TOPICS 1.
Genesis of Contract.....................................................................................
7
2.
Contract : How to make............................................................................ 11
3.
Justification for Contract............................................................................ 19
4.
Types of Contract......................................................................................... 23
5.
Terms of a Contract.................................................................................... 26
6.
Contract in the Changing Society.............................................................. 29
7.
Relevant Provisions of the Act................................................................... 33
8.
Case Law...................................................................................................... 34
9.
Problems....................................................................................................... 36
10. Supplementary Readings............................................................................. 40
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1. GENESIS OF CONTRACT SUB - TOPICS 1.1 Introduction 1.2 Early history of Contract Law 1.3 Contract as a method of creating new rights 1.4 How is a contract made? 1.5 Definitions 1.1 INTRODUCTION A modern industrial society is primarily built upon the fabric of ‘contract’. The relational integration and determination of mutual rights and obligations to a great extent, are dependent on ex contractum (out of contract) terms. There is contract around, between employer and the employees, producers and distributors, vendors and the customers, carrier and the buyer of services and the like. Even family relations also start with contract, marriage being either a contractual relation or similar to it. The very basic principle of market functioning in the early period of mercantalism and industrialisation was laid down on the efficient functioning of contractual relation by relative assessment of rights and duties arising out of a contract. In a modern state, government is also becoming a very important party in contractual relations. It is, therefore, necessary to understand how and when parties enter into such a contract in order to examine their mutual rights and obligations, and the time of origination of such rights and obligations. In order to correctly evaluate these aspects, one has to understand the following: 1.
Whether the parties have agreed to make any binding right and obligation for themselves?;
2.
How they have made it?;
3.
What are their mutual advantages and obligations?;
4.
How they intended to perform their mutual duties and when?;
5.
What are the conditionals? and
6.
What happens if one of the parties is unable to fulfil his/her obligations?
Here we shall try to explain you why, when, and how a contract is made. 1.2 EARLY HISTORY OF CONTRACT LAW Generally speaking history of human civilization has experienced several legal systems. Some of which are still in vogue in pure or moderated form. Leading legal systems are: 1.
Ecclesiastical/religious system is based on the religious, textual and customary processes inducted through religious faith and belief;
2.
Romana-Germanic system is based on growing codification on logical foundation as well as clear customary practices
which are secular in character. One of the earliest code was Justenian code; 3. Civil law system based on a well structured constitutional legal regime with inquisitorial procedural system. Western European countries follow this system; 4. Socialist system with high public interest involved specially on the issue of freedom of contract; and 5. Common law system which provided golden opportunity for mercantilism and capitalism to develop with rapid industrialisation. Besides, more than half of the globe was under the domination of this common law system under the British in eighteenth, nineteenth and early twentieth centuries. In Common law, Law of Contract was carved out of the law of tort in the fourteenth and fifteenth centuries. Initially, three ‘writs' (‘Writ’ is a specific order/direction by the court to act in a manner specified) used to play a very important key role. In case of agreements of loan and credit Writ of debt was issued. In clear cases of agreements, especially in writing, on transfer of landed properties writ of covenant was issued asking the party to perform his part and a writ of trespass was issued in the event of any party to the contract of quasi contractual situation transgressing the rights acquired by the other party. Another writ to provide remedy in the event of a party to the contract committing breach, known as Writ of deceit was also issued. Trespass was issued in the event of physical injury to person and property and deceit was issued in wide range of cases. Similarly a composite writ of debt-debtenu used to be issued in a situation where the defendant used to unjustly detain something, on which, the plaintiff had the claim or was entitled to possess. Of course the functional distinction between the writs could not be very clearly stated now. One can, of course, start carefully tracing the history. The basic principle of action on civil wrong was based upon three clear actions or inactions on the part of the defendant. For example a person could have done something which is per se wrong. In law it is known as Misfeasance. Such as, A agreeing to sell to B something on which A has no right of title and possession, and consequently B cannot acquire title or possession. Secondly, a right act could be wrongly done, which in law is termed as Malfeasance. Such as, A by use of coercion forces B to sell his land to A. Here, A has used foul means which he could rightly do as well i.e., without the use of force. On the other hand, a right thing not done at all is known in law as Nonfeasance. Such as, A not paying back the amount of loan taken from B. In all these above cases the plaintiff could seek justice against the action or inaction of the defendant. The court used to issue writs in order to deliver justice to the plaintiff by appropriately designing a simple or compound writ. But as matters got complicated during the period of mercantilism at the early part of industrialisation, different theoretical foundations were necessary to legally bind parties in different 7
contractual situations. In early sixteenth century the court of King’s Bench formulated another remedy known as Assumpsit. One could trace the conflict of ideas on remedying in the event of breach of contract between court of King’s Bench and court of Common pleas. Anyway, according to the court of King’s Bench under every executory contract the parties used to assume or promise to pay an amount or deliver goods. Thus action on assumpsit was held to be more appropriate than the limited applications of writs. ‘Writs’ had pigeon-hole application whereas contract required a wider legal remedies, especially when contract of services were also involved during the period of early industrialisation. In actions of assumpsit during the earlier period there was scope for speculation as to the matter of promise gratuitously made. Gradually, English courts held that a ‘quid pro quo’ would be required in all cases of promises to be legally binding excepting where a promise is ipso facto made binding under court’s seal [This is explained in detail subsequently on consideration]. With the rapid growth of industrialisation in the last hundred and fifty years, importance of contract could not be over estimated in all legal systems. Moral foundations of a promise to make it legally binding in religious or ecclesiastical systems, could not hold the system. The principle of ‘Pacta Sunt Servanda’ of Romano-Germanic system meaning thereby, promise once made is binding or ‘one must observe one’s words given to other, else he takes the curse of the God’, a principle of the ecclesiastical system could not hold the test of time. Rapid industrialisation required more transparancy in the legal system. Gradually more and more countries started codification of the law of contract. India however, has its codified contract law enacted in 1872. One can easily understand the benefits of codification, viz., 1. transperency of law at any given point of time; 2. easy public accessibility; and 3. amendability with the change of time and need. The argument made by common law advocates against codification is that it makes law more rigid as compared to the judge made law, is untenable. Judges by their nature of training and work, tend to become rigid and Status quoist (meaning person supporting status quo). Hence Common Law system based upon case law became mostly non-dynamic specially before Karl Marx came on to the scene. Legislative process, on the other hand, is bound to respond quickly to the requirement of time. Members of the legislature as represent the people so they understand well the need of the time and the people in a better way. In fact with rapid globalization of economic production relations and quicker communication links, a uniform commercial code is bound to come for the whole world in the long run. The movement is already felt strongly. Through multi-lateral treaties and conventions many areas of the commercial contract have already been globally codified. Marine contracts, contracts of transnational services, telecommunication contracts, contracts of exports and imports, international commercial arbitration, technology use contracts, contracts on Intellectual properties etc. are either already under 8
some sort of globalised code or under high globalisation. One can, at this stage, note the growing number of global legislations in the area of contract. Sir Henry Maine (Friedman, Law in a Changing Society, 119-120) is perhaps right when he said that codification is a test of modernisation of the legal system. One may further add to it by suggesting that universalisation and secularisation are perhaps other two attributes of the most advanced legal culture. 1.3 CONTRACT AS A METHOD OF CREATING NEW RIGHTS ‘Contract’ is the method through which individuals make law for themselves by creating rights and obligations ex contractas. As a human being, a person shall have some rights, duties and obligations ex factum i.e., by mere fact of being a person in the society. For example, basic human rights or fundamental rights or family rights like right of parenthood, right of succession, right of paternal or maternal names etc., are rights ex factum. But each individual is an economic being as well as a social identity. As an economic being he/she takes rational economic decisions to enter into contracts with others to derive better social, economic and other pleasures, through such relations by creating new rights and obligations. A person understands that his/her factual social existence shall be more meaningful if he/she takes economic decisions rationally. By entering into a new contractual relation and thereby altering his/her position in relation to creation of wealth. Contract is the sole method of altering factual situations and raising more and more wealth and economic satisfaction. Without ‘contractual relations’ society would have remained static. Through contract wealth of a person is increased, so also of society’s and society is made dynamic. 1.4 HOW IS A CONTRACT MADE ? A contract is made between two or more parties wherea. An agreement is made through one party making an offer and the other accepting the same; an offer accepted becomes a promise; b. The agreement being legally enforceable in so far as it fulfills the following conditions: (i) parties must be willing to enter into a legal relation; (ii) parties must be competent to enter into a contract that results in legally enforceable rights, duties and obligations; (iii) parties must have given free consent to the terms of the contract; (iv) there is a lawful object and consideration; (v) the agreement is not against public policy or morality; and (vi) the agreement is not otherwise void in the eyes of law. c. Once an agreement fulfills the above conditions it becomes a legally binding contract. All these conditions require critical analysis.
1.5 DEFINITIONS In order to understand the law and technicalities of contract specially as to when and how a contract is made, we are required to have a clear understanding of denotative (area of application) and connotative (quality and attribute) definitions of some of the terminologies we use in this course. (a) Proposal In English common law a proposal is known as an offer. In every contract one party, generally speaking, is required to take initiative for proposing or offering a term which other party may accept if interested to make an agreement. A proposal or offer can be defined as ‘an intimation by words or conduct, of a willingness to enter into a legally binding contract, and which in its terms expressly or implicitly indicates that it is to become binding on the offer or as soon as it has been accepted by an act, forbearance or return promise on the part of the person to whom it is addressed. (Guest, A.G, Ansons’s Law of Contract, (24th Edn, LPE), p.28) According to sec. 2(a) of the Indian Contract Act (ICA) when a person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of the other to such act or abstinence, he is said to make a proposal. [See sec. 2 (a)] (b) Acceptance According to sec. 2(b) of the Indian Contract Act, when the person to whom the proposal or offer is made signifies his assent thereto, the proposal is said to be accepted. (c) Promise According to sec 2(b) a proposal when accepted becomes a promise. Suppose A offers to sell his horse to B, and B accepts the offer, there is a promise. (d) Agreement To make a contract there has to be an agreement. An offer and acceptance constitute the agreement. According to sec.2(e) of the Indian Contract Act, every promise and every set of promises, forming the consideration of each other, is an agreement’. Suppose A offers Rs.1,00,000/- for B’s plot of land and B accepts the offer, there is an agreement between A and B. (e) Contract According to some juristic writers of the nineteenth century, contract is an agreement between free and consenting minds. In this subjective sense, the concept is very near to the Roman idea of ‘consensus ad idem’, i.e., the meeting of two minds. There are obvious difficulties in accepting this definition because ‘individual liberty’ and ‘freedom of contract’ - the two essential notions necessary for consenting minds, are two ideal classical notions that have cased to have idealistic attraction in an acquisitive society of modern times. For example, a young boy of 13 or 14 years, Ram Kishan, ran away from his home at Baheri on the 9th of June 1993. The father offered a reward of Rs.500 to “anybody who traces the boy and brings him home”. On July 19, Mr. Harbhajan was at Dharmshala of Bareilly
Railway station. There he saw the boy, overheard part of the conversation of the boy and realised that he was Ram Kishan. He promptly took the boy to the Railway Police station where he made a report and sent a telegram to the boy’s father. Could Mr. Harbhajan be entitled to the reward? In this example, it is immaterial to argue whether the extent of Mr. Harbhajan’s liberty to trace the boy is of paramount consideration, or the extra effort to undertake the liability of finding out the boy. Rather objectivists try to define the term more positively by defining the contract as a ‘promise enforceable by law’. This positive definition has also certain demerits of irreconcilability with questions of morality and ethics at times. Suppose, the father came to know that Mr. Harbhajan traced the boy but just before he could take the boy to police station and sent the telegram he withdrew the proposal for reward. Is this not an immoral or unethical act for him to do? In fact, at times some subjective considerations become essential on the issue of legality and illegality. For example, in the above situation, the question whether Mr. Harbhajan did fulfil all conditions of the offer for reward was the issue in consideration. For the time being let us take the advice of Anson, that certain legal concepts are ‘defeasible’. These are capable of being ‘withered or defeated in a number of different contingencies’ but if no such contingency arises, the import ‘remains intact’. The Indian Contract Act 1872, has tried to define the term in Sec. 2(h) in the same positive manner as ‘an agreement enforceable by law is a contract'. (f) Void agreements An agreement which is not enforceable by law at all is an agreement void ab initio i.e., from the very beginning. This means that such agreements do not create any rights or obligations in favour of or against the agreementing parties. The second marriage of a Hindu spouse, while the first marriage subsists, does not create any rights in favour of the second spouse, and hence there is no necessity of a decree of divorce. In other words, if a party to an agreement, agrees to do an act which he is forbidden by law to do, no contractual rights or obligations arise. Such an agreement cannot be the basis of any further agreement, because all those consequential or collateral agreements also become void ab initio. For example, A agrees to sell a property to B to which he has no title or right of possession. This agreement therefore cannot create any right in favour of B, nor an obligation against A. Now suppose, relying on the validity of this agreement B agrees to sell the same property to C, that agreement is also void ab initio. In Cundy v. Lindsay [(1878) 3 App.C.459]. The plaintiff received an order for handkerchiefs from Blenkarn who gave his address as, 37 Woodstreet, Cheapside. He signed his name to make it look like Blenkiron & Co. a respectable firm known by reputation to the plaintiffs and carrying on their business at 123, Woodstreet. The plaintiff sent the goods to “Blenkiron & Co, 37 Woodstreet,” where Blenkiron took possession of them. He later sold them to the defendants. It was held that there was no contract between the plaintiffs and Blenkarn, as the plaintiff had never intended to deal with him. So the property in the 9
handkerchiefs did not pass to Blenkarn, and, consequently, he could pass none to the defendant. So plaintiff was entitled to take the whole lot of handkerchiefs from the defendant, and the defendant’s argument that they had purchased the goods bonafide, for value consideration was not deemed a valid defence. (g) Void Contracts A contract which is valid at the time of entering into it, but becomes void at the time of performing the contract due to change of circumstances is known as void contract. That is, if a contract is enforceable by law at the time of entering into it, but becomes unenforceable at the time of execution, such contract is known as void contract. A contract collateral to a void contract is not necessarily void. For example, suppose Suresh has landed property in Bombay. He received a notice of acquisition on 1-1-1994. He thought that in order to substantiate the market rate of the land or a reasonable value he could resort to an agreement of sale of the land. So he offered his land for sale to Dinesh for Rs.50 lakhs. Dinesh was unaware of the notice of acquisition. This agreement is void ab initio and no importance is to be given to the existence of agreement while computing the compensation. Whether Dinesh had paid any advance on the agreement need not also be considered. But suppose Suresh and Dinesh had entered into the agreement for sale - purchase of land before the issuance of notice of acquisition to Suresh. In such a case, consideration could be given while computing compensation about the existence of that contract, which had become void on the service of the notice. We can take another example to this point. Manish, a minor, sold a property to Dinesh, who later on sold part of the property to Harish. Here both the sales are void, because the agreement between Manish and Dinesh is void ab initio, and consequently the later agreement between Dinesh and Harish is also void. But suppose, Manish is an adult person and he
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agrees to sell the property to Dinesh because Dinesh has threatened to kill his brother unless Manish agrees to sell the property. Now suppose the sale did take place, and thereafter Dinesh sold part of it to Harish. After sometime Manish applied to the court and did prove that he had to agree because of the threats from Dinesh. The Court gives the decree of avoidance i.e., declares the contract between Manish & Dinesh void. Here Manish will not be able to get the part of the property sold to Harish, because the contract between Dinesh and Harish was valid and could not be terminated on grounds of avoidance of contract due to ‘Coercion’, unless of course Harish was also a party to that coercion or Harish had purchased the property with knowledge of the coercion. (h) Voidable Contracts A contract which is avoidable at the option of a party is known as voidable contract. In other words, a voidable contract is one where one party can go to the court on justifiable plea and can avoid the contract under the direction of the Court. Such a contract remains absolutely valid until the court gives the order of avoidance. As per sec. 19(a) & (b) of the Indian Contract Act, a contract is voidable by the party suffering from the consequences of coercion (S.15), undue influence (S.16), fraud (S.17), and misrepresentation (S.18). Once the court gives the order, the contract becomes void. (i) Illegal agreement An illegal agreement is one where, if the agreement is performed parties would violate the provisions of some law. For example, A offers to pay Rs.1,00,000 to B if B murders C. This agreement is illegal. Such an agreement itself is an act of conspiracy. If B murders C, B will be prosecuted for murder and A on charge of murder or abetment of murder. All illegal agreements are void, but all void agreements are not illegal.
2. CONTRACT : HOW TO MAKE SUB TOPICS 2.1 Introduction 2.2 Proposal (a) Various methods of making a proposal (b) Buyer is the offeror in the common law system (c) Proposal must not be confused with invitation to treat (d) Proposal must be communicated (e) Counter offer (f) Proposal to be made to a person (g) Withdrawal or revocation of a proposal 2.3 Acceptance (a) Acceptance must be in toto (b) When is acceptance made? (c) Silence is no acceptance (d) Acceptance by conduct (e) Revocation of acceptance 2.4 Where is the contract made? 2.5 Proposal and acceptance in three forms 2.6 Types of Agreement 2.7 Contract : A final comment
us take an example. A proposes to sell his land for Rs. 50,000 and signifies it to B, which B may accept. This is a proposal. But one must not confuse ‘desire’ of a person with ‘intention to do’ or ‘abstain from doing a thing.’ For example, A has a desire to become Prime Minister of the country, which he tells to B. This is not a proposal in the legal sense of the term. 2.2.1 Various methods of making a proposal Proposal or offer can be made in various ways. A bus plying in a route is an offer by conduct. Any intending passenger getting into the bus, accepts the service. But that is not so in the case of plying a train. Train fare has to be tendered in the counter proposing the destination and the ticket must be obtained. Proposing the place for journey and tendering the fare is the proposal and issue of tickets is the acceptance, the railway ticket itself being the formal document of acceptance. A railway timetable or a book list or a menu chart are not proposals. These are mere documents of information available to the intending buyer. Proposal may be given in writing. In some cases a proposal is required to be in writing. For example, a government contract, a contract of significant resource mobilization or a contract for transfer of immovable property are given in writing. On the other hand, in innumerable contracts in our daily life proposal is made orally. When parties are situated at a distance, an oral as well as a written proposal is generally made through the use of tele-communication system like telephones, telex, teleprinter, telegram, fax or through letters.
2.1 INTRODUCTION
2.2.2 Rules for ascertaining the offeror:
According to the provisions of Indian Contract Act, 1872, an agreement enforceable by law is a contract. So to make a contract there has to be (i) an agreement and (ii) it must be enforceable by law. An agreement is a promise or a set of promises. A proposal when accepted becomes a promise. Formation of contract can be explained by the following chart.
1. Labelling Method
CONTRACT
“
(S. 2h) Agreement enforceable by law
“
(S. 2e) Promise/Set of promises
“
(S. 2a) Proposal + (S. 2b) Acceptance Note: From the above, it is clear that the basis of contract is a proposal made by one person and an acceptance of the same by another. 2.2 PROPOSAL The following are the ingredients in a proposal : (i) two persons are necessary for a proposal - One to make it and the other to receive it. If A wants to sell a house, there has to be another person B, who would be willing to buy the house i.e., A cannot sell the house to himself; (ii) the proposer must signify his/her willingness; (iii) to do something or to abstain from doing; and (iv) the proposal requires the consent of the other person. Let
In the common law system a buyer is generally the proposer. In a modern agreement, the proposal is given in a clear form and conditionalities of it often become transparent over a series of dialogue which is required to be taken together to formulate the final proposal. Sellers often stipulate conditionalities but these are not the proposals. It is the buyer who formulates his proposal on the conditionalities stipulated in such a form that the seller can accept the proposal. For example, a person requires a project loan from a bank. He makes an enquiry. The bank stipulates that the project papers are required to be given in a stipulated form specifying certain informations required to be certified by a recognised chartered engineer and the loan can be sanctioned on some definite terms and conditions. Whatever the bank has stipulated would be considered as mere information and the person seeking that information cannot say ‘I accept your terms’ and hence the bank would be liable to provide a loan. It is upon the person seeking the loan to prepare all papers as per the conditionalities and submit the proposal which the bank may or may not accept. Conceptually speaking, this principle of suggesting that a buyer is always the proposer can be said to be a ‘labelling process’ i.e., the buyer is labelled as the offeror. In this ‘labelling process’ the court generally starts its calculation from the behaviour of the customer in order to locate what is his offer and what are the terms and when it is made in its entire form. Thus the court makes the forward calculation as to what has happened one after the other from the point of buyer giving his proposal. 11
2. Back Calculation Method Some of the authors suggested a different inquisitorial method of back calculation (meaning the court goes back to the first instance giving rise to the contract to ascertain the rights and liabilities of the parties. In this method the courts do not start with the presumption that the buyer is the offeror) in which the proximate action of the defendant is examined for determination of plaintiff’s remedy and then back-calculate the chain of actions according to the approximation of remedy. Whereas the former has a question of moral hurdle involved, the latter has a principle involved in decision making. To make things clear, suppose, a seller has marked a packet of dozen table tennis balls at say, Rs.100.00 in the self-service counter. A possible customer picks the packet up and tenders Rs.100.00 which the seller in the counter refuses to sell. In the labelling method, buyer being the proposer, proposes the packet to the seller at Rs.100.00. The seller may or may not accept it. Since seller does not accept it, there is no remedy. The question involved here is that how far the seller displaying the packet in the self-service shelf stipulating a price and thereafter refusing to sell it, is morally justified? Has he not ditched the buyer? According to this argument the court has to critically look into the behaviour pattern of the seller which has immediately caused the grievance. Suppose the court finds the action of refusal to sell as unjustified and unreasonable, it may back calculate and decide that the price stipulation is itself a proposal. Suppose, the packet is already sold and is inadvertantly placed in the shelf, then the court may decide the action of the seller to be justified and placement of the article and stipulation of the price to be not an offer. Here the ‘certainty in law’ is at stake. Labelling makes decision making definite whereas the ‘back calculation’ meets the need for variations to be taken into decision-making in each individual case but sacrificing ‘certainty’. Business world prefers ‘certainty’ than judicial discretion and uncertainty. In Mc Pherson v. Appanna, (AIR 1951 SC 184) the owner of a house property had two local representatives for two properties. Both were told to look after a particular property to be sold. One customer wanted to pay for the house rupees six thousand and the caretaker of the property sent the information to the owner communicating the offer of rupees 6,000 by telegram. The owner, in return, sent a telegram to the caretaker stating “Won’t accept less than ten thousand”. Caretaker informed the proposer about the content of his master’s telegram. The same proposer immediately accepted whatever was stipulated by the owner of property as the counter-offer and later on sent a letter communicating his acceptance of the term of paying Rs 10,000 for the property. Meantime, the other representative sent another offer of Rs.11,000 which the owner accepted and asked his representative to complete the sale-deed. The earlier person filed a suit for breach of contract. Here the court tried to examine the nature of the telegram of the owner suggesting that he would not accept anything less than Rs.10,000/-. This according to the court was not a counter offer which could be accepted. Incidentally, it may be noted that an offer cannot be conditionally accepted. If any condition is attached to the acceptance, it becomes a counter offer. But in this case it was not a counter offer since there was no definite proposal in the telegram. It was merely an information that 12
anything less than Rs.10,000 would not be accepted. There was no definite proposal. The earlier person’s accepting to pay Rs 10,000 was itself the proposal which was never accepted by the owner. Hence there was no agreement and, as such, no breach of contract by the owner. 2.2.3 Proposal must not be confused with invitation to treat Proposal and invitation, information and intention to propose must be distinguished. The following examples would illustrate the same: i. The Secretary of a school advertised inviting applications for the post of headmaster. X, an applicant was interviewed for the post. The board of managers interviewed the candidates and selected X for the post. A manager in his individual capacity informed X about the selection. But X did not get any letter of appointment. The court held that there was no contract. The fact remains that there was no offer. Advertisement for the post was merely intention to offer. Application for the post was information. Interview as the preparatory step for the possible offer. The letter of appointment would only be the offer. (See Powell v. Lee (1908) 99 L.Y. 284) ii. A through telegram communicated to B, “will you sell us your Bangalore house ? Telegraph at what price”. B replied by telegram, `lowest price of the Bangalore house rupees nine lakhs’. A communicated back by telegram “accepted your offer of nine lakhs”. It is not a contract because B’s telegram of `lowest price is simply an information and not a definite proposal. (See Harvey v. Facey ((1893) A C 552-59) IE & E. 295, 309) (iii) A advertised in the newspapers that an auction shall take place at an address on a stipulated day and time. B reaches the spot but finds the auction withdrawn without notice. No action can be taken because it is an invitation to offer and not an offer. (See Harris v. Nickerson [(1873) L.R.8 Q.B. 286] The three examples given above relating to intention, information and invitation to contract show the common law situation of ‘invitation to treat’ to be distinguished from the offer or proposal. In civil law system things are not very different. But in civil law system, for example in France, a group of lawyers (Notably, Baudry Lacantinerie et Barde, 1,30.) consider catalogues or trade circulars as conditional offers, i.e., offer open until the stock is exhausted. Goods displayed in the shop window or on a counter with a price attached are also legally analysed in the same way. According to them this is the natural way. Ofcourse other section of the jurists as well as the courts seems to be inclined in interpreting in the common law way. They consider it only as an ‘invitation to treat’ without attaching any liability to the seller on the statements made. (See Planiol et Ripert, 6,no 127,ni; Req. 29.4.1923 D 1904.1.136 et al.) Ofcourse, as against the later there is a very strong objection that this is ‘to impute artificially the initiative to the wrong party [See Carbomier, 2 (100)]. In most of the commercial contracts parties go through a chain of events. In case everything goes well there is no problem. But once a problem arises the whole process of the contract requires a thorough scrutiny, in order to understand wherefrom the offer started and upto what situation is simply remains as
an invitation to treat. It has already been stated earlier that the common law system (followed in India) and the civil law system of France and Germany have different ways of approach. Whereas, in common law the identification is based upon the buyer and seller, and the buyer makes the offer unless it is clearly provided otherwise; in civil law the point of origin of the right of promise, is taken as the first point of origin of the contract i.e., the offer. Upto that point, the dialogue between the parties in exchanging information remains as an ‘invitation to treat’. Often the offer itself crystallises after a long dialogue, containing several enquiries, information, identification of subject matter, offer of trade and cash discounts etc. Until the total offer crystallises, there is no question of any acceptance. It means that before the subject matter of the agreement is determined a lot of information passes between the parties, and only then, the buyer identifies the article he intends to buy. After a course of dialogue and exchanges the buyer comes to understand the reasonable price that he can offer. And, finally, they talk of a lot of other issues like terms of sale, guarantees and warranties and the after sales service. It may appear to the onlooker that there are innumerable number of offers and acceptances constituting the whole deal, but that is not so. In fact, when everything crystallises and the buyer is in a position to propose comprehensively, the ‘offer’ is said to be made. Upto that level, all that is thought to be various offers and acceptances are only in reality ‘invitation, intention and information’ necessary for making an offer. Due to this complexity in modern commercial contract, European law on contract started becoming codified according to the common law practice of ‘the buyer being the offeror’ unless otherwise intended by the parties. (d) Proposal must be Communicated According to sec.3 of the Indian Contract Act, offer must be communicated to the offeree in the manner intended by the offeror. Uncommunicated offer is no offer and it cannot be accepted. In Lalman Sukla v. Gouri Dutt,[(1913) ALJ 489] the plaintiff was an employee of the defendant. He agreed to go to Haridwar to search for the missing nephew of the defendant and finally found the boy without knowing that the defendant had announced some reward for the work. The issue was ‘could he demand the reward’ ! The court held that ‘being under the obligation, which he had incurred before the reward in question was offered, he cannot claim the amount’. A person ignorant of the offer cannot be said to have accepted it only because he has done something which the offer has stipulated. Anson has rightly observed ‘ a person who does an act for which a reward has been offered in ignorance of the offer cannot say either that there was a consensus of wills between him and the offeror, or that his act was done in return for the promise offered. (Guest Ansons’s Law of Contract 24 Edn, LPE, p.34). Communication of offer is essential for its consequent acceptance. A pair of cross offers with same terms from opposite parties do not make an agreement unless one is made with reference to the other. For example, suppose X intends to purchase 800 tons of coal at Rs.700 per ton and writes to Y and Y at the same time writes to X for selling 800 tons at Rs.700 per ton. These are known as cross offers where one crosses the other at the transit. This is not a contract. (Tim v. Hoffman LC (1873) 29 L.T. 271)
Terms of offer must also be communicated to bring out the terms and conditions within the offer. This is very important specially in the case of standard form agreements (Standard form agreement is one where conditions are standardised by the sale of goods and services in the form of information based on which terms the proposer has to submit his proposal). For example, a customer intending to get power connection has to submit his proposal or application for power connection on the basis of terms and conditions stipulated by the Board or in the offer where terms and conditions are written elsewhere. Suppose, the terms and conditions in a laundry are stated on the backside of the ‘bill’. The notice of the customer must be attracted to those conditions. In such a case it will be sufficient if the proposal gives a reasonable notice of the contractual terms. Suppose the front side of the document refers to ‘vide reverse’ or ‘turn back’ or ‘conditions given overleaf’, such a notice is enough to bring those conditions within the fold of the offer. But if no notice is given and the conditions are kept outside the promise, then the offer is not complete. A proposal made through a telephone but not heard does not become a proposal or offer. A teleprinter or a fax not bringing the total proposal does not constitute any offer or proposal. According to sec. 4 of the Indian Contract Act, the communication of proposal is complete only when it comes to the knowledge of the person to whom it is made. (e) Counter-offer If the offer is not accepted in its original terms and conditions and is accepted with different terms or new terms stipulated, the original offer is rejected and it stands terminated. Afterwards the same cannot be activated. The acceptance with new terms or suggestion of new terms becomes a counter-offer. For example, A offers to sell a farm to B for Rs.10,00,000. B wants to pay Rs.9,50,000. This is a counter-Offer. Suppose A refuses it. B afterwards wanting to pay Rs.10,00,000 would not be able to accept A’s earlier proposal because that proposal has been terminated or cancelled with the counter-offer. B’s offer is to be termed as a new proposal, i.e., a counter-offer. Sometimes in a business contract it becomes very difficult to identify the proposal in its entire form with conditionalities, because the proposal crystallises over a bilateral dialogue. If the dialogue is through correspondence or is made orally, the whole of it must be viewed in its entirety according to the intention of the parties in order to determine the proposal in its entire form. (f) Proposal to be made to a person Proposal or offer must be made to another person. In one sense it means that offer must not be made to self. For example, a stock broker’s offer for buying and selling the same share benami, shall not constitute a proposal at all. The second meaning is that offer requires two persons, one to make it and another to whom it is made. A proposal made by the Managing Director of a limited company for and on behalf of that company to the Managing Director but acting in his private capacity, is a good proposal. Here the proposer is the limited company since it is a legal person. The other person is the MD, acting in his private capacity. But it is not necessary that offer has to be made to a definite person. Offer not made to anyone in particular i.e., one which may be accepted by anyone, is a general offer. 13
When offer is made to a specific person it is a specific offer. For example, if a reward is declared to anyone who finds the lost dog, it is a general offer, but X’s offer to purchase Y’s law books for Rs.50,000/- is a specific offer. The third meaning is that a ‘person’ to make an offer and to receive it must be either a person-in-fact or a person-in-law’. The corporate bodies are person-in-law and can make or receive offer, ofcourse, within the scope of its terms of incorporation. These principles are same or similar in all other legal systems. (g) Withdrawal or revocation of proposal Offer or proposal may be withdrawn at anytime before it is accepted. This is the general principle of revocation of offer in common law as well as in civil law. In India the codified law is more detailed, because the law relating to acceptance was not the same earlier in India as it was in the common law or in the civil law system. According to sec.5 of the Indian Contract Act, proposal can be revoked at anytime before the communication of acceptance is complete as against the proposer but not afterwards. Suppose X proposes to buy B’s motor car for rupees one lakh on 1.1.92. The letter reaches X on 5.1.92. The offer is made on 5.1.92. Now suppose B agreed to sell the car and sends the letter on 8.1.92. The communication of acceptance is complete against X on 8.1.92. So if X wants to withdraw or revoke the offer, he has to do it before 8.1.92. Suppose X agrees to be the guarantor if Y discount bills with State Bank of India for a period of twelve months. This is known as a standing offer for twelve months against acts of discounting bills. On every bill being discounted, the offer or proposal turns into a promise. Suppose after three months X revokes his guarantee giving notice, he shall not be liable for further discounting of bills. (See Offord v. Davies (1862) 12 N.S. 748. A Statutory law, or a law passed by the legislative system of a country and promulgated on the people is known as a codified law. So Indian Contract Act, 1872 is a codified law). In unilateral contracts (Unilateral contract is a promise for an act e.g. reward for an act) the revocation of the proposal becomes sometimes a complicated issue. Suppose X proposes a reward of Rs.1000 if anyone brings back his lost dog. Here if X is allowed to withdraw his offer before the finder of the lost dog brings it to him, there may be a miscarriage of justice. Suppose X comes to know that B has found his lost dog and is about to come with it and X withdraws his offer. This will be against fairness and natural justice. In order to prevent such miscarriage of justice Lord Denning held that when the other party started to execute the act, the acceptance is complete and hence it cannot be withdrawn thereafter. In Errington v. Errington, [(1952) 1 KB 290] a father promised that if his son and daughter-inlaw paid up the mortgage amount on the property, the property would be theirs. They started paying off the mortgage amount in instalments. Lord Denning held that the promise could not be withdrawn thereafter though the execution of the promise could be done only when the payment is made. Some authors argue that acceptance must be distinguished from performance of the act. To the parties who have already commenced execution, the proposer is obligated to keep the offer open for a reasonable time. But there are contradictory decisions on this issue. For example, The House of Lords in Morrison Steamship Co. Ltd v. The Crown ((1924) 20 U.L.R. 283) held that commencement of execution of an act does not convert 14
offer into a promise. It may only entitle the party for an action for damages on ‘quantum merit’. According to sec.6 of the Indian Contract Act, revocation may be (a) by way of notice; (b) by lapse of time; (c) by failure of the acceptor to fulfil condition precedent to acceptance; and (d) by incapacity or death of the acceptor. Distinction must be made between lapse of an offer and revocation. Though effect is same, revocation is by the deliberate action of the proposer. He withdraws it by notice. But a proposal is ‘dampened’ due to lapse of time. A proposal standing for a specific time limit, becomes automatically withdrawn at the end of the time unless it is renewed. Infact, such a withdrawal does not require a notice to be served. If it is to be renewed, then only a notice is to be served again. Similarly, if the acceptor is unable to fulfil prior condition, the proposal is automatically withdrawn. A proposes to pay B Rs.500 if B marries C. B marries D. The proposal is automatically withdrawn. Death or incapacity automatically revokes the proposal, if the other party comes to know of it before acceptance. In civil law, such as French law, death or insanity of the proposer automatically terminates the proposal provided it happens before acceptance. Knowledge of the acceptor is immaterial. (Req. 21.4.1891 D.1892.1.181) It seems that French law in this regard is more logical than the common law on which statutory law in India is framed. Similarly, a proposal open for a definite period, according to French law cannot be retracted but in common law, so also in Indian law, proposal for definite or indefinite period can be revoked with notice. 2.3 ACCEPTANCE A proposal becomes a promise only when it is accepted by the other party to whom the proposal is made. For example, a traveller intending to go to a place by train tenders the fare at the railway counter. This is a proposal made to the railways for going to a place by train. When the ticket is issued to the proposer, it is said to be accepted. Once accepted the proposal becomes a promise. Acceptance can be formal through written documents. For example, suppose A writes to B, offering to purchase B’s plot of land for Rs. 50,000. B writes back accepting the proposal. This is a formal acceptance. But acceptance may also be made orally or by conduct. Suppose A advertised in the newspaper announcing that anyone who contracts influenza within a fortnight of taking the ‘antiflu’ tablet made by the proposer would be given a thousand rupees. If B takes the tablets after seeing the advertisement and gets the flu within a fortnight, B would be entitled to the money because B’s taking, of the antiflu tablet is his acceptance of the proposal. (See Carlill v. Carbolic Smoke Ball Co). Similarly, if B gets into a plying route-bus, he is bound to pay the fare since he has accepted by his conduct to travel in the bus. (See Derry v. Peak) Thus acceptance may be in the form of (a) an act ; or (b) a promise. If A proposes to give his daughter in marriage to B and B accepts, B is actually promising to marry A’s daughter on the stipulated date and time. According to sec.2 (b) of the Indian Contract Act, “when the person to whom the proposal is made signifies his assent
thereto” the proposal is said to be accepted. As such, a proposal to be accepted requires (a) assent of the promise; and (b) of the actual proposal in its entire form. (a) Acceptance must be in toto A offers B his ‘horse in harness for £ 30e. B accepts it ‘in double harness’. (Jordon v. Norton) This is no acceptance. This is only a counter-offer. Acceptance in order to convert a proposal into a promise must be ‘absolute and unqualified’.(U.P. State Electricity Board v. Goel Electric Stores, AIR 1977 All 494) Any alteration of terms or changing of conditions of the proposal by the acceptor while accepting will make the acceptance a counter-offer. Counter-offer is the new offer which now the original proposer is to consider for acceptance. Suppose A proposes to purchase B’s house for Rs.60,000 and B says he may consider a proposal not below Rs. 1,00,000. B’s statement is not a counter-proposal. B’s statement amounts to (1) rejection of A’s proposal out right and (2) information to A that B is likely to consider any proposal unless it is Rs. 1,00,00 or more. So far as manner of ‘acceptance is concerned the acceptor is to accept the proposal “in some usual and reasonable manner”. But if the proposal prescribes a manner in which it is to be accepted, and the acceptance is not made in such manner, the proposer may, within a reasonable time after the acceptance is communicated to him, insist that his proposal shall be accepted in the prescribed manner not otherwise, but if he fails to do so, he is deemed to have accepted the acceptance. For example, A writes to B offering to purchase B’s house for rupees nine lakhs and requires acceptance by post. Suppose B meets him and communicates his acceptance orally. A may insist that B write his acceptance. If he does not insist, it will be presumed that A has accepted his acceptance. (b) When is acceptance made? Unless the proposer dispenses with communication of acceptance, for example by proposing that ‘find out my lost dog’ I will pay you rupees two hundred, acceptance is made when it is communicated. According to sec.4 of Indian Contract Act, acceptance is complete. (a) as against the proposer when it is put into the course of transmission so as to be out of the power of acceptor, and, (b) as against the acceptor when the proposer receives the acceptance. For example, A accepts by a letter or by a telegram, B’s proposal of offering Rs. 6 lakhs for A’s house, as per A’s instruction. As soon as the letter is posted or the telegram is despatched, the communication of acceptance is complete against the proposer and the acceptance is complete as against the acceptor as soon as the letter or the telegram reaches B. In England acceptance is complete against both acceptor and the proposer as soon as the acceptance is put into the course of transmission. That is, acceptance once made cannot be taken back because it is complete and binding against both the parties as soon as it is put in the course of transmission. According to the principles of law in England, the course of transmission is stipulated by the proposer and therefore, the course of transmission becomes agent of the proposer. Suppose if the proposer stipulates either post or, telegram or telephone or Fax, as the course of transmission, the communication media becomes the instrumentality of the proposer, or in other words
the agent of the proposer. As such, a letter posted with proper stamp and correct address, or telephone made or a telegram sent or a letter sent by fax must be taken as complete against both the parties. But a cut-off communication or a dead letter box or a disconnected fax system or a dead telephone line cannot set the acceptance in the course of transmission. Such as, a proposal orally made and accepted orally with a disturbed sound on account of an overflying aeroplane and not being heard by the proposer is not a communication, as Lord Denning tries to explain. If a modern course of communication is inoperative, one cannot say that the acceptance is complete when the acceptor puts the acceptance in the inoperative system. But if the fax machine is operative and the message is received, the proposer cannot take a defence by saying that “there was no staff in the office to send the message to the defendants”. On the contrary, if the fax machine does not receive the message or suddenly stops taking the message in full without communicating the exact position, the acceptance is not made at all. (c) Silence is no acceptance Silence is no indicator in a positive legal system such as ours. Justice Macnaughten once observed that human mind is a trait, even the devil does not know what is in the mind, what to talk about a poor judge ! Positive law requires clear positive indication of acceptance. So long the matter is confined to the ‘self’ of the acceptor, it is not regarded as acceptance. Besides, no one can compel another to consider his/her proposal and therefore to speak. Suppose X makes a proposal to Y. X cannot compel Y to consider the proposal and to speak on it. Y has the right to completely disregard it and maintain his silence. So silence cannot be presumed as a mode of acceptance because if it is allowed, a person is compelled to speak. Suppose X proposes to Y and suggests ‘if you remain silent’ I will take it as acceptance. It means now Y has to say ‘no’ if she does not intend to marry X and as such cannot ignore X’s proposal. This is unreasonable and an infrigment on the ‘right’ of a person. But that does not mean that ‘conduct’ cannot be prescribed as a means of acceptance. Suppose a pharmaceutical company advertises ‘reward’ to anyone contracting influenza within a fortnight of using the anti-flu tablet manufactured and sold by the firm, the firm has to give the amount to anyone who purchases the pill, uses it and has an attack of ‘flu’ within the time. This is not a mental acceptance only because communication of acceptance is not made i.e., ‘swallowing the pill’ was not informed to the company. ‘Acceptance’ may not be communicated if the proposer dispenses with the communication. If ‘swallowing the pill’ is enough prescription, no further communication is needed. If one follows the instructions printed in the prescription of the company, as in the instant case, that would constitute ‘acceptance’ and no communication to the company is necessary. Acceptance may be made either by a ‘Promise’ to act in future or immediately. The nature and manner of acceptance is determined by the proposer. In a case where a proposal was made to supply coal at a price to a railway company and the manager of the railway company wrote the letter of acceptance but kept the same in his drawer, it was held there was no communication of acceptance and hence no contract. (Brogdan v. Metropolitan Railway Company). It was almost similar to a mental acceptance and not allowed in a positive legal structure. Ofcourse under old 15
Hindu law in India ‘silence used to be treated as acceptance’. However under our present contract laws, this principle does not find a place. (d) Acceptance by conduct Acceptance can be validly made by conduct if ‘conduct’ is prescribed by the proposer to accept an offer. As for example, any proposal to reward against an act by the offeree can only be accepted if the offeree does that act. Suppose a pharmaceutical company gives an advertisement for paying Rs.10,000 to any person who takes the ‘anti-flu’ tablet for 7 days continuously and yet contacted with flu within a month after taking the tablets. Now suppose Mrs. X purchased the tablets and consumed those tablets for 7 days and then suffered an attack of flu within 15 days, can she demand Rs.10,000 from the company? Can the company refuse payment because Mrs.X did not inform them about her taking the tablets and thereby accepting their offer? Can the company take a plea that it was only inviting offers for taking the tablets manufactured by the company? Here the advertisement of the Company cannot be treated as ‘information to treat’. In an ‘information to treat’ a response is needed for making a proposal. Here no such reaction is needed. As such, it is a proposal by itself. The proposal stipulated the action of “taking the anti-flu tablet for 7 days and contacting flu within one month”. It did not prescribe that the proposer had to communicate acceptance before taking the tablet. Hence fulfilment of the prescription by the company is quite a valid acceptance. It is acceptance by conduct. (e) Revocation of acceptance In English common law acceptance once made cannot be revoked. But as suggested earlier in English law over the years two rules of communication transpired. One for oral communication of ‘offer’ and ‘acceptance’ in which the communication of acceptance to the offer is emphasised, i.e., acceptance is made only when acceptance is communicated to the offeror. The other for the acceptance in writing and sending it by post where communication is complete as soon as it is put into the course of transmission. Here in the second case, whether the offeror really got the communication of acceptance or not cannot be the issue at all. In both the cases, common law is based upon the premise that acceptance once made cannot be revoked or withdrawn. According to Anson, acceptance is like a lighted match-stick to a train of gun-powder. Once the lighted match-stick is thrown, there is no escape from explosion. A lighted match-stick cannot operate explosion unless the gun powder is dampened by operation of time or by counter-offer. It can also not operate if the gun-powder is removed i.e., the offer is revoked before the acceptance. Otherwise, acceptance once made, makes the proposal a contract which is a complete fusion between a proposal and acceptance. In India, the law is different. Here acceptance can be withdrawn at anytime (sec. 4 and 5 of ICA) before the acceptance is complete as against the acceptor i.e., before the acceptance is actually communicated to the proposer. Suppose A accepted through a letter a proposal from B. As soon as A puts the letter of acceptance in the post box, it is binding on B and he cannot thereafter withdraw his proposal. But as far as A is concerned 16
it is still not binding because as against A the acceptance is complete only when the letter reaches B. If A sends another letter through speed post and that letter reaches B earlier than the letter of acceptance, the second letter withdrawing the acceptance is valid and binding. According to sec.5 letter of revocation is complete against the revoker as soon as it is posted and against the other party when it reaches. So, A’s withdrawal letter is required to be posted before his letter of acceptance reaches B. The reason for giving an opportunity of revoking the acceptance is perhaps an equitable one. While the proposer has a reconsideration time between his proposing the issue and acceptor’s putting in his acceptance, acceptor is given a breathing and rethinking time between putting in a letter of acceptance and its reaching the proposer. This is perhaps, a demand of equality of opportunity. In India therefore there can be a situation where the acceptance is complete against the proposer, because the communication of acceptance is put in the course of transmission, but the acceptance is not complete against the acceptor himself even though he puts the acceptance letter into the communication line. Apparently it looks illogical, because, the proposer is bound by the contract though he does not know when was the communication put into the course of transmission and he is not in receipt of the same. He cannot take the plea that since he has not received the communication of acceptance, he is not bound by it. Lord Justice Macnaughten explained this apparent contradiction. According to him, while making the offer usually the offeror stipulates the media of communication. So if the acceptor has correctly and in time puts the acceptance in transmission as per the offeror’s directions, has he not done everything what he is required to do? So on account of any fault in the media of transmission if either party has to suffer it is illogical that the proposer should suffer instead of the acceptor. Ofcourse Justice Macnaughten did not take into account mechanical faults of the communication media in his principles of communication but by and large his logic is sound. According to some authors, this rule of communication of acceptance is full of dichotomy, because, even with knowledge that the acceptance has been made the acceptor himself is not bound by the contract until the letter reaches the proposer. In defence of the statutory provision it can be said that the Statute wanted to extend similar opportunity of revocation to both the offeror and acceptor; because, the offeror can revoke his offer until the acceptance is put in course of transmission. Hence the opportunity to ‘rethink’ is also given to the acceptor also, and, he can withdraw the acceptance before the acceptance is received by the proposer. Those who argue for the dichotomy, offer and acceptance according to them are made in two places, which makes the problem of jurisdiction of the court very complicated. This is explained in the next issue. 2.4 WHERE IS THE CONTRACT MADE The question ‘where is the contract made’, is a very important issue because (a) it determines the time of forming the contract; (b) it stipulates the jurisdiction of the court; and (c) it affixes the rights and obligations of the parties. A contract is made as soon as it is accepted. Under the common law system, as per
the postal rules acceptance is complete as soon as acceptance letter is put into the course of transmission. So if the ‘acceptance letter’ is put into the course of transmission in ‘Rai-Bareilly’, acceptance is complete there at ‘Rai-Bareilly’, and the District court there will have jurisdiction. In England once the letter of acceptance is put in the course of transmission, the acceptance is complete against both the parties and the contract is immediately formed. Sir William Anson gave a simili for acceptance in the ‘lighted match-stick’ to a ‘train of gun-powder’ example. In this logic the media of communication acts as the agent of the proposer. In India we do not follow the same rule in totality. Acceptance is complete, as already stated, against proposer, when the letter is posted. Hence, in so far as formation of the contract is concerned, the time and place of posting the acceptance letter in transmission is decisive, the acceptor also gets an equitable opportunity to withdraw his acceptance till the letter reaches the proposer. The media of communication is treated independent and not as an agent of the proposer. The postal rule is clear and easily applicable in cases where conventional communication method is followed. But in case of modern communications the difficulty arises. For example, if acceptance letter is posted at Bangalore, acceptance is complete in Bangalore and Bangalore city court shall have the jurisdiction. But suppose it is faxed from Bangalore to Delhi. Where is the contract made? Lord Denning explained the situation in Entores Ltd v. Miles Far East Corporation [ (1955) 2 ALL ER]. According to him “there is no clear rule about contracts made by telephone or by telex. Communication by these means are virtually instantaneous and stand on a different footing”. Lord Denning, therefore, rejected the postal rule and decided that ‘it is not until the message is received that the contract is made’. In essence original offer was faxed by the defendant firm, Miles Fax East Corporation of Amsterdam, against which, the London firm being the plaintiff made a counter offer. As such the court decided that since the acceptance through fax was received in London, the London court has the jurisdiction in deciding the case. Thus according to this decision, in all cases where telephone, telex or fax is used, the place of receipt of the message is construed as the place of contract. This rule is against the postal rule and Indian law regarding communication. According to this age-old principle, as soon as the acceptance is put into the course of transmission at its place, acceptance is complete (in case of India, of course against the proposer). So the place of dispatching fax or telex or telegram should be the place determining the jurisdiction, not the place of receipt of the message. As such decision in Entores is just the reversal of the common law principle, “acceptance is effective when and where it enters the channel of communication”. Justice Shaw also noticed that the views of state courts in the US which enforced this old Common law principle. According to the state courts in the US “by the technical law of contracts the contract is made in the district where the acceptance is spoken” (See Traders & Co. v. Arnold Gin Co. Tax Civ App 225 SW. 29 1011). Justice Hidayatullah had very rightly doubted the justiciability of the `ratio’ in Entores and held that the language of sec.4 of the Indian Contract Act could cover the case of communication over the telephone, as well.(Bhagwandas Goverdhandas Kedia v. Girdharilal Purshottamdas & Co. & others, AIR 1966 SC 543).
2.5 PROPOSALAND ACCEPTANCE IN THREE FORMS Proposal and acceptance can take shape in three ways, viz, promise for a promise or bilateral promise ; promise for an action or unilateral promise ; and action for an action or bilateral action. A bus plying on a route and an intending traveller makes a contract by bilateral action i.e., plying of the bus is the proposal and getting into it is the acceptance. A promise of a reward for an act is a unilateral promise, e.g., a promise of a reward for finding a lost child is a unilateral promise. A promise to buy a land is a bilateral promise because there are two promises one proposes to buy the land and the other accepts it. Contract may be executory or executed. For example, a promise to pay railway fare for a travel takes the form of a contract only when the promise to pay the fare is executed. This is an executory contract, but a land deal remains an executory promise for long because execution of the contract takes place after a long time. This is an executory contract. A unilateral promise is binding only when the other party has acted according to the demand of the promise. 2.6 TYPES OF AGREEMENT A proposal accepted becomes an agreement. Such agreements may be either expressed by words spoken or written or it may be implied i.e., not spoken or written in words. For example X sits in Y’s shop and sells goods in the presence of Y. There is deemed to be a contractual relation between X and Y authorising X to sell goods. (sec 9) An agreement may be reciprocal in nature. Bilateral promises are reciprocal promises. For example, a contract between A and B that A will deliver goods and B will pay on delivery of the goods. This is a reciprocal promise (sec 8 & 51). An agreement may be a joint promise by two or more promisors or by two or more promisees. In an agreement there can be an alternate promise, as well. For example, A promises his home X or Y to B for Rs. 51,00,000. This is an alternate promise. Agreements may be contingent depending upon a future uncertain event or conditional, based on conditions, expressed or implied. 2.7 CONTRACT : A FINAL COMMENT An agreement enforceable by law is contract. Therefore, to be a contract there has to be (a) agreement as explained above and (b) such an agreement must be enforceable by law. Sec.10 of the Indian Contract Act stipulates that an agreement to be enforceable by law : (i) must be entered into by persons capable of entering into the contract (Ss. 10, 11 and 12); (ii) must be a product of free consent i.e., consent free from coercion, undue influence, fraud, misrepresentation or mistake (Ss, 15 to 22) ; (iii) must have valid consideration and lawful objects (Ss. 23, 24 and 25); and (iv) must not be otherwise void under Ss. 26 to 30. Ofcourse, contract is to be entered into by parties intending to create a legal relation. Social agreements are kept out of the realm of contract because otherwise social relations shall be vitiated by stringent legal provisions. In Balfour v. Balfour, Lord Justice Atkin opined that in respect of such social and domestic promises “each home is a domain into which King’s 17
writ does not seek to run, and to which his officers do not seek to be admitted”. In this case a husband promised to send £ 30 monthly to run the household to his wife who remained in England on medical grounds whereas the husband returned to his place of work at Ceylon. The Court held that “the promise
here was not intended by either party to be attended by legal consequences”. A flow chart of agreement and the revocation of offer and acceptance is given below :
Figure 1: Flow Chart of Agreement & Revocation
Explanation of Chart On 1-1-94, A dropped a letter of offer to B which reached B on 7-1-94 at 1 p.m. In the meanwhile A had sent another letter withdrawing the offer on 7-1-94 at 10 a.m. B had despatched his letter of acceptance on 14-1-94 at 4 p.m., which reached A on 23-1-94 at 6 p.m. Before the letter of acceptance reached A, B had sent his letter revoking the acceptance on 22-1-94 at 1 p.m. which reached A on 27-1-94. In the light of these facts, let
Communication of offer is complete on Revocation of offer is complete on Communication of acceptance complete Revocation of acceptance complete Now the questions are: 1) Is there a valid offer and acceptance? 2) Is there a valid revocation of offer? 3) Is there a valid revocation of acceptance? 4) Ultimately, what is the effect of correspondence? Since the letter of acceptance is posted at 4 p.m. on 14-1-94, by which time the offer is already withdrawn, there cannot be a 18
us ascertain whether a valid contract has been achieved between the parties applying the principles governing communication and revocation of offer and acceptance. The sequence of events relating to communicatin and revocation of offer and acceptance against A and B may be explained as follows: Communication of offer is Against 'A' Offeror 1-1-94 10 a.m. (Posted) 7-1-94 at 10 a.m. (Posted) 23-1-94 at 6 p.m. (Reached) 27-1-94 at 10 a.m. (Reached)
Against 'B' Acceptor 7-1-94 at 1 p.m (Reached) 14-1-94 at 2 p.m. (Reached) 14-1-94 at 4 p.m. (Posted) 22-1-94 at 1 p.m. (Posted)
valid acceptance. In effect, there cannot be a binding contract. Similarly the letter of revocation of offer is valid because it has reached the acceptor before the letter of acceptance is posted. Letter of acceptance is not valid against 'A' because it reached him on 23-1-94 by which time, the offer was withdrawn and came into effect against 'A' on 7-1-94 itself. Revocation of acceptance is not significant and effective as there was no valid offer, nor acceptance existing on 22-1-94.
3. JUSTIFICATION FOR CONTRACT SUB-TOPICS 3.1 Introduction 3.2 Sociological Reasons 3.3 Political Reasons 3.4 Economic Reasons 3.5 Towards building of a Legal Theory 3.1 INTRODUCTION Contract is a method through which individuals make law for themselves by creating rights and obligations through mutual understanding and contract. As a human being a person enjoys some rights and at the same time he is liable to discharge certain duties and obligations ex factum, i.e., by mere fact of being a person in the society. For example, some human rights or fundamental rights or family rights like right to parenthood, right of succession, etc, these are rights ex factum. But each individual is also a social, political and economic being having a distinct identity. Thus each one of us design and acquire some rights or are subject to certain duties and obligations by mutual understanding for making a society developed and progressed. Contract is the sole method of altering factual situations through the process of give and take. Without this contractual relations society would have remained static. This contractual phenomenon is explained by different people in different ways. Several theories are formulated to explain why a contract is a dynamic process of building up of a society. According to the theoretical justifications the reason why a contract is made is explained in the following paragraphs. 3.2 SOCIOLOGICAL REASONS Society progresses through the process of contract. Contract brings various sections of the society closer through interacting processes which make the culture uniform and standardise the practice. Through the instrument of contract, Hobbs explained, that there is a constant mix in the society. Some sociologists term it as a ‘hot-pot’ in which there is a constant movement of social institutions. According to Durkheim through the process of mutual give and take a social equilibrium is arrived at. Contract is a modality through which individuals as well as social institutions reach at a consensual goal. Even the patterns of contract depends upon the structure of society. As for example, the patterns of a contract in a pre-feudal or feudal society are different from that of an industrial society. The technique of contract, therefore, differs on a basis of social mores. In a feudal society the personalised variations in the contractual paradigm is more visible than in an industrial society. In an industrial society on the other hand, there has to be a growing standardization, and therefore, the span of individual choice or action is limited. Obviously, why contract, what contract, and how contract - all these questions are dependent upon the social structure and the social system. According to
Max Weber in a capitalist society social institutions have conflicting interests. Necessarily, therefore, people involved in those social institutions have conflicting interests. Such conflicting interests are constantly at friction by their respective positions and through their respective strengths and weaknesses. These conflicting strengths and weaknesses are adjusted through the method of contract. Therefore according to him there is no presumption of equality in the status of contract. Contract brings those conflicting social interests at an optimal balance beyond which the system cannot be stretched. Hence, contract is a limited modality of interest adjustments. 3.3 POLITICAL REASONS Various political theoreticians tried to explain the emergence of the state through a system of multi partite contract between people living over a geographical location with a distinct identity of a common language, culture and ethos. According to Hobbes, state is a product of a social contract of all persons in a given geographical location with distinct identity in a situation of utter chaos and confusion which Indian philosophers described as Matsyanyaya, and the French philosopher called it leviathan i.e., anarchy. In such a desperate situation, people who wanted to put an end to the chaos and confusion argeed to transfer all their rights to a ruler/sovereign who in turn would protect all individuals. Thus according to Hobbes the state, authority and kingship originated. The other French philosopher propounding the social contract theory gave another version. According to Locke people of a given area having distinct identity agreed amongst themselves not in a stage of chaos but at a stage of understanding and mutual cooperation to transfer, one most important power in them to a person or a group of persons. This important right was the right of interpretation of law of nature. Thus contract was the method through which one right of all the individuals, viz, the right to interpret the law of nature was reposed to their Sovereign. In fact, the Constitution of India has also followed the same pattern of social contract process and that is the reason why the preamble declares that the people of India gave to themselves this Constitution. According to the political theoreticians contract is a mutual agreemental process through which a party acquires a right, interest or a profit or a benefit as against duty, responsibility, loss or detriment. Whereas the power of a person is acquired initially by factual situation like strength, force, etc, and consequently been limited by the terms of agreement. The alteration of this power is possible through collective processes which may be bi-partite, tripartite or multipartite. These mutual consultations, understandings and give and take make the whole socio-political system dynamic with substantial moral foundation. Thus positivists who believe contract being a process of regulation of inter-personal relations through understanding which can be explained through right duty correlation. Naturalists explain the basis of contract through 19
the moral foundation of mutual understanding, faith and trust. This type of theoretical foundation of contract is explained by Stoics in their rule of pacta sunt servanda. On the other hand, a positivist political philosopher would try to explain the foundation of contract through an Hohfeldian process. According to the contract emanates from power to determine right of a person as against duty to another. It is a process of empowering one and disempowering the other. It involves a kind of immunity to one as against liability to another. It is therefore seen as a distinct political process. In fact the citadel of democracy through adult franchise is based upon the political justification of contractual social living. Of course such a kind of political justification of contractual power is based upon certain assumptions. For example, all human beings are equal, each of them has the minimum level of conscience to determine and regulate inter-personal and intra-societal rights and duties, immunity and liability, empowerment and disability. Citgwick in his Element of Politics (1879) said, “Performance of contract presents itself as the chief positive element, protection of life and property been the chief negative element. Withdraw contract — suppose that no one can count upon the fulfilment of any engagement — and the members of a human community are atoms that cannot effectively combine; the complex cooperation and division of employments that are the essential characteristics of modern industry cannot be introduced among such beings. Suppose contracts are freely made and effectively sanctioned, and the most elaborate social organisations become possible, at least in a society of such human beings as the individualistic theory contemplates; gifted with mature reason and governed by enlightened self-interest. Of such beings it is prima facie plausible to say that, when once their respective relations to the surrounding material world have been determined so as to prevent mutual encroachment and secure to reach the fruits of his industry, the remainder of their positive mutual rights and obligations ought to depend entirely on that coincidence of their free choices, which we called contract” (p.82). Thus the very basic political foundation of industrial society is based on the principle of contract. Sir George, Jessel, M.R., observed in Printing and Numerical Registering Company v. Sampson, that “it is that men of full age and competent understanding shall have the utmost liberty of contracting, and that their contracts entered into freely and voluntarily shall be held sacred and shall be enforced by courts of justice. This is how the moral philosophy of a liberal society has been built up”. 3.4 ECONOMIC REASONS Economic theoreticians try to explain contract as an economic means of acquisition of wealth. If there is no contract between parties for mutual exchange of goods and services the society shall remain as primitive and static. According to them the productivity of the whole society depends upon the individuals’ right to mutually exchange their economic resources to the maximum exploitation of utilities. The economists rely on certain basic presumptions. As for example, according to them 20
every human being is an economic rational being. This rational human being constantly attempts to maximise his material satisfaction through exchange of economic goods and services and while doing this the person takes the decision on the pure consideration of the quality of the goods that can maximise his satisfaction. And of course every economic being is a dissatisfied identity having insatiable demands. The function of economics depends upon the triangle of scarcity, choice and exchange. Material goods and services are scarce, and that is why there is always an existence of a person whose demand is more than the others. Therefore, he tries to acquire the goods. The peaceful way of getting the goods is achieved through exchange. Here comes the importance of contract. Suppose in A’s family there is a patient and the doctor has advised A to give oranges to the patient. A’s demand for oranges would go up because utility of the orange to the patient has become very high. Suppose A is mentally prepared to offer one rupee for an orange. The market price is 75paise per orange, then there is no difficulty for A to contract for orange with the supplier. A then thinks of having the second orange for which he may be ready to pay not more than 90 paise, third one for 80 paise and the fourth one say 70 paise. A has to stop his purchasing after third orange because seller is not in a position to give him at less than 75 paise per orange. That is, why a person enters into a contract for what thing, and in what quantity depends upon his need and the utility of goods to him, and at what stage his marginal utility and supplier’s marginal cost is same as the supplier cannot sell at a price below his marginal cost. Utilitarians like Bentham would explain the reason of contract through the concept of pain and pleasure. According to him every person while entering into contract with another person makes a comparative assessment between the pleasure that he would enjoy by acquiring goods or services from another person and the pain that he is going to sustain on account of losing goods or services or money. Therefore this exchange is going to be the key work in the contract. Through this exchange process individuals maximise their satisfaction of their utilities and the state attains their highest gross national income. Therefore, economist will always try to explain the basis of a contract through assessment of comparative advantage. Economists who belong to the critical, analytical thought explain contract through relative improvement of capital building process. According to Pareto, a change in the betterment of an individual without injuring the interest of any one is an improvement in the economic standing of the parties. This improvement is known as ‘Pareto improvement’. If all individuals in a given society through the process of contract make improvements to their lot without any detriment to another, the total improvement thus arrived at is known as ‘Pareto optimality’. For example in the following two diagrams we find that the price of a commodity in a competitive market is Rs.10/-, in which A and B are two operators. Their marginal cost curve is as follows:
Figure 2
In this diagram the vertical line represents price and the horizontal base is the number of commodity produced by A and B. Whereas MM’ is the marginal revenue curve of firm A and firm B. The two figures show that A’s marginal revenue equals the price in the market while the production is at 20 and the price is at Rs. 5. In the above example, if A produces 21st unit, his marginal revenue shall be less than Rs. 5. In case of B, if B produces one less, his marginal revenue is higher than Rs. 5. Now if A produces the 21st unit and sells it to B at Rs.5/- and suppose B in a year could produce only 5 units and purchases the additional unit from A, B will have no profit no loss situation because had he produced the 15th unit his marginal cost would have been Rs.5/-. This is a situation where one party improves the position but not at the cost of the other. This is known as Pareto improvement. In a perfect competitive market Pareto optimality is reached at a point when marginal utility of the consumers becomes equal to the marginal cost of the producers. After that point further Pareto improvement is not possible. So people resort to contract and mutually exchange either goods and services or money in order to arrive at this Pareto optimality, provided there is a free competitive market. According to Posner, if contract is allowed to operate resources it will gravitate their most valuable use. If A owns a good that is worth only $ 100 to him but $150 to B, both will be made better-off by exchange of A’s goods for B’s money at any price
between $ 100 or $ 150 ...” “By making both of them better-off the exchange will also increase the wealth of the society (of which they are members), assuming the exchange does not reduce the welfare of non-parties more than it increases A’s and B’s welfare. Before the exchange which, let us say, takes place at a price of $ 125 A had goods worth $ 100 to him and B had $ 125 in cash a total $ 225. After the exchange, A has $ 125 in cash and B has a good worth $ 150 to him, a total of $ 275. The exchange has increased the wealth of society by $ 50 (ignoring, as we have done, any possible third party effects)”. [Economics of Contract Law, p.1] According to Marxian economists the production relation of a society which is the fundamental economic relation determines its political structure. Individual freedom which is talked about in market-contract society is essentially based upon the status of the contracting party. As such a contract society is based upon the dynamics of inequality and exploitative exercise. Thus Marxians economists are against contract society. Whether such a society is possible or not is a matter of conjecture where each one will be equal to others and each will have rights and obligations on all material sections of the society. Naturally Marxians economists also believe that contract is the method through which individuals make alteration to their material relation. 21
3.5 TOWARDS BUILDINGA LEGAL THEORY After carefully appreciating the various social, political and economic explanations and theories on contract one may try to build up a legal theory of contract. For example, a positivist (one who believes that law “is” and not `ought’ ; there is a cause and effect relationship in legal application to fact and decision and there has to be a sanction element in the instrument of law.) would try to theorise contract as a mutual agreement between the parties which law as public instrument will enforce and therefore it has to take care of a private agreement. Such a theory is based upon the concept of right, duty, correlation. The definition of contract in the Indian Contract Act as “an agreement enforceable by law” is, therefore, based upon the principle of legal positivism. This type of theorisation is independent of the concept of morality. But when issues arise out of the question of inconceivable gain in an agreement with a pardanashin woman or an agreement against public policy or morality, should law enforce such a type of agreement ? Basic requirement of judgement based upon law and justice are not co-equal. Therefore often a positivist approach faces a limitation.
22
Lewellyn in one of his articles [1931, 40 Yale L.J. 704] attempted a realist approach in answering the question why contract? According to him contract is a “social and legal machinery appropriate to arranging affairs in any specialized economy which relies on exchange rather than tradition (the manner) or authority (the army, the USSR) for apportionment of productive energy and of product. It is a machinery which like status, but in contrast to torts, makes it easy to insist on affirmative action. Contract in the strict sense is the specific legal machinery appropriate when such an economy moves into the phase of credit — meaning or connoting thereby future dealings in general; in which aspect, the mutual reliance of two dealers on their respective promises comes of course into major importance. This machinery of contract applies in general to the market for land, goods, services, credit or for any combination of these ....” Thus one can see the distinction in approach in the theoretical perspective as well. Whereas positivist theory emphasizes the political foundation of contract, i.e., the character of enforceability, realists look from multidisciplinary angle with more emphasis on the economic relations, of course without minimizing “the utility of legal enforcement of promises”.
4. TYPES OF CONTRACT SUB-TOPICS 4.1 Introduction 4.2 Types of contract on the basis of parties 4.3 Types of contract on the basis of time 4.4 Types of contract on the basis of function 4.5 Types of contract on the basis of nature 4.6 Standard form of contract 4.1 INTRODUCTION Contract may be of different types based upon its nature, parties, time and function. 4.2 TYPES OF CONTRACT ON THE BASIS OF PARTIES A contract essentially involves more than one party. It has already been pointed out earlier that such contract can be formed in three ways, viz., promise for an act. Therefore, there cannot be a contract which involves either an act or promise of one party alone. There can be a situation where a unilateral contract involving only one party’s promise or an act can be treated as contract. For example, if A promises to donate Rs.10,000/- to the commissioner of a municipality for the construction of a town hall, such promise of donation cannot be a contract because there is no reciprocity of either promise or action. That means A in exchange does not receive any right or benefit for the promise. This type of promise is known as promise without consideration and therefore not a valid contract. But suppose based upon that promise of A, the Commissioner of municipality undertakes the construction work and incurs the liability for paying the construction bill. A shall be liable for his promise of donation, based upon the principle of promissory estoppel. (Kedar Matt v. Gouri Mohammed) This is an equitable principle which we will discuss in the chapter on consideration. This type of unilateral promise can be called as unilateral contract, is specified in sec. 25(1) of the Indian Contract Act. Almost all commercial contracts are bilateral in nature. Where two parties enter into a contract each promising to do some act for the other, such contracts are known as bilateral contracts. For example, in a contract for the construction of a bridge the contractor promises to construct the bridge against the promise of government or local body’s promise for payment. All contracts for sale of movable and immovable properties and other contracts for lease, rent, mortgage etc are bipartite contracts. In fact most of the contracts are bilateral, determining rights and obligations of the two parties to the contract. In a multilateral contract, there are several parties determining their rights and duties under the contract. For example GATT (General Agreement on Tariff and Trade) is a multipartite contract.
4.3 TYPES OF CONTRACTS ON THE BASIS OF TIME OF PERFORMANCE In a contract one party generally agrees to perform an act for another. Such contracts shape the rights and obligations of the parties in reference to that contract within a reasonable time, provided that, the execution of the contract is completed. Such contracts where both parties have fulfilled their obligations are known as Executed contracts. But if both the parties are yet to execute the contract, the contract is known as executory. Time is a very important factor in the capital market contracts (Stock Exchange Contracts). A contract which is to be performed within one day from the date of entering into the contract, is known as ‘Spot’ contract. A contract which is to be performed within a reasonable time though no time limit is mentioned is known as ‘Ready’ contract. On the other hand if a contract is to be performed on a future date, i.e., if the contracting parties agree that on a future date the stock shall be transferred and the payment shall be made it is known as ‘future’ contract. 4.4 TYPES OF CONTRACT ON THE BASIS OF FUNCTION When private parties enter into a contract to determine their mutual rights and duties, it is known as private contract. All mercantile contracts, property contracts, service contracts, etc are private contracts. On the other hand contracts entered into by the state or the government or by any instrumentality of the state are known as public contracts. There is distinction between private contract and public contract in so far as procedure in making the contract itself is concerned. This will be discussed in detail in the chapter on government contracts. 4.5 TYPES OF CONTRACT ON THE BASIS OF NATURE Contract may be written or oral. Most of the commercial contracts are entered in writing, but contracts made by common people in their daily life are oral. Contracts may be express or implied. Oral contracts or written contracts are express contracts. But sometimes contracts may be made impliedly. For example, if A allows B to sit in his shop and transact business in his absence, in the eye of law it shall be deemed that there is a contract of employment or agency between A and B. A contract made between parties based upon mutual promise is known as reciprocal promise. For example, A agrees to deliver goods to B as against B’s promise of paying the money on delivery. Here both the parties promise to perform an act. This type of contract consisting of mutual promises/acts is known as reciprocal contract. A contingent contract is one to perform or not to perform an act, if some future uncertain event, collateral to such contract does or does not happen. As for example, A contracts to pay B Rs.10,000/- if B’s house is burnt. This is a contingent contract (sec.31), because burning of B’s house is an uncertain event 23
which cannot, under normal circumstances, be controlled by the parties to the contract. A contract is conditional if the performance or non performance of a contract depends upon a condition. For example, A agrees to take B’s house on rent at Rs.5,000/- per month provided the house is re-furnished. This condition may be either prefixed or suffixed. Conditions are said to be prefixed, if the performance of the contract depends upon prior fulfilment of the condition. A suffixed condition on the other hand is one where contract terminates on happening of the condition after the contract is performed. For example, A transfers his house to B on condition that B will not marry C. The house will remain with B only till he refrains from marrying C. The moment he marries C, the contract is terminated and A gets his house back. 4.6 STANDARD FORM OF CONTRACT The impact of industrial civilization in realm of contract is felt mostly through the process of standardization. For example, a seller selling two sets of the same model of TV cannot sell them at different terms to two customers at a given point of time. The terms of sale are standardized for all possible customers. Any variation in the terms is treated as unfair trade practice. Standard form of contract is, therefore, one where terms of the contract are all standardized and generally printed. These terms are often determined by trade association for the use of its members either contracting inter se or with outside public. The basic idea behind standard form contract is that a trader of uniform goods cannot discriminate between his customers. The argument of buyer being the offeror shall not insulate the seller for discriminating between the buyers of the same or similar commodities in so far as price, quality and services are concerned. To make it clear suppose X approaches a dry cleaning shop with some of his garments. The charges are fixed according to the nature of clothes. The condition of the service and the delivery are all printed at the back side of the bill. Therefore, the customer has no other option excepting agreeing to terms and conditions so fixed. The philosophy that ‘like must be treated alike’ is the outcome of the culture of industrial civilization. Therefore the shopkeeper cannot argue that since the customer was willing to pay more and offered more he accepted a price higher than what was fixed. Standard form contract, therefore, is a contract where the customer after being fully aware of price, terms and conditions i.e., conditions of delivery and terms of payment opts to enter the contract. The Standard form contract, therefore, is philosophically against the principle of ‘buyer’ being always the offeror. Standard form contracts save time and make several types of contract based on risk assumptions and risk distributions quite possible. As for example, contract of insurance, carriage, banking and the like. It is also a device to clearly exclude liability by express provision where under normal circumstances a liability would arise. Ofcourse taking this plea a person cannot avoid the professional risk. Standard form contracts have the following pattern: 24
(i) Conditions of the contract, like subject matter, services, price, delivery, payment, etc. are clearly stated (ii) Prefixed or suffixed conditions either binding the contract or terminating the contract are stipulated (iii) Rights and duties of the parties are specifically outlined, if not positively atleast by negative statements commonly called as ‘Exemption Clauses’; and (iv) Consent of the parties are indicated either by signature or by reference. Standard form contract has certain basic principles: (i) Knowledge presumed A signatory to the contract cannot argue that the contents of the agreement have not been communicated, or that these were not read or not explained. Suppose X gives her clothes to a dry cleaner and in the bill it is printed that if the goods are not taken delivery off within a week from the delivery date indicated in the bill the dry cleaner shall not be responsible for any damage caused. In such a case suppose the goods are not taken delivery off within a week and the goods are kept open on the floor, and are partly damaged by rats, the shopkeeper may refuse to accept liability. X cannot take the plea that she is ignorant about the condition. Of course liability from negligence cannot be exempted through any exemption clause like this. For example, X takes a cycle on rent from a shop. The standard form receipt states that for personal injuries the shop shall not be liable. But if the injury is caused to X on account of the cycle being not fit for riding the shop shall be responsible. (White v. Warwrick & Co Ltd [(1953)1 WLR 1285] The exemption clause is one where insulation is provided against negligence. For example, if X undertakes to decorate B’s premises at the sole risk of B as regards loss or damage by fire, howsoever it may be caused. Under such circumstances even if the house is damaged by fire due to negligence, X is not liable to compensate, especially when X urges Y to take an insurance against fire.(J. Archdele Ltd v. Com Services Ltd (1954)1 WLR 459) At present consumers are generally protected against loss on account of negligence inspite of such exemptions, provided these exemptions can even remotely be connected with unfair trade practices. (ii) Notice of Exemption The exemption is required either to be printed in the document of contract or clearly mentioned in it. Suppose X asks her niece to buy a railway excursion ticket for her. The ticket on the face of it had the printed words “see back” and on the back a statement that it is issued subject to the conditions set out in the company’s time table which one could buy for Rs.12/-. If one of those conditions exempt the railway company from liability of personal injury, can X being injured in the trip claim damages on the plea that she is illiterate and could not get the notice from the ticket nor had she enough money to buy the time table? In a similar situation the British court held that as the notice was
clear and as the ticket was a common form document the railway was not liable (Thompson v. L.M & S Rly [(1930) 1 K.B 41]). Similarly if X purchases an air ticket and puts his baggage in the carrier for which he is given a ticket containing a clause that ‘damages rule as per the conditions stipulated in the ticket’. In the ticket the rule is printed in very small words which X knows to be printed but cannot read. A clause so printed stipulates that for loss of the baggage a compensation of $ 40 only is payable per bag unless a higher value is declared and higher freight is paid. Can the traveller in such situations, claim the higher compensation on the plea that such a small printing cannot be properly read ? Such an important condition is required to be directly brought to notice. In a similar case it was held by a British court that the defendants would have to show that they gave a reasonable notice that the writing contains conditions.(Burnett v. Westminister Bank Ltd [(1965)3 WLR 863]). Presently this type of notice is critically reviewed by the judiciary from the point of view of public interest. If any small indication of notice goes against the consumers’ interest then the courts generally started ignoring such exemption clause. In an interesting case, the plaintiff booked a room in the defendant’s hotel, and nothing special was told to her at the reception desk where the contract was made. She later saw a notice in her bedroom exempting the defendant from liability of articles lost or stolen unless handed to the management for safe custody. It was held that such a notice in the bedroom cannot be said to have been incorporated in the contract because the contract was made at the reception desk, where no instructions were given to see notices provided in the bedroom. (iii) Exemption clauses are strictly interpreted : “It is a well settled rule of construction that if one party puts forward a printed form of words for signature by the other, and afterwards it is found that these words are inconsistent with the main object.... of the transaction as disclosed by the terms specially agreed, the court will limit or reject the printed words so as to ensure that the main object of the transaction is achieved. [New Chatel Asphalte Co v. Bernett (1957)]. An example may be taken from Glynn v. Margetson [(1893) A.C 351 1 WLR 356]. A bill of lading provided for shipment of oranges by a ship lying in the port Malaga and bound for Liverpool with liberty to proceed to and stay at any port or ports in any station in the Mediterranean, Black Sea or Adreatic or on the coasts of Africa, Spain, Portugal, France, Great Britain or Ireland for the purpose of delivery of coal, cargo or passengers or for any other purposes whatsoever”. The ship went east of Malaga, retraced her course and then reached Liverpool. As a result of the delay the oranges deteriorated. The carrier was held liable despite the deviation clause because the court limited the import of the general words of the exception with reference to the main object or intent.
(iv) Exclusion from fraud, misrepresentation, fiduciary obligation or natural justice cannot be made: No standard form contract can contain a clause excluding a party from the liability arising out of misrepresentation, fraud or fiduciary obligations or natural justice. Lord Denning in several cases also held that the rules of a union purporting to oust rules of natural justice would be void. Similarly a Director or a promotor of a company has a fiduciary duty to the company not to make a profit without disclosing his self interest. He cannot opt out of such a duty by providing any exemption clause in a contract between him and the company. (v) Exemption clause should not be unreasonable : The Common Law principle is that the exemption clause is not invalid merely because it is unreasonable [Luddit v. Ginger Cooti Airways Ltd (1947) AC 233]. But inherent inconsistency and unreasonableness or irrelevance for the main purpose of the contract shall vitiate exemption clause. Similarly a lawfully bound duty cannot be obliterated by an exemption clause. (vi) No fundamental breach can be covered up by an exemption clause : In Woolmer v. Delmer Price Ltd, [(1955)1 Q.B. 291] the defendants agreed to store the plaintiff’s fur coat ‘at customer’s risk’. The coat was lost in some unexplained way. It was held that the defendant could not rely on the exemption clause as the coat might have been lost as a result of a fundamental breach. Government contracts or big turn key contracts are examples of standard form contract. Standard form contracts have several advantages. They are : (i) It shifts the risk of contract from buyer to the seller as far as fixation of terms of contract is concerned. So buyer’s option is either to enter into the contract or not to enter into the contract; (ii) Standard form contract saves buyers from exploitation; (iii) All conditions of contract are certain and definite; and (iv) The complexity of the burden of proof and evidences are to a great extent simplified. Example of a Standard Form Contract : All insurance policies are standard form contracts. When a person wants to insure his life, he has to accept the terms and conditions specified by the Insurance company. He himself cannot make any changes in the contract. It is a take it or leave it contract, i.e., there is no compromise or special considerations for anyone, and, even if some of the conditions result in hardship to the person he cannot complain. Some other examples of standard form contracts are : a cloak room ticket ; a laundry/dry cleaner’s bill; a telephone bill etc.
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5. TERMS OF CONTRACT SUB-TOPICS 5.0 Introduction 5.1 Terms of Representation 5.2 Test of Contractual intention 5.3 Conditions and Warranties 5.4 Implied Terms 5.5 Construction of Terms 5.6 Exception Clauses 5.0 INTRODUCTION The rights & obligations of contracting parties arise on account of the express and implied contracts and warranties. In order to enforce these rights and obligations, one must look into the facts and context of each case, the intention of the parties etc. Let us now examine the principles pertaining to the interpretation of terms of contract. 5.1 TERMS OF REPRESENTATION A commercial contract generally contains various terms in the contract. All these terms are determined through a detailed discussion over a period of time. Sometimes it becomes necessary to analytically examine the whole affair of the contract in order to understand what are the terms and conditions of the whole contract. Some of these terms are expressedly stipulated by the parties, but some other terms remain hidden and implied. Some terms though stipulated are not essential but some other terms though not expressly stipulated are treated as being very important for the existence and performance of the contract. Justice Williams explained these terms in Behn v. Burness [(1863), 3 B.45.751] in the following terms: “Properly speaking a representation is a statement, or assertion, made by one party to the other, before or at the time of the contract, of some matter or circumstance relating to it. Though it is sometimes contained in the written statement, it is not an integral part of the contract; and consequently the contract is not broken though the representation proves to be untrue”. In order to explain such type of representations, Anson has cited two cases [Contract, pg.125]. In the first case, a private seller sold a motor car to a firm of dealers. He told them that the car was of 1948 model. The log book showed that it was first registered in 1948. But, in fact, the car was a 1939 model and the log book had been altered by some unknown person. The court held that it was a mere representation, not giving rise to any action for breach of contract. In the second case, a motor dealer stated to a private purchaser that the car has done only 20,000 miles, based on the reading of the milometer whereas the fact was that the car had already done 1,00,000 miles. The court held that the term was a contractual one, and therefore, the contract was terminated. The court distinguished the above two cases on the ground that, in 26
the first case the seller honestly believed what was stated, whereas in the second case the fact stated should be within the knowledge of the seller. The above distinction shows that some terms in the contract become an essential part of the contract, whereas others remain as representations. Therefore, terms of contract are divided into two groups : (1) those which form, the basic core of the contract, denial of which will either amount to denial of contract or entitlement of substantial damages. These types of stipualtions/statements are called contractual terms or conditions; (2) those statements which are innocent in formation, stated bonafidely, but are not fundamental to the conception of the contract are mere representations. 5.2 TEST OF CONTRACTUAL INTENTION The main test as to whether a statement in a contract is a representation or a contractual term is based upon the intention of the parties, which is to be identified in the totality of the evidence collected. As for example, take the following instances. Raman offered hops for sale to Rahim. Rahim asked him whether, sulphur has been used in the treatment of that year’s growth as brewer’s were refusing hops contaminated with sulphur. To this enquiry Raman said ‘no’. Rahim was very particular about the condition and said that he would not even ask for the price if sulphur was not used. On Raman’s saying no, the parties determined the price, and Rahim agreed to purchase the hops based upon the sample given to him. After that the hops were delivered to his warehouse, weighed and the amount due on purchase determined. Rahim afterwards repudiated the contract on the plea that the hops contained sulphur. It was proved that, sulphur had been used over 5 acres, though the entire growth consisted of 300 acres. It was proved that, Raman did not make the false statement wilfully, because he forgot that sulphur was used in only 5 acres. In this example it is clearly shown that Rahim wanted to purchase the hops only if sulphur was not used in the growth. Therefore, Raman’s assurance was a contractual term on which the contract was specifically made, hence Rahim was justified in refusing the contract. Anson stipulates four probable factors in determining such a representation or contractual terms. According to him, time is a very important factor in determination of representations. If interval between the time of making the statement and the final manifestation of the agreement is a long one, it point to representation instead of a contractual term. Secondly, importance of the statement in the minds of both the parties indicates the status of the statement. Thirdly, if the statement was followed by the execution of a formal written contract it will probably be regarded as a representation if the statement is not incorporated in the written document. Finally, where the maker of the statement is in a better position to ascertain the accuracy of the statement, according to Anson, courts will tend to regard it as a contractual term.
5.3 CONDITIONS AND WARRANTIES Terms of contract, has various grades of importance. Parties to the contract may regard some of these terms as vital and others as subsidiary or collateral to the main purpose of the contract. As for example, A wants to purchase a car from B. B makes a statement that the identified car goes 15 Km/Lt. After the deal was entered into, A finds that the car goes only 12Km/Lt. Here, the statement of B migh have been relied by A, which finally motivated him to select the car. This situation can be distinguished from the following fact. Here, A approaches B to purchase a car, stating that he did not want to purchase any car giving less than 15 Km/Lt. Now if B identified a particular car and suggests that it would go 15 Km/Lt which prompted A to finalise the contract. A afterwards comes to know that the car goes only 12 Km/Lt, could rescind the contract. Here, the statement of B, that the car goes 15 Km/Lt was a vital statement for the formation of the contract. In the earlier instance, the statement was a collateral one. A term which is essential and vital to a contract, the denial of which would entitle the innocent party to treat himself from any liability is known as ‘condition’. But, the term which is only collateral or subsidiary to the contract is known as ‘warranty’ ; its failure can only give rise to an action for such damages as is actually suffered by a party on the failure of the term. In Glaholm v. Hays [(1841)2 M.N.G. 257], a vessel was chartered to go from England to Trieste, and, there load a cargo. The charter party contained this clause: ‘the vessel to sail from England on or before 4th of February next’. The vessel did not sail for some days, after the 4th Feb. and on its arrival at Trieste, the charterer refused to load the cargo and repudiated the contract. While holding the action of the charterer’s as justified, the Court of Common pleas, held that, whether a particular clause in a charter party shall be held to be a condition upon the non performance of which by one party .... or it amounts to an agreement only is the breach whereof is to be recompensed, to be collected ...” depends upon the intention of the parties to the contract as specified in the terms of the contract”. Conditions maybe promissory conditions, contingent conditions, condition precedent or a condition subsequent. A promissory condition is one which is an essential undertaking in the contract, whereby one party promises to the other. If it is not made good, not only will the other party be entitled to treat as discharged, but it can also sue for damages for breach. A contingent condition is a provision, that a contract shall not take effect unless and until the condition is fulfilled. In Trans Trust S. P.R. L. v. Danubien Trading Co. Ltd [(1952)2 Q.B. 297], the distinction between promissory and contingent conditions was brought into by Lord Denning. In this case, a stipulation concerning the sale of goods relating to the opening of the buyer of the banker’s estoppel credit in favour of the seller. Lord Denning held, “sometimes it is a condition precedent to the formation of a contract, i.e., it is a condition which must be fulfilled before any contract is concluded at all. In those cases the stipulation subject to the opening of credit’ is rather like a subject to the contract’. If no credit is provided, there is
no contract between the parties. In other cases, a contract is concluded, and a stipulation for credit is a condition which is an essential term of the contract. In those cases, the provision of the credit is a condition precedent, not to the formation of a contract, but to the obligation of the seller to deliver the goods. If the buyer fails to provide the credit, the seller can treat himself as discharged from any further performance of the contract, and can sue the buyer for damages for not providing the credit”. Condition is subsequent when the parties agree that the contract is to be immediately binding, but on happening of certain events either the contract would cease to bind or one party is to have the option to cancel the contract. Warranty on the other hand, is collateral or subsidiary term, not as vital as a condition. For example, suppose B enters into a contract with G a director of an opera, to sing in the Opera concerts for a period of 3 months. Suppose, one of the terms of the contract is that B has to report to Bombay, 6 days before the commencement of engagement for rehearsals. Now if B arrives only 2 days before for the rehearsals, can G refuse to go with the contract? In a similar case, the court held that, in such a contract the term is not a condition, but merely a warranty, its breach does not operate as discharge of contract, but only entitles the party to demand compensation for damages. 5.4 IMPLIED TERMS Sometimes in a contract, many of the contractual terms remain implied. As for example, in the business world, there are many customs of trade. These customs are not required to be repeatedly stated in the contract. Such customs require express stipulation for exclusion. In sale of goods, there are implied conditions such as (a) implied undertakings as to the title to the goods to be sold; (b) in a sale of description, goods shall correspond to the description; (c) goods have quality or fitness; (d) bulk of goods correspond to the sample and description; (e) if the purpose is stated, the goods are suitable for the purpose; (f) goods are marketable. An example can be taken from Wallie v. Russel [(1902)2 I.Rep.585]. A girl brought from a fishmonger, ‘two nice fresh crabs for tea’. The crabs were not fresh; indeed they were highly poisonous. The fishmonger was held liable for damages for breach of this implied condition. Similarly in Gotley v. Perry [(1960)1 WLR 9], a 6yr. old boy brought from a retailer, a plastic toy catapult. It was made of cheap, brittle polysterene, and while the boy was fixing a stone from it, the catapult fractured, and he lost the sight in one eye. In an action by the boy against the retailer for damages, the court held that there was a breach of implied condition as to merchantable quality. 5.5 CONSTRUCTION OF TERMS The court has a responsibility of construction of the contractual terms in accordance with the intention of parties. It means that, the court has to discover the intention of the parties by looking at the terms of the contract. In a written contract, the task is easier. The court generally explains the terms of the contract in plain and literal meaning. In the event that two meanings are possible, court takes that meaning which would make the instrument valid, and avoids one which would make the 27
instrument void or ineffectual. Where there is an express mention in the instrument of a certain thing, it would exclude any other thing of similar nature [expressio unius est exclusio Alterius]. 5.6 EXEMPTION CLAUSES Often in commercial contracts we find a party taking shelter under an ‘exemption clause’, express or implied. Exemption clause is one which stipulates one party to be exempted from certain liabilities in certain events. This type of exemption clause is evident in standard form contract. Anson very rightly suggested that one of the most important developments in the sphere of contracts during the last 100 years, has been the appearance of ‘standard form contracts’ or ‘contracts of adhesion’ as it is sometimes called. These types of contracts have clear provisions delimiting the liabilities of the parties. Each time an individual travels on a bus/train, takes his clothes to the dry cleaners, receives gas, electricity, water from the municipal supply, deposits his luggage in the railway cloakroom, takes the lease of a house/flat, he will receive a standard form of contract. He has to either accept it in toto or go without it. He does not have any other alternative. The court in such situations applies ordinary principles of contract law and examines the fairness and reasonability of the stipulation. An unfair stipulation is struck down, and all reasonable considerations are taken for the purpose of protecting consumer’s interests. If the terms are written in a contract and parties to it sign the document, they are bound by the terms, even though they have not actually read the stipulations. The problem is where the document is not signed by the customer, but it has merely been delivered to him. In such cases problem arises, as to whether the terms of the contract were adequately brought to his notice or not, at the time of entering into contract. In Ouey v. Marlborough Court Ltd. [(1949) 1 K.B. 532)] the plaintiff and her husband, were accepted as guests in a hotel. They paid their week’s board and lodging in advance as required by the rules of the hotel, over the counter. After that they were given the key of the room. In the room, they found another notice which stipulated that ‘the proprietors of the hotel would not be liable for articles lost or stolen from the room’. Owing to the negligence of the hotel staff a thief gained access to the room and stole some articles. The Court of Appeal held that, the notice in the room did not form part of the contract, since the plaintiff could not have seen it until after the contract was made. A previous course of dealings between the parties generally does not validate an implied exemption clause. In British Crane Hire Corp. v. Ipswich Plaint Hire Ltd. [(1974)2 WLR 856], it was observed that an exemption clause may be implied where each party has led to the other reasonably to believe that he intended that their rights and liabilities should be ascertained by reference to the terms of a document which had been consistently used by them in previous transactions. Notice of such exemptions is strictly interpreted, with a view to objectively determine whether the parties to the contract arrived 28
at a consensus with full knowledge. If a customer of a dry cleaning shop receiving the receipt, did not see or note that there was anything written in the receipt, he is not bound by the condition. But if he knew or believed that exemption clauses were contain or conditions were specified in writing though he himself did not read it, he is bound by the clause. As for example, ‘A’ deposited his bag in the cloakroom of a railway station. He received a paper ticket which said on its face ‘vide reverse’ and on the backside there were a number of printed conditions including a clause limiting the liability for the loss of any package to $ 20. If ‘A’s bag is lost, he can claim only $ 20. The notice must be reasonable. Whether a notice is reasonable and adequate or not is a matter of fact. In Union Steamship v. Barnes [(1956)5 DLR 2 535 (Canada)], the plaintiff tendered the passage money to a steamer company and purchased a ticket. The ticket was folded and given back to the plaintiff. The plaintiff knew that something was written on the ticket, but did not open the ticket to see it. One of the conditions was limiting the company’s liability for any lost/damaged goods to $ 100. The court held that sufficient notice was not given because the ticket was delivered in a folded condition, and conditions were obliterate in part by a stamping red ink. Exemption clauses are very strictly interpreted. In most of the cases, consumer forum interprets these exemption clauses in a very narrow sense to give adequate protection to the consumer. One of the hotly debated issues is whether the defendant can exclude himself from tortious liability for negligence. According to common law, the defendant can protect himself, his servants and agents, with a clear provision of exemption. In Rutter v. Palmer [(1922) 2 K.B.87], the plaintiff left his car at the defendant’s garage for sale on commission. One of the terms of the contract was that, defendant’s drivers would drive ‘the run test’ if required by the customer. On such a test run, there was a collision and the car was damaged. It was held that the defendant was not liable to pay compensation because of the clear terms of the contract. One of the fundamental principles of common law is that a third party can not acquire any right on a contract. In Scrutions Ltd. v. Midland Silicones Ltd. (1962 AC 446), a drum of chemicals was shifted from New York to London, was consigned to the respondents upon the terms of bill of lading which exempted the carriers from liability, in excess of $ 500 per package. In the course of being handled in a warehouse, the drum was damaged by the negligence of the appellants, a lim of Stevedores employed by the carriers and the damage amounted to $ 593 (or nearly $ 2500). Though the appellants were not a party to the bill of lading, not expressly mentioned therein they claimed to be entitled to the benefit of the clause limiting liability. The majority of House of Lords held that, the appellants could not claim the benefit of an exemption clause in a contract to which they were not a party. Of course Lord Denning, in his minority judgement, considered that the appellants were protected since the respondents had assented to the limitation of liability.
6. CONTRACT IN THE CHANGING SOCIETY SUB-TOPICS 6.1 6.2 6.3 6.4 6.5 6.6
Introduction Essential assumptions in a contract Critical review of assumptions Conditions in the changing society Contract in changing society Concluding remarks
6.1 INTRODUCTION According to Sir Henry Maine the progressive society has developed from status to contract. Friedman took this argument further by stating that “as against a legal status determined by ties and conditions outside personal decisions, contract allows the individual to change his country or employment” (Law in the changing Society, 1996). A feudal Society of serfs and slaves was a static society where things used to be determined by status of the individual. In order to evolve a progressive society an ideological conflict was inevitable, which we find evident in the American civil war when South tried to defend a farm society of serfs and slaves and the North aspired for a free economic society to develop commerce and industries. According to a section of sociologists the domination of caste and class in Indian society, is a point in evidence of Indian society being backward, static, immobile and feudal. A mobile society always aspires for change and progress. It demands freedom of every individual being to determine his/her course of action. 6.2 ESSENTIAL ASSUMPTIONS IN A CONTRACT A contract-society is one which is based on certain essential assumptions. Some of these basic assumptions are: 1. Equality of status — Unless there is a freedom of contract an individual does not have the liberty of determining his economic destiny through the contractual process. Thus, equality and freedom of contract are interchangeable assumptions of a contract society. Friedman opined that lack of freedom, to make or unmake a contract, or to bargain on his terms, also implies lack of equality (1970 - 93). In a contract society the fundamental issue, therefore, is that each party to the contract must be equal to the other party in so far as his or her bargaining ability and stipulating terms are concerned. It is, therefore, necessary that there shall be no social or political restraints which may stand in the way of individual contractors to assume a position of equality. According to John Stuart Mill every human being has the right to determine what he should do and what he should not do. Bentham in his Utilitarian thesis explained the contractual ability of a person through his/her relative understanding of marginal utility of the fruits of his action. The Constitution of India has guaranteed this right to equality in so far as dealings of the state with the citizens is concerned. Ofcourse this concept of equality has undergone several
interpretations in an open market and a socialist economic transactions. But the basic issue of equality of the parties and their right to determine terms and conditions in the contract on different considerations, specially the economic consideration of transaction costs, is presumed in democratic functioning of the state. 2. Freedom of choice — Economists are of the view that essential conditions of success in a contract society depends upon its market conditions. A market which cannot be determined either by an individual buyer/seller achieves perfection of a contract society. Such a market condition therefore essentially requires: (a) alternate actions; and (b) freedom of choice. A buyer may be compelled to buy a thing at a dictated price because of the absence of either of the conditions or both. Such a structure leads towards the status, more than the ability. This is an antithesis to a contract society. 3. Free exchange — Contract envisages exchange through volition. The concept of exchange has of course undergone a systematic change from the days of barter-economy to the present days of money economy. Presently exchange is circuitous i.e., commodities/services are exchanged for money, and money in turn is exchanged for commodities/services. Any regulative mechanics preventing exchange either in the stage for money or for goods tends to create an obstacle to the development of a contract society. 6.3 CRITICAL REVIEW OF ASSUMPTIONS 1. Equality — A contract society is growingly made equivalent to capitalism, whereas, a regulated society is termed as socialistic. This political overtone on economic relations may not always signify the truth. In a capitalist society of high industrial growth, the equality of bargaining between an employer and employee becomes a myth, specially in the context of populace developing countries. (In any country number of employers are less than the number of employees seeking jobs.) However, employees uniting themselves may strengthen their bargaining capacity; and so may the employers unite themselves to create a monopoly. In several countries anti-monopoly or anti-trust laws prohibit any attempt of creating monopoly and cornering of the market. The same logic is now growingly used against the state action of allowing trade unionism. If the state does not allow trade unionism and also does not stipulate the minimum wages, the inequality of status in fact between the employer-employee especially in the developing world will reduce the wages to be paid to the employees to sub human levels. It would further encourage the unethical competition of wage reduction between existing employees and unemployed people (the unemployed persons in their eagerness to become employed, would be willing to accept very low wages, and, the employers would be in a position to exploit this situation to their own advantage, paying scant regard to the rights of the employees). It is true that in a democratic country with a free economy the state has to confine its role in regulating activities 29
by — (1) recognising all players; (2) ensuring the rule of the game; (3) seeing that all possible unevenness in playing conditions are avoided; and (4) strictly policing so that none can disturb the situation. It is, therefore, argued that creating unevenness in the field of contract by prescription of minimum wages or payment of bonus etc amounts to disturbing the economic operations and conditions of inequality. These in fact, as argued by some, prevent employers from increasing the productivity and creating job opportunities. Therefore two different types of arguments are clear. Firstly, that equality itself becomes a myth in economic operations like employer-employee relationship. The mere capital movement itself creates inequality in the playing conditions which the state cannot overlook. Secondly, state cannot allow the economically weaker section of its population exploited by stronger section of its population in any manner, whatever be the form of exploitation i.e., social, economic or political. Based on these two arguments, a third opinion emerges. That is, the state has to ensure minimum public welfare and a sound public policy. The concept of contract as a vehicle of exploitation cannot be allowed in a democratic set-up. On the other hand protagonists of colonialism argue, firstly that the state intervention in the freedom of contract violates the basic moral and political issues of democratic governance. Secondly, it effects the efficiency of the economic system by increasing the transaction cost (one of the noble bureaucrat of recent times has attributed credit to system of slavery in rising American economy.) Thirdly, state intervention in the area of freedom of contract prevents growth and restricts employment opportunities. Fourthly, social welfare must not be confused with hard-core economic rules, which regulate the price for factors of production on demand and supply. More supply of labour would reduce the cost of labour, encourage more investment creates more job opportunities and ultimately increase the wage structure, thus, striking a balance of investment, productivity and employment. In fact the dynamics of society revolves around this question of balancing the interests of various sections of society. Accordingly over the years we see the change in the nature and formation of contract itself — from individual contract i.e., parties to the contract determining terms & conditions, we entered into a concept of the state regulating terms & conditions, i.e., a third party directing the conditions of contract. This brings into various forms of contract as well as principles, for example, the standard form of contract is one in which all terms and conditions are stipulated by one party either on its own (since it is in fact the powerful party) or because of the state intervention (since the state is concerned in protecting the public interest). The other party to the contract has to submit to it. A basic principle has arisen out of this form of contract which ideally suits mass production in an industrial setup. The principle is that the seller cannot stipulate different prices for similar products to different customers. In some countries this principle is covered under unfair trade practices and in some other countries it is taken as against business ethics. 30
2. Choice — Freedom of choice is dependent upon many macro-level policy concerns of the state, for example, the people want more choice in motor cars, more import of machineries and technology is needed, as well as need for more roads. So where the capital of the country is limited and there are multiple needs it may be necessary for the state to regulate the capital deployment to some avenues more than the other. Necessarily, therefore, in short supply choices are restricted. In a socialist society, private satisfaction does not take a leading role specially because supply of the essential commodities is limited and free choice would lead to disaster. Free choice is possible when there are several alternatives, each having sufficient supplies and all people have contracting abilities (according to Marshall need is not demand. A person having the purchasing power and ability to go to the market and to place the order according to his/her ability for the product, is the demand). State as the friend of the people determines what is the essential need of the people, how to meet the essential need and what amount of capital is to be deployed in producing that. In the changing society which tends to globalize economists of the free market variety, argue that state is not required to be engaged in the production and distribution level operations. Free entrepreneurs from any part of the globe shall look after the people’s interest and design their standard of living. According to them, choice is not merely to be free in the national context, it has to be free in the international context. The question, therefore, shall influence the building up of international transactions and regulations at the cost of the national system. The concept of freedom is itself questionable. Even where choice is unlimited like the choice of hire and fire, raises many questions of wider interest. Some people argue that having such a policy of hire and fire only because there is an abundant labour supply can become dangerous to a country. It may create huge unemployment which the national economy cannot absorb. It will encourage destabilization and ultimately lead to de-industrialization. Open market protagonists on the other hand argue that conditions of efficiency can only be maintained by providing freedom of choice. State interference in this area will lead to an immobile society. The question of choice has not remained an individual issue any longer. Choice involves a risk. Suppose A chooses to purchase a couple of bullocks for his cultivation it bears a risk to the life of the bullocks. It means that people having similar choice run a similar risk. In modern times this risk sharing amongst all those who have similar choice has become an essential part of the transaction. It is even absorbed in the cost of an article. 3. Free exchange — This is seldom allowed totally in any country. Lack of foreign exchange, adverse balance of payment, regulated imports, all these are evidences of restrictions imposed on exchanges. In a chronically short supply of market price regulation by the state is often practised. Restrictions on free exchanges are often recognised by the common law courts in various parts of the world. Restrictive covenants are generally held valid in sale of business good-will.
6.4 CONDITIONS IN THE CHANGING SOCIETY Friedman has mentioned four factors that are mainly responsible for transformation in the function and substance of the contract (Changing Society, p.97). They are: (1) Localization of Industry, trade and commerce with corresponding urbanization and standardization of life. This results in a standard form of contract or a contract of adhesion; (2) Increasing collectivisation. This results in collective bargaining, consumer movement and various forms of interference by the state; (3) Tremendous expansion of welfare and social service functions of the state. This results in multitude of statutory terms of contract, wide expansion of government departments for regulation and control; and (4) Economic security aspects of contract de-emphasized in the wide range of state interference. This results in frustration of contract and extension of legal excuses for non performance. The society is growing very fast. The above four factors responsible for transformation of the substance of contract in one direction especially in the post war free world. In the nineties we are experiencing some other factors in the socioeconomic and political movement requiring transformation of function and substance of contract in the opposing direction. They are : (i) Globalization of market. This requires unrestricted free movement of capital which will necessarily require the dismantling of the national regulatory system and exposing the national interest to be subjective to the global regulation. It may, therefore, herald a new era of international regulations and practices influencing the national system. This will weaken the public control on terms and conditions of contract, dismantle public authorities for regulation of contracts, and reduce national authority to its police role ; (ii) Prolific growth of Multi-National Corporations [MNCs] and adaptation of different techniques of MNC functioning. Transnational and multinational companies are gradually gaining ground and the days are not far off when these TransNational Corporations [TNCs] and MNCs will take over a significant control of the economic affairs of the global economy. This will change various forms of contracts between holding - subsidiary relations and other organisational and managerial techniques. The growth of their occupation in relation to agriculture shall necessarily commercialise the whole area of land-tenancy system, production structure, seed, patenting and the like. Growing strength of these TNCs and MNCs shall weaken the role of state in contractual situations. It will, therefore, mean de-emphasizing public interest and reduce the realm of contract as essential instrument of determining private interest ; and (iii) Wide scale de-regulation of public control. In the last fifty years the argument of public policy and consequently the public control were built up both statutorily as well as through
judicial pronouncements. In India the activist judiciary started expanding the right to life and including in it almost everything under the sun like health, education, shelter, etc., (Olga Tellis, Mohini Jain, Asiad Workers’ case, M.C. Mehta (environment case). This has necessarily developed a system of government with a distinct policy of governance. This policy of governance can be said to be social policy of the government. As a result there have been several implications of this type of governance specially effecting the realm of contract in the following manner: (a) Government used to regulate the terms and conditions of the contract to protect the disadvantaged groups and the interest of the public. For eg., a wage structure was imposed through Minimum Wages Act. The collective bargaining of the workers was strengthened by encouraging trade union movement, the prices were determined by a strong price policy etc.; (b) If countries like India being predominantly agricultural formed a very strict regulatory land holding and tenancy system, any type of land alienation through contract affecting this fundamental policy was made unconstitutional and illegal. Commercialization of land holdings was prevented at all costs; (c) Workers and employees were considered as protective area of the state and therefore, several regulatory and welfare statutes were passed directly the employer to ensure their statutory obligations; (d) There was a growing tendency of private agreemments being scrutinised through public law arguments. Questions like reservations were taken into the functioning of all government companies and corporations discharging only commercial functions. The concept of instrumentality of State was growingly used by the judiciary and as a result the responsibility of the state became all pervasive; and (e) The state took the responsibility on itself to regulate control and involve itself in the capital movement and had built up a strict regulative framework through license, permissions and certification. Consequently many public authorities were constituted to oversee the legal regime as well as its economic operations. A mixed economic model started being managed on the principle of public enterprise leadership. Presently under the globalization scheme the whole structure of this public control mechanism is debased involving deregulation, delicensing, de public sector monopolisation, depublic control and obviously dismantling the public interest logic. 6.5 CONTRACT IN CHANGING SOCIETY In the above paragraphs we have attempted to explain that the function and substance of contract changes with the changing society. No human society is static in nature - even ‘status society’ like a nomadic society was never static in character. Similarly a ‘contract society’ could also develop certain static characters. This is a sociological and anthropological question and not within our realm of discussion. 31
Function and substance of contract in early industrial civilizations were based upon the assumptions already discussed i.e., equality of status, freedom of choice and free exchange. But soon it was realized that all were not equal, all do not have absolute freedom of choice and liberty of exchange is also controllable. With this understanding both trade union movements and cartelisation of organisations started to wriggle out power. After all money begets power, therefore, those who were employers were more powerful. In order to counteract them, trade union movements started collective bargaining. Initially discounted, rejected and confronted by the state, ultimately the state had to yield to the movement for the sake of promoting welfareism. Gradually welfare state started dictating terms to both the parties in the democratic setup of governance. Prescription of minimum wages by the state which was declared as ultra-vires, was ultimately accepted as a norm of good governance. The welfare state, therefore, enforced conditions in a contractual relationship between parties in the name of social welfare, public policy and equity. Free market contracts were taken over by public distribution system contracts i.e., freedom to choose customers/sellers, commodities and price was substituted by fair price shop, rationing definite quantity at definite price. Freedom of contract is substituted by direction and order. An offer is replaced by a petition and an acceptance by license. The performance of contract became equal to execution of an order. Though the society in that welfare state did not become a society full of status in the form of capitalists and labourers, the state nevertheless brought itself within the interactive centre for capital and labour. State became essentially a friend of the people against all types of exploitation. In India we followed mixed economy for more than 40 years and developed a system of governance with restrictive control and rigid administration. Naturally we established a legal regime for the function and substance of contract as indicated below: 1) Government contracts outnumbered the private contracts, courts started interpreting the government contracts with increasing reliance on natural justice disregarding the freedom of contract. In one of the leading cases the court held that in a contract where one party was the government or any instrumentality of the State, conditions of natural justice must be observed upto the threshold of the contract. This has been explained in a later chapter on government contracts; 2) Public policy has been attempted to be enshrined even in private contracts. An agreement between a money lender and a farmer could be struck down on the grounds of public policy. Sale of land to a non-agriculturist was stipulated as unlawful. The public policy became so much dominant that a form of standardization started developing in contracts; and 3) Various public control systems that are regulatory in nature were introduced. Necessarily the private law area of contract was increasingly challenged by public law reasoning. This was most evident in cases on frustration of contract. Before the war the common law courts used to apply the principle of frustration in order to what is just and reasonable in the new situation. But as Lord Denning would say the courts went to exercise their power even when there was no frustrating event but only an 32
uncontemplated turn of events took place. Friedman tried to explain this transaction as the mixture of heterogenous factors that make up the complex picture of modern contract and have turned it into something, rather different from chief commercial guarantee of a private enterprise society, which is best illustrated by problem of sanctions. The controversy whether the primary sanction of contract is actual performance or a promise to make preparation for non-performance is of old standing. Holmes long ago proposed a view ‘the only universal consequence of a legally binding promise is that of the law making the promisor pay damages if the promised even doesn’t come to pass’. This view has been widely criticised, mainly on the ground that the law does not leave the promisor, the freedom to choose between performance and the payment of damages where he is able to perform. The history of common law tends to support Holme’s view...... (Changing society, p.113) in both common and civil laws only in a very few contracts where equity demands an additional or alternative remedy to damages like specific performance/injunction is awarded. The proportion of public/ private elements in a contract determines the degree to which traditional sanctions of contract apply..... (ibid p.114). In a contract where public are substantially interested like the Bethelham Steel Case (315 US 289), the US government alleged that the contract was exploitative in character on account of war time emergency and the government was compelled to accept the terms of the country’s leading ship builders. In a minority judgement Frankfurter J., held that the court should not permit Bethelham steel to recover these unconscionable profits thereby making the courts instruments of injustice. This 1942 dissenting judgement became a landmark guide afterwards in the judicial history for computation of public interest. The situation is again rapidly changing in favour of an argument for the state to withdraw from all economic transactions on the argument of achieving pareto optimanity. It shall mean that in future, state shall not take any active role in regulating, controlling, devising, any terms of contracts. Freedom of contract shall be allowed on the presumption of equality of status between the contracting parties. State shall not interfere in hire and fire principles of TNCs and MNCs. In the name of reducing the cost of governance and increasing democracy a lot of area considered under public interest and hence susceptible to regulation shall now become open to the private players to mutually bargain. Forms of contract, therefore, change, with the changes in society. 6.6 CONCLUDING REMARKS It can therefore be seen very clearly that the course of form and substance of contract has not been same and straight throughout the course of history. Though contract is an instrument for determining private rights and obligations it cannot always remain mutually exclusive from the domain of public interest. As a result not only the methodology of contract started changing throughout the course of history but its functions and impacts have also been constantly subjected to review under public policy. At times of course the degree of such public policy scrutiny varied. In the coming ages the free market advocates are going to de-emphasize the state’s role and emphasize freedom for the MNCs to globally operate on agreements of efficiency and lowering costs.
7. RELEVANT PROVISIONS OF THE ACT Section 2 : Interpretation-clause:- In this Act the following words and expressions are used in the following senses, unless a contrary intention appears from the context :(a) 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; (b) When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a promise; (c) The person making the proposal is called the “promisor”, and the preson accepting the proposal is called the “promisee”; (d) When, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such act or abstinence or promise is called a consideration for the promise; (e) Every promise and every set of promises, forming the consideration for each other, is an agreement; (f) Promises which form the consideration or part of the consideration for each other, are called reciprocal promises; (g) An agreement not enforceable by law is said to be void; (h) An agreement enforceable by law is a contract; (i) 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; (j) A contract which ceases to be enforceable by law becomes void when it ceases to be enforceable. Section 3. Communication, acceptance and revocation of proposals- The communication of proposals, the acceptance of proposals, and the revocation of proposals and acceptances, respectively, are deemed to be made by any act or omission of the party proposing, accepting or revoking by which he intends to communicate such proposal, acceptance or revocation, or which has the effect of communicating it. Section 4. Communication when complete- The communication of a proposal is complete when it comes to the knowledge of the person to whom it is made. 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; as against the acceptor, when it comes to the knowledge of the proposer.
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; as against the person to whom it is made, when it comes to his knowledge. Section 5.- Revocation of proposals and acceptances.- A proposal may be revoked at any time before the communication of its acceptance is complete as against the proposer, but not afterwards. An acceptance may be revoked at any time before the communication of the acceptance is complete as against the acceptor, but not afterwards. Section 6. Revocation how made- A proposal is revoked 1. by the communication of notice of revocation by the proposer to the other party; 2. by the lapse of the time prescribed in such proposal for its acceptance, or, if no time is so prescribed, by the lapse of a reasonable time, without communication of the acceptance; 3. by the failure of the acceptor to fulfil a condition precedent to acceptance; or 4. by the death or insanity of the proposer, if the fact of his death or insanity comes to the knowledge of the acceptor before acceptance. Section 7.- Acceptance must be absolute.- In order to convert a proposal into a promise, the acceptance, must 1. be absolute and unqualified; 2. be expressed in some usual and reasonable manner, unless the proposal prescribed the manner in which it is to be accepted. If the proposal prescribes a manner in which it is to be accepted, and the acceptance is not made in such manner, the proposer may, within a reasonable time after the acceptance is communicated to him, insist that his proposal shall be accepted in the prescribed manner, and not otherwise; but if he fails to do so, he accepts the acceptance. Section 8. Acceptance by performing conditions, or receiving consideration.- Performance of the conditions of a proposal, or the acceptance of any consideration for a reciprocal promise which may be offered with a proposal, is an acceptance of the proposal. Section 9. Promises, express and implied.- In so far as the proposal or acceptance of any promise is made in words, the promise is said to be express. In so far as such proposal or acceptance is made otherwise than in words, the promise is said to be implied.
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8. CASE LAW 1. Balfour v. Balfour [(1919) 2 KB 571] Mr. & Mrs. Balfour residents of Ceylon moved to London when Mr. Balfour was on leave. On expiry of his leave Mr. Balfour returned to Ceylon whereas Mrs. Balfour remained in England on medical advice. Mr. Balfour promised to send £ 30 every month. Mr. Balfour did not send the money. Later on they decided to live apart. Mrs. Balfour sought to recover the promise money in the court of law. The main issue for decision was, whether a promise of domestic nature between a husband and wife could be binding ? It was held that, the promise between the parties was not intended by them to be legally binding. Hence, Mrs. Balfour could not enforce the payment. 2. Jones v. Padavatton [(1969)2 All ER 616] The daughter of a Trinidad resident was employed at a satisfactory salary with pension rights. Though unwilling to do so, she accepted the offer from her mother to leave her job, go to England and study for the Bar with an intention of practising in Trinidad. In return her mother promised to pay her fees & a monthly allowance; but nothing was recorded in writing of the arrangement and of the period of arrangement. After sometime the daughter was asked to purchase a house for her own residence as also for taking in lodgers, the rent from which could be applied towards her maintenance. Once again, nothing was put in writing. The mother paid off the cost of the house in several instalments. The daughter moved in, took in lodgers and rents started arriving. The mother never received any rent nor was she supplied with accounts. After about 2 years she issued summons claiming possession of the house from the daughter, who counter claimed for £ 1,655 18s 9d. said to have been paid in respect of the house. The main issues involved were : 1. Could the daughter claim that the arrangement between herself and her mother was to continue indefinitely; and 2. Could the mother be presumed to have waived all her rights over the house only because of the fact that the daughter was in possession of the house and was the person receiving rents? It was held that, the mother was entitled to the house as against her daughter, because (1) the arrangement between the two of them was throughout a family arrangement depending on the good faith of the parties in keeping the promises made and not intended to be a rigid binding agreement & the arragnment was far too vague and uncertain to be enforceable as contract; 2. a reasonable time was implied for the original agreement of payment of allowance, because completion of daughters study for Bar could not possibly exceed 5 years, the daughter could not claim to be entitled to anything beyond that period. 3. Carlill v. Carbolic Smoke Ball Co [(1893)1QB 256] The defendants issued an advertisement in the newspapers, offering a reward of £100 to any person who contracted influenza, cold etc. after using their smoke balls thrice a day for 2 weeks according to the printed directions. It was further stated that, £ 1000 has been deposited in the Bank showing our 34
sincerity. The plaintiff used the balls as per the directions, but still contracted influenza. She filed a suit claiming the reward announced by the company. The defendants argued that as it was an offer made to the public, there was no contract between the plaintiff and themselves and hence they were not liable. The main issues involved were, is notification of acceptance to the offeror essential to constitute a binding offer? And what was the consideration for this contract? It was held that, a person who makes an offer in an advertisement impliedly indicates that he does not require notification of the acceptance of the offer. In such cases performance of the condition is sufficient acceptance without express notification of it. Further, the very fact that the plaintiff took the trouble of using the smoke balls was enough consideration to support the contract. The plaintiff was entitled to the reward. 4. Lalman Shukla v. Gauri Dutt [(1913) 11 ALJ 489] The defendant’s nephew absconded from home and could not be traced. The plaintiff who was his servant, was sent to Haridwar to look for the boy. Meanwhile the defendant offered a reward of Rs. 501/- to the finder of the boy. The plaintiff traced the boy, and wired the defendant, who went and brought the boy back; giving some money to the plaintiff as a reward who did not ask for more. The plaintiff was dismissed six months later, and he then filed a suit claiming the remaining reward amount. It was held that, as the plaintiff was in the service of the defendant at that time, and having incurred the obligation to search for the missing boy he could not claim the reward; because when there is a subsisting obligation performance of an act cannot be regarded as a consideration for the defendant’s promise. 5. Household Fire Insurance Co v. Grant Court of Appeal [(1879) 4 Ex.D 2161] Kendrick was the agent of a company in Glamorgan. The defendant handed to him an application in writing for shares in the company, which stated that the defendant had paid to the bankers of the company £ 5, being a deposit of 1s. per share, and requesting an allotment of 100 shares. Kendrick forwarded the application of the plaintiffs in London and the secretary of the company made out a letter of allotment in favour of the defendant and posted it addressed to the defendant. The letter never arrived. The defendant’s name was entered on the register of shareholders. The company then went into liquidation and the liquidator sued for £94.15s. being the balance due upon the 100 shares. The main issue involved was, whether a contract by correspondence could be deemed to have been concluded even though the letter of acceptance was not received by the offeror? It was held that, the contract is actually made when the letter is posted, and not when it is received, because, the acceptor, in posting the letter, “puts it out of his control and does an extraneous act which clinches the matter and shows beyond doubt that each side is bound”. Grant was thus held liable for the unpaid amount.
6. Jawaharlal Barman v. Union of India [AIR 1962 Supreme Court 378] The respondent Union of India, filed a petition against the appellant. M/s. J. Burman and Co., through its proprietor Jawahar Lal Burman under Ss. 33 and 28 of the Act. The respondent alleged that a concluded contract had been entered into between the parties on August 31, 1949, for supply of 170/ 2 Cwt. of coconut oil by the appellant to the respondent. The respondent had advertised in the Indian Trade Journal for the said supply and the appellant had submitted its tender No. SM1/104524. This tender was accepted by the respondent which concluded a contract between the parties. The respondent’s case was that the said contract was governed by general conditions of contract Form WS.B. 133. These conditions included an arbitration agreement. Disputes arose between the parties regarding the said contract and so, in pursuance of the arbitration agreement they were referred to the two arbitrators appointed by the parties. After the arbitration proceedings had gone on for a considerable time before the arbitrators the appellant objected to their jurisdiction on the ground that there was no concluded contract between the parties. This plea made it necessary for the respondent to move the court for decision on the question about the existence and validity of the arbitration agreement. It was on these allegations that respondent in its petition claimed that it may be held that there was a concluded contract between the parties containing a valid arbitration agreement. The petition having been made under S.28 along with S.33 the respondent prayed that suitable extension of time be granted to the arbitrators for making the award. The appellant pleaded in defence that no concluded contract had been made between the parties and that there was no jurisdiction of the court to grant extension under S.28. It was held that the general conditions of the contract prescribed by Form W.S.B.133 were made part of the tender, and the contract itself was intended to be executed expeditiously. The tender shows that the appellant represented that the earliest date by which delivery could be effected would be within twenty days from the date of the receipt of the order and it also said that full quantity of coconut oil required was held by it. Therefore, to begin with the tender treated the security deposit as a subsequent condition, the contract was for the immediate supply of goods and the acceptance purports to be in accordance with the relevant government rules. Therefore reading the letter as a whole it
would not be possible to accept the appellant’s argument that the letter was intended to make a substantial variation in the contract by making the deposit of security a condition precedent instead of a condition subsequent. 7. M/s Suraj Besan and Rice Mills v. Food Corporation of India [AIR 1988 Delhi 224] The plaintiff firm is registered with defendant. It is alleged that under this registration, the annual requirement of the plaintiff has been assessed at 1500 M.Ts. As such plaintiff can quote only for this registered quantity. Regional Office of defendant at Chandigarh invited tenders for the purchase and removal of damaged food grains declared fit for cattle/poultry feed etc. Plaintiff submitted their tenders, but it was not signed by all the partners. The tenders were opened on 29.06.83. The tender of plaintiff was not valid if accepted beyond the annual assessed capacity of 1500 M.Ts. However, the tender of plaintiff was accepted and an acceptance telegram was issued by defendant on July 22, 83 which was received by plaintiff on July 24, 83. It is alleged in the plaint that plaintiff’s offer was only for 1500 M.Ts, but to the surprise of plaintiff, telegram dated July 22, 83 placed an order for stock of about 6200 M.Ts of damaged paddy for purchase. According to plaintiff, the aforesaid acceptance did not bring about a valid, legal, and binding contract between the parties, as it was a counter offer to the original offer of the plaintiff for 1500 M.Ts. As there was no binding contract between them the plaintiff did not furnish the security deposit. There was a threat on behalf of the defendant for selling the stocks of 6200 M.Ts of damaged paddy at the risk and cost of plaintiff and to take steps for the cancellation of the certificate and various benefits and privileges which plaintiff has been enjoying. The main issue in this case was, whether the contract entered between the parties as per the tender dated 28-6-83 is valid and binding on the plaintiff? If so, to what effect? It was held that, under law the plaintiff was entitled to withdraw or modify their offer before the communication of the acceptance was complete as against the plaintiff. Thus, the letter dated July 8, 1983 amounted to modification of offer. Hence acceptance issued by telegram on 22.7.1983 did not result in a concluded agreement between the parties as, there was no offer in existence at the time when defendant accepted tender of plaintiff. Hence there is no legal and binding contract for the sale and purchase of 6,176.790 M.Ts of damaged paddy as per the telegram of 22.7.83.
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9. PROBLEMS Instructions for answering Problems: While answering problems in any module, the student should thoroughly read and ascertain important facts. Then 1. he/she should narrate brief facts of the case; 2. identify relevant issue/s in the problem; 3. discuss about the position of law as per relevant statute/s and judicial decision;
4. apply the above position of law to the facts and circumstances of the case/problem in hand; and 5. finally give the decision on the issue/s. Besides the above, one should refer basic text (both Indian and English), hint cases (if any given), important Journals and Reports for ascertaining the law on given issue/s. The answering in each subjects should be neatly typed computerised and should be sent in a spiral bound format.
1. Western Coal fields of India Limited Tender Notice T.Mo. 486/94-95 : Sealed, superscribed tenders are invited from registered civil contractors for the following Job Description
Approx Value
EMD
Time of Completion
Tender Cost
Tender Availability
Tender Opening
Construction of 600 Type B Qrs Kamptee Colliery
Rs.80 Lakhs
Rs. 80,000
1 Yr. from date of tender opening
Rs.200 Rs.30/extra if required by post
From 20.4.94 to 1.5.94 between 10.00 am to 1.00 pm
2.5.94 at 3.00pm
Tenders can be obtained from the office of Chief Engineer, 6th floor, WCL H.Qrs, Civil Lines, Nagpur - 10. Completed tenders may be sent by post, deposited in the box kept outside the Chief Engineer's Office before 3.00 pm on 2.5.94. WCL reserves the right to accept/reject any or all of the tenders. The above tender accepted in 8 national newspapers on 15.4.94. In response to the notice, Mr. Chawla sent a draft for Rs.230/drawn in favour of WCL, Nagpur alongwith an application for a set of tender documents on 16.4.94. The application was received on 20.4.94 and the documents were duly dispatched to him at 4.00 pm on the same day. This fact is recorded in the dispatch register. Mr. Chawla deposited the duly filled documents at 2.50 pm on 2.5.94, and as the rates quoted by him were the lowest he was awarded the tender on 4.5.94 a formal letter was sent to Mr. Chawla informing him that his tender had been accepted and that he was required to deposit a Bank Guarantee for Rs.5,00,000/- within 30 days from date of letter. This letter failed to reach Mr. Chawla, WCL meanwhile after waiting the prescribed 30 days, decided to start legal proceedings against Mr. Chawla on ground of non-receipt of Bank Guarantee and failure to start the work resulting in a breach of contract. Structure arguments for and against WCL based on the above facts, taking into consideration one additional fact, viz : that in response to a Government regulation forbidding the undertaking of any work over the value of Rs.5,00,00/- till the end of 1994, the Chief Engineer has instructed the Supdt. Engineer to keep the decision in abeyance even though Mr.Chawla’s tender had been formally accepted. 36
2. In the above fact situation presume that the letter from WCL reached Mr.Chawla on 10.5.94. In the meanwhile Mr.Chawla has written a letter dated 4.5.94 revoking his offer which reached the WCL office on 12.5.94, WCL now wants to start a breach of contract proceeding against Mr.Chawla. Argue for and against WCL. 3. M/s Mosegay & sons, manufacturers of a nasal spray advertised that, any patient from any kind of respiratory problems, would be cured for life provided he used the spray as per directions. The spray was to be used once a day continuously for two months. It was specifically stated that the spray was to be used only after sunset and in open air. A reward of Rs.1,00,000 was announced for any person whose disease continued after the use of spray in the recommended manner. A patient of chronic asthama, started using the spray as per the directions. After about a month, he suffered a mild attack of flu and was confined to his room for a few days, but he continued the use of the spray. After the scheduled 2 months, he found that his asthma was still very much there and that in addition he has developed a permanent rash around his nose. He sues the company for the announced reward and Rs.3,00,000/- in addition as damages for the rash. The MD of the company has come to you with the case. Advise him, taking support from decided cases. 4. A the owner of four thoroughbred horses, employed two trainers to look after them. Of these horses ‘Toofan’ a 3 year old Stallion was the pride of the stable. Being in dire financial straits, A decided to sell ‘Toofan’, and accordingly informed
his trainers to look out for prospective buyers. B approached the first trainer and offered Rs.1,50,000/- for ‘Toofan’. This price was telegraphed to A on 1.4.94. On 12.4.94 A sent a reply that he wont accept less than Rs.4,00,000/-, which was received on 15.4.94. On 17.4.94 B telegraphed his acceptance of the price. Meanwhile on 12.4.94 the other trainer sent another offer of Rs.4,25,000/- which reached A on 19.4.94. A had already sent a letter of acceptance to B on 18.4.94, so he sent a telegram dated 19.4.94 revoking his acceptance and another to his other trainer accepting the second offer. B didn’t receive the telegram but the other party did. Now both of them claim that they have a right to buy ‘Toofan’. Decide. 5. A proclamation by the government offered a reward for information leading to the arrest of certain murderers and a pardon to an accomplice who gave the information. A saw the proclamation in January 1992. On Feb. 6th he gave false information to protect the murderers. On March 10th he gave information which led to their conviction. He admitted that his only object in doing so was to clear himself of a charge of murder and that he had no intention of claiming the reward at that time.
7. On 14th December, 1992, the Indian Express carried the following Tender Notification. NATIONALMINERALDEVELOPMENT CORPORATION LTD. 10-3-311/A CASTLE HILLS MASAB TANK HYDERABAD - 500 028 No. HqMM/III/Ferro Silicon/92 GLOBAL TENDER NOTICE Sealed tenders in triplicate are invited from manufacturers on their agents for supply of around 100 tonnes per year of Milled Ferro-Silicon meeting the following standards and specifications for use in 50 TPH Heavy Media Diamond Mining Project, Panna, Madhya Pradesh State (Nearest Rly. Station : Satna). SPECIFICATIONS : Silicon
: 14-16%
Carbon
: 1.3 Max
Iron
: 80% Min
However, after a considerable period of time, A filed a suit against the government for the reward. Decide in the light of Indian and English cases.
Sulphur
: 0.05% Max.
6. A carried on business at Ludhiana under the style ‘A & Co.’ dealing in motors and accessories. R of Bangalore wrote to A asking him to send a complete catalogue of motors and accessories and also full particulars of an electric machine and oil engine shown in an old catalogue published by A. In reply to this letter of R, A wrote on July 14, 1992 giving him full particulars of an electric machine which he had at hand. The closing passage of his letter was as follows :
Micron
: WT%
106
: 0.1
75
: 0.3
“All the above things are ready for fittings ; price Rs.7500 only, nett, for the outfit including all the articles mentioned above. I recommend you the above outfit very strongly so if you are to have it, kindly wire me at once to reserve it for you. I have got only one set left”. R sent a telegram to A stating “Reserve the set for me”. A’ s telegram followed : “Send Rupees one thousand in advance for balance will send engine dynamo complete by V.P.” R sent Rupees one thousand. A sent in due course the machine packed by rail. R took delivery of the packet from the railway. R, thereafter, found that the machine was broken when it arrived and that it was second hand and did not answer the description given by A. R filed a suit for a breach of contract in the Bangalore Munsif Court. A pleaded that the suit was not maintainable at Bangalore. Decide the case giving reasons as to place of completion of offer and acceptance and maintainability or otherwise of the suit. Critically review the Indian law on the issue both statutory and judicial decisions.
26.11.92
SIZE DISTRIBUTION
Tender must be accompanied by Earnest Money Deposit of Rs.25,000/- or US $ 1,000 by way of demand draft or bank guarantee in favour of N.M.D.C. Ltd., Hyderabad, payable at Hyderabad & valid for six months from the date of tender opening. Tenders not accompanied by EMD are liable for rejection. The offer should be valid for six months from the date of tender opening and should clearly specify all technical details (pamphlets/catalogues), basis of price, tax structure, showing prevailing rates, packing and forwarding, delivery time (preferably by April 1993), clients list (to whom already supplied), payment terms and other commercial details. Tender superscribing the tender notice number, date and date of opening should be addressed to Chief Materials Manager, NMDC Ltd., 10-3-311/A, Khanji Bhavan, Masab Tank, Hyderabad - 500 028, so as to reach on or before 2P.M. of the date of tender opening. Tender will be opened on 20.1.1993 at 3.00P.M. in the presence of tenderers who choose to be present. Only authorised representatives of the tenderers will be allowed. The Corporation reserves the right to accept (in full or in part) or reject any or all the tenders without assigning any reason thereof. CHIEF MATERIALS MANAGER 37
M/s.ABC Ferro Alloys Corporation, Bangalore, in response to the above tender notification, have applied for a tender application through their letter dated 16.12.92 (vide Ref.No. 118A/Ten./92). The Chief Materials Manager received their letter on 25.12.92 and immediately the tender application was posted to M/s. ABC Ferro Alloys Corporation. After two days, they have posted the filled in application to the Chief Materials Manager. On 20.1.93, the Chief Materials Manager, after perusing all the filled in tender applications, in view of the fact that many tenderers have quoted the same price, has reserved his decision. After waiting a period of over 3 months, M/s.ABC Ferro Alloys Corporation in their letter dated April 10, 1993 (Ref.No.219B/Ten./93) posted on April 12, 1993 addressed to the Chief Materials Manager have enquired about the fate of their tender application. They have also demanded for refund of E.M.D. if their tender application is rejected. After receiving this letter, the Chief Materials Manager made some trade enquiries about the commercial credibility of M/s. ABC Ferro Alloys Corporation and decided to accept their offer. Thereafter he instructed his officer to send the acceptance letter to M/s. ABC Ferro Alloys Corporation. Accordingly, he posted the letter of acceptance dated April 23, 1993. Around that time, M/s. ABC Ferro Alloys Corporation, as they have not received any reply to their letter dated April 10, 1993, decided to revoke their offer. Thereafter on April 24, 1993, they have posted their letter of revocation, which reached the Chief Materials Manager on April 26, 1993. When the Chief Materials Manager read the contents of the letter, decided not to reply, as they have already posted the letter of acceptance which has reached M/s. ABC Ferro Alloys Corporation on April 25, 1993. After perusing the contents of the letter of acceptance, M/s. ABC Ferro Alloys Corporation, decided not to reply, as they have posted their letter of revocation by that time. The Chief Materials Manager, after waiting a period of 21 days has initiated legal proceedings against M/s. ABC Ferro Alloys Corporation on the ground of non-supply of materials. You are required to write a brief for and on behalf of both the parties, namely, the Chief Materials Manager, N.M.D.C. Ltd., Hyderabad and M/s. ABC Ferro Alloys Corporation, Bangalore, in the light of the following issue also. (Besides the issue raised in the text). Assuming that M/s. ABC Ferro Alloys Corporation have submitted the filled in tender application without depositing EMD/Bank Guarantee as given in the tender notification and was accepted by the Chief Materials Manager by waiving the clause of EMD. After receiving the letter of acceptance, in view of the steep increase in the market price of the materials, (much more than the price quoted in the tender), M/s. ABC Ferro Alloys Corporation have decided to invoke their offer, particularly on the ground that their offer was not in accordance with the terms of the tender, thereby no valid acceptance could be made by the Chief Materials Manager. 8. The following tender notification has appeared in the Deccan Herald dated December 13, 1993. 38
KARNATAKA ELECTRICITY BOARD TENDER NOTIFICATION Sealed tenders in duplicate in the prescribed forms subscribing the name of the work on the cover, duly signed by the registered contractors, are invited from the party/firm upto 4 P.M. on 24.12.93 along with the previous experience certificate. Sl.No.1: Name of the work : Providing experience K.V. S.C. Tap line for a distance of 11.6 K.M. for 66.11 K.V. Halavagalu Power Distribution Station, Harpanahalli taluk, Bellary District. Approximate amount put to tender : Rs.14.00 lakhs. E.M.D. : at 2.5% : Rs.35,000/-. Time limit for completion of work : three months. Sl.no.2 Name of the work : Erection of Station Towers and Laying foundation for them at 220KV power receiving station at Lingasugur. Approximate amount put to tender : Rs.3.29 laksh. E.M.D. at 2.5% Rs.8.225/-. Time limit for completion of work : Three months. Cost of tender form per set (non refundable) : Rs.216/- for the work at Sl. No. 1 and Rs.108/- for the work at Sl.No.2. The party/ firm who have previous experience certificate may submit requisition for blank tender documents to this office from 20.12.93 to 22.12.93 upto 4 P.M. E.M.D. may be paid by cash at the undersigned office or furnished in the form of Demand Draft drawn in favour of the Executive Engineer (Electrical) M.W. Division, KEB, Raichur. Tenders not accompanied by E.M.D. will be rejected. Further details may be obtained from the office of the undersigned during office hours. The competent authority reserves the right to accept or reject any or all tenders wihtout assigning any reason. RAICHUR Executive Engineer K.E.B. a) M/s. ABC Contractors, Bangalore have obtained the relevant tender documents from K.E.B with a view to respond to the tender notification. After hectic discussions, they have decided to apply only for the work given under Sl.No.1. Accordingly, they have filed their tender documents with K.E.B. in time. After about one month, M/s. ABC Contractors received a letter from Executive Engineer, K.E.B, stating that their application has been rejected on the ground that their application was not absolute. M/s. A.B.C. Contractors seek your advice. b) Assuming that the tender application filed by M/s. ABC Contractors has been selected and both the parties entered into a formal contractual relation. With a view to expediate the work progress, M/s. ABC Contractors have appointed M/s. XYZ Co. as sub-contractors to conduct part of the agreed work. However, the construction work could not be completed owing to certain problems. Thereafter Executive Engineer, K.E.B. filed a suit against M/s. XYZ
Co. for failure to complete the work within a stipulated period of three months. Advise M/s. XYZ Co. c) Assume that there is a valid contractual relation between Executive Engineer and M/s. ABC. & Co. The party could not complete the construction work because of acute shortage of raw material. In view of recurring power failure and continuous labour unrest, the production of raw material for the construction activity has been severely hampered. Executive Engineer files a suit against M/s. ABC Contractors for non-completion of work. Identify the issues with regard to above fact situation. Advance arguments for and on behalf of both the parties and decide.
d) At the time of construction, Executive Engineer, K.E.B, has realised that M/s. ABC Contractors is not a registered contractor. He seeks your advice to rescind the contract. 9. H brought a horse from T. The contract of sale provided among others, these two terms: that the horse was warranted to have been hunted with the Bicester Hounds, and that if it did not answer to its description, I should have the liberty to return it by the evening of the fourth day of sale. The horse did not answer to its description and had never been hunted with Bicester Hounds. It was returned on the day mentioned in the contract, but in the meantime, the horse had been injured accidently through no fault of H. T demanded the price for the horse, or an adequate compensation for the injury to the horse. Decide explaining the nature of the condition. Give reasons.
[Note: Specify your name, ID No. and address while sending answer papers]
39
10. SUPPLEMENTARY READINGS 1. Avtar Singh, (1989) Law of Contract, Eastern Book Co., Lucknow. 2. Anson, (1984), Law of Contract, English Language Book Society & Oxford University Press, London. 3. Athiya, P.S. (1986), Essays on Contract, Oxford University Press, London. 4. Cheshire and Fiefoot, (1986), Law of Contract, Butter Worths, London. 5. Cheshire and Fiefoot, (1977), Cases and materials on Contract, Butter Worths, London. 6. Friedman, (1996), Law in the changing society, University Book House, Delhi. 7. Joga Rao, S.V. (1991), Cases and materials on contract, NLSIU Publication.
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8. 9. 10. 11. 12. 13.
Kronman and Posner, (1979), Economic analysis of contract law, 13 Stanford L.R. Llewellyn, (1941), Nature and functions of contract, 13 Standford L.R. Macneil, Economic analysis of contractual relations, 13 Standford L.R. Puri and Ponuswamy, (1974), Cases and materials on contract, Eastern Book Co., Lucknow. Trietal, G. H. (1966), Law of contract, Steven & Sons, London. Venkatesh Iyer, (1987), Law of contract, Asia Law House, Hyderabad.
Master in Business Laws Law of Contracts Course No : I Module No : II
CAPACITY AND CONSIDERATION
Distance Education Department
National Law School Of India University (Sponsored by the Bar Council of India and established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 080-3217858 E-mail:
[email protected] 41
Materials prepared by: Ms. Sudha Peri, M.A., LL.M. Prof. N.L. Mitra, M.Com., LL.M., Ph.D. Materials checked by: Prof. P.C. Bedwa, LL.M., Ph.D. Materials edited by: Prof. T. Devidas, LL.M. Prof. V. Vijayakumar, M.A., LL.M., M.Phil.
© National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore - 560 072
42
Instructions In module I we have discussed how a contract is entered into. A contract is an agreement enforceable by law. In fact, if you read module I carefully, we have discussed how an offer being accepted makes an agreement. Now, if this agreement is ‘enforceable by law’, it becomes a contract. Contract is a design through which persons create rights and duties through promise. One may wonder, if contract is a ‘private realm’, why State has to spend so much of resources to settle private disputes! Of course, some political scientists argue that State has to provide the facility to arbitrate in all dispute resolution situations. This is a sovereign function of the State. As such, whether an agreement is enforceable by law or not is a decision State has to take on the basis of certain objective conditions. Moralists argue that ‘giving the consent’ is enough consideration for making the contract enforceable by law, unless the agreement is against the public morality. But those who argue that ‘law’ is a norm, formulate some objective conditions validating the norm. Utilitarians like Bentham and Mill argued that morality is a matter of individual judgement for evaluation of utility of anything beneficial to the individual. As such, utilitarians gave much emphasis on certain assessment criteria in justifying the legal enforcement. Anyway, excepting the classical moralists, all other legal theoreticians stipulate some objective criteria for legal enforceability of an agreement. In the next two modules we shall examine these objective criteria for enforcing an agreement. In some countries the need for legal enforceability is a judicial policy. But in India, objective conditions are prescribed in the Statute itself. As for example, according to Section 10 of the Indian Contract Act an agreement in order to be legally enforceable nust be: (a) entered between parties competent to enter into a contract as per this provision of Sections 11 and 12, (b) for a lawful object as per Sections 23-24, (c) against a valid consideration as per Section 25, (d) both the parties having consented freely as specified in Sections 13 to 22 and (e) not otherwise invalid under expressed statutory provision specified in Sections 26-30. With these, some common law basic principles are also attached like parties must intend to create legal relation, a social agreement being kept out of the jurisdiction of law of contract. The present module shall deal with the role played by capacity and consideration in an agreement. Issues on capacity may be both factual and legal. As for example, mental capacity is a factual question but issue like insolvency is a legal question. We shall try to explain exhaustively all possible factual and legal situations. But, it is always advisable to refer to some of the supplementary readings for comprehensive understanding. Similarly, we have discussed consideration in all its theoretical and practical details. But it would be encouraging if you could resort to some extra-readings specially some American text books in order to compare the position there with the present Indian Legal Situation. I am sure you will take maximum advantage from this basic material. Dr. N. L. Mitra Course Co-ordinator
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Capacity and Consideration
Topics 1.
Essential conditions of a valid contract...........................................................................
45
2.
Capacity..............................................................................................................................
47
3.
Consideration.....................................................................................................................
61
4.
Case Law.............................................................................................................................
71
5.
Problems.............................................................................................................................
73
6.
Supplementary Readings..................................................................................................
74
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1. ESSENTIALS OF A VALID CONTRACT getting into it. Once the agreement is formed, then one has to see whether the agreement is enforceable by law or not. Sec. 10 of the Contract Act stipulates the conditions that makes the agreement lawfully building and hence a contract. These conditions are essential to make the agreement binding in law.
SUB TOPICS 1.1 Introduction 1.2 Essential elements of a contract 1.3 Intention to create legal relations 1.1 INTRODUCTION In module 1 we have come to understand that an agreement enforceable by law is a contract (Sec.2h). We have also noted that an agreement is made when an offer is accepted. As such when an offer or a proposal made by one party is accepted by another party, the agreement is made by the parties. The offer (or proposal) and acceptance can take place in three ways i.e., it may take the form of a promise by one party against a promise made by another; a promise by one party against an act by another; an act by one party for an act of another. In the first case, a set of promises forming the consideration for each other form the agreement. In the second case, it is a promise against an act of another, called as unilateral promise like promising a reward for finding a lost dog. In this case, the acceptance takes the form of an action. In the third case, i.e, bilateral action one acts in a manner expecting from another person a definite act, like plying of a bus on a public route by one person, and another
1.2 ESSENTIAL ELEMENTS OF CONTRACT So, basically there are two essential elements of a contract, viz. 1. An agreement (under section 2b) 2. Enforceability by law (under section 10) Two essential elements of an agreement are: - an offer (2a); and - an acceptance (2b) According to Sec 10 of the Act the following conditions must be fulfilled by an agreement to make it a contract: - parties are required to be legally competent to enter into the agreement (Ss 11 & 12); - parties must have exercised free consent (Ss 13-22) - there must be lawful object and consideration (Ss 23-25) - the agreement must not be otherwise void (Ss 26-30)
Flow Chart Essential Elements of a Contract Given below is a flow chart enumerating the essential elements of a contract as per the definitions given under sec. 2(b) and sec. 10 of the Act. Contract (s 2h) Enforceable by law (s. 10)
An agreement : A promise or set of promises [s 2b] An Offer
Acceptance (s 2b) Capacity (ss. 11-12)
Minor (s.11)
Coercion (s. 15) (s.16)
Unsound mind Lunatics
Undue Influence
in restraint of marriage (s. 26)
Consideration (ss. 23-25)
Free consent (ss. 13-14)
Legal incapacity (under particular laws like Insurance, Company Law Banking etc.) Fraud (s.17)
Lawful object (ss. 23-24)
Misrepresentation (s. 18)
in restraint of trade (s.27) (s.28)
Otherwise not void (ss. 26-30)
Mistake (s.20)
of one party (s.22)
of both parties (s.20)
of fact (ss.20,22)
of law (s. 21)
in restraint of legal proceedings (s.2a)
ambiguous agreement
Wagering agreement (s. 30) to do impossible act (s. 36)
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1.3 INTENTION TO CREATE LEGAL RELATIONS The making and performance of agreements flourish in our society. Consider how many agreements a person is a party to at any given moment. Generally a person has an agreement with his employer, with his land lord, and so many others. The reason why agreements are so widespread in our society is complex. One explanation is specialization of labour, which because of its efficiency creates the need for exchange behaviour. As individuals specialize, they become less selfsufficient and more dependant on other’s goods and services, which they must secure through agreements. [Summers, Hillman, p.31] But this does not mean that all agreements one enters into are contracts. Consider, an agreement to go to a movie with a friend. Is this a contract ? If your friend does not go with you, can you go to the court claiming damages for breach of contract? Obviously not. So how would you differentiate an agreement leading to a contract and an agreement not leading to a contract?
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The basic ingredient which converts an agreement into a contract is the ‘intention of the parties to create a legal relation’. It is only when the parties to an agreement intend their agreement to become ‘legally enforceable that a contract comes into picture. In the absence of such an intention, an agreement remains a ‘mere agreement’ and recourse to the courts cannot be had on its breach. For example, in Balfour v. Balfour [(1919)2 KB 571] Mrs & Mr. Balfour residents of Ceylon moved to London when Mr. Balfour was on leave. On expiry of his leave Mr. Balfour returned to Ceylon whereas Mrs. Balfour remained in England on medical advice. Mr. Balfour promised to send £ 30 every month for her expenses. He did not send the money after a few months. Later on both of them decided to live apart. Mrs. Balfour sought to recover the promised money in the court of law. The main issue for decision was, whether a promise of domestic nature between a husband and wife could be binding? The court held that, the promise between the parties was not intended by them to be legally binding. Hence Mrs. Balfour could not enforce payment.
2. CAPACITY SUB TOPICS 2.1 What is capacity 2.2 Physical incapacity 2.3 Mental Incapacity 2.3(A) Minors 2.3(B) Unsound Mind 2.4 Legal Incapacity 2.4(A) Of Natural Persons 2.4(B) Of Legal Persons
the juristic persons capacity is limited for the purpose and object for which the personality is conferred on a group of individuals to constitute a distinct legal personality through registration or incorporation under various statutes like company law, trust law, society law or special law passed by the legislature. Therefore in the case of a natural person there is no question of ‘ultravires’ but in case of a legal person the first issue that the other party to the contract has to ensure is whether the juristic person has the capacity to enter into the contract for a particular purpose, else the contract becomes ultravires for the juristic person. In case of natural persons’ incapacity may be either latent or patent. A ‘latent incapacity’ is one which is due to inherent incapacity on account of various reasons like infancy, unsoundness of mind, lunacy etc. ‘Patent incapacity’ may be due to application of laws like insolvency law nationality laws etc. The following flow-chart shall depict various types of incapacities to which a person may be subjected to in the realm of contracts.
2.1 WHAT IS CAPACITY? According to Sec.10 of the Act, an agreement made between parties competent to enter into a contract shall be enforceable by law provided certain other conditions are fulfilled. Persons may be either person in fact i.e., ‘natural person’ or person in law i.e., ‘legal person or juristic person’. Whereas natural persons have unlimited power of capacity to enter into contract,
Incapacity Of Juristic Person due to
Of Natural Person due to
Winding Up Any other
Ultra Vires Physical reasons
Mental reasons
Minor
Unsoundness of mind
Due to Drugs/Alcohol Visually impaired
Oldage
Legal reasons
Lunacy
disease
Pardanashin Woman Insolvency
Contract is the main instrument through which acquisitive market society acquires and distributes wealth and income. As such the limitations on the capacity has to be very rigidly constituted. The essential ingredients of a contract are freedom of choice, consideration and exchange. In most of the developing world, limitations caused by way of certain physical disabilities like illiteracy and very low economic capacity are apparent. As such, a vast majority of people remain outside the parameter of the freedom of contract. As a result of this, contract as an instrument of right - duty correlation can operate within a very limited portion of the population. These physical restrictions
Foreign National
Alien enemy
on capacity necessarily restrict the area of operation of contract. Even if freedom of contract is available to everybody the market remains limited. This is one of the reasons why foreign investment is not opening up in India in the desired manner. According to the Act capacity of a natural person in its latent sense means that the person who enters into an agreement has to understand the nature of the agreement and be able to form a rational judgement as to whether what he is doing or is about to do is to his interest. Though minority is fixed by statute but the basic philosophy of incapacity lies in the explanation to Sec.12 47
of the Act. Legal incapacities of a natural being are all laid down by specific statutes. Juridical persons have a fixed capacity the jurisdictional limits of which are stipulated in the constitutional documents of the body. The common law courts very strictly interprets the vires specifically created by the constitutional document of the concern. Anything which is not mentioned in this document is taken to be something ‘the person is not authorised to do’. This principle is known as the ‘doctrine of ultra vires’. Of course the present tendency of the corporate courts throughout the world is to liberally interpret the vires and extend it as far as is reasonably possible to facilitate wider range of activities beneficial to carry on the main objective of the juristic person. This matter is widely discussed in module-2 of the Corporate Law. A contract entered into by a representative of a juridical person, which is ultra vires does not bind the juridical person but may be enforced against the representative in his personal capacity. The various incapacities to which a natural or juristic person is subjected to in the realm of contract are discussed below. 2.2 PHYSICAL INCAPACITY In general a physical incapacity does not act either as a privilege or a burden for a person entering into a contract. The Contract Act itself does not impose any disability on a physically handicapped person [section 11]. But in certain situations, law may have to extend a special protection to such persons to see that because of their handicap they are not taken advantage of by some unscrupulous persons. Some of such handicapped persons to whom law extends a helping hand are discussed below. 1. Visually Impaired Person Blindness or weak eye sight by itself is no bar to enter into a contract. But a blind person may be placed in a disadvantageous position if the other party to the contract intentionally misleads the person as to the nature of transaction. In such cases the defence of non est factum enables a person who has signed a contract to say that it is not his document because he signed it under some mistake. This defence was evolved by the courts to relieve illiterate or blind people from the effect of a contract which they could not read and which was not properly explained to them. For example, in Foster v. Mackinnon [(1869)LR 4CP 704] a person was induced to sign at the back of a paper, the face of which was not shown to him, and he was told that it was an ordinary guarantee the like of which he had signed before and under which no liability attached to him, when, in fact, the paper was a bill of exchange and he was sued by a holder in due course as an indorser. The court held, that “the defendant never intended to sign that contract or any such contract. He never intended to put his signature to any instrument that then was or thereafter might become negotiable. He was deceived not merely as to the legal effect, but as to the actual contents of the document. It was as if he had written his name on a sheet of paper for the purpose of franking a letter, or in a lady’s album, or an order for admission to the Temple or Church, or on the fly 48
leaf of a book, and there had already been, without his knowledge, a bill of exchange or a promissory note payable to order inscribed on the other side of the paper. “Explaining the principle governing such cases, Byles J. held, “It seems plain, on principle and on authority, that, a blind man, or a man who cannot read, or who for some reason (not implying negligence) forbears to read, has a written contract falsely read over to him, the reader misreading it to such a degree that the written contract is of a nature all together different from the contract pretended to be read from the paper which the blind or illiterate man afterwards signs; then, at least if there be no negligence, the signature so obtained is of no force. And it is invalid not merely on the ground of fraud, where fraud exists, but on the ground that the mind of the signer did not accompany the signature; in other words, that he never intended to sign and therefore in contemplation of law never did sign, the contract to which his name is appended”. 2. Aged Person Sometimes old age may result in a physical incapacity due to lack of strength and resultant loss of mobility. A person so enfeebled may have to depend more and more on others for the discharge of their day to day functions. Such dependance may result in an unscrupulous person’s taking advantage of the feebleness of the old person. In such cases, the old person can avoid the contract, by taking the plea either of ‘undue influence’, ‘non est factum’, or fraud etc. For example, in Wajid Khan v. Raja Ewaz Ali Khan [(1891)18 IA 144] “an old and illiterate woman, incapable of any business, conferred on her confidential managing agent, without any valuable consideration, an important pecuniary benefit under the guise of a trust”. It was held by the Privy Council that, “all the facts of the case go to show that there was active undue influence. The onus is on the grantee to show conclusively that the transaction is honest, bonafide, well understood the subject of independent advice and free from undue influence. This protection is generally needed where old age is coupled with illiteracy, so that the person is totally at the mercy of one on whom he or she reposes confidence. 3. Pardanashin Women At the very outset it should be clarified that being a woman (even a pardanashin woman) is not deemed to be a handicap under the Indian law especially in the realm of Contract law. There is absolutely no bar in our legal system prohibiting any woman from entering into a contract. Further, a pardanashin woman cannot be technically called a physically incapacitated ‘person' but for the sake of better understanding this topic is being dealt here. Though the legal status of the women in India may be equal to the men, their social status is something entirely different. A large number of women in our society are so brought up and conditioned that they are incapable of independent thought and action or of exercising a rational judgement in their own best interest. It is to protect this section of women from persons
wanting to take advantage of their position, that law makes special provisions.
case of pardanashin ladies on the ground of mere status [K.M. Vati v. K. Raghunath Singh (1976) A.H. P.41]
Under sec.16 of the Act, a prima facie presumption of undue influence arises in any contract entered into with a ‘pardanshin woman’. She can avoid the contract unless the other party can show that it was her “intelligent and voluntary act”. There is, however, no statutory definition of the term ‘pardanashin woman’ and to understand the term recourse will have to be taken to judicial interpretation of the word. In Shaikh Ismail v. Amir Bibi [(1902) 4 Bom LR 146], a lady appeared before the Registrar for registration of certain documents, that she stood as a witness in the box in a suit, that she put in tenants and fixed and recovered rents from them in respect of her house. The Court held that, ‘she could not be treated as a pardanashin lady. A woman does not become pardanashin simply because “she lives in some degree of seclusion”. The concept probably means a woman who is ‘totally secluded from ordinary social intercourse’.
2.3 MENTAL INCAPACITY
Once it is shown that the contract was entered into with a ‘pardanashin woman’, the law presumes undue influence. The burden lies on the other party to show that no undue influence was used, that the contract was fully explained to her and that she had freely consented to it. The entire scope of this concept was explained by the Privy Council in Kalibaksh Singh v. Ram Gopal Singh [(1913)41 IA 23]. In this case, about two months before her death, a Hindu widow (who was a pardanashin woman) gifted half of her landed properties to the son of her paramour, who was also the manager (mukhtar) of her estate. It was contended that combined with the fact that she had no independent advice, was sufficient to show that the gift was the result of the influence the mukhtar had over the lady. Their Lordships held, “In the first place, the lady was a pardanashin lady, and the law throws around her a special cloak of protection. It demands that the burden of proof shall in such a case rest, not with those who attack, but those who found upon the deed, and the proof must go so far as to show affirmatively and conclusively that the deed was not only executed by, but was explained to, and was really understood by the grantor. In such cases it must also, of course, be established that the deed was not signed under duress, but arose from the free and independent will of the grantor. The possession of independent advice, or the absence of it, is a fact to be taken into consideration and will be weighed on a review of the whole of the circumstances relevant to the issue of whether the grantor thoroughly comprehended, and deliberately and of her own free will carried out the transaction. If she did, the issue is solved and the transaction is upheld”. The protection afforded to pardanashin women can be extended to ladies of similar class who though not pardanashin technically are similarly placed in that they are illiterate and sometimes old and sick and have lack of understanding and appreciation of the transaction without independent advice and are helpless and thus exposed to the danger of entering into unfair deals. The emphasis should be on the factual understanding of the transaction entered into and not the disability presumed in the
It has to be understood in the very beginning itself that when we talk of ‘mental incapacity’ we do not use the word in the medical sense. A person may be medically sound, but the law may presume him to be lacking in the mental capacity necessary to enter into a contract (ex: a minor). So, the term mental capacity or incapacity in this section is used to denote the legal incompetence of the person rather than his medical fitness. Section 11 of the Act, lays down that, “every person is competent to contract who is of the age of majority according to the law to which he is subject, and who is of sound mind .....” Thus, the Contract Act disqualifies two categories of persons from entering into a contract, viz: (a) the minors; and (b) those of unsound mind. Each of these will be dealt in detail. 2.3 (A) MINORS POSITION IN INDIA The term ‘minors’ is nowhere defined in the Contract Act. But taking into consideration the wordings of the section, a minor is a person who has not attained the age of 18 years. The age of majority of a person is regulated by sec.3 of the Indian Majority Act, 1875. But where a guardian has been appointed to the person or property of a minor by a court or when the minor’s property is under the supervision of a Court of wards, the age of majority of such a person is 21 years and not 18 years. Sec.11 of the Act expressly forbids a minor from entering into a contract. The effect of this express prohibition is that, any contract entered into by a minor is void ab initio regardless of whether the other person was aware of his minority or not. Prior to 1903, it was felt that the proposition, “no person is competant to contract who is not of the age of majority ..... “was capable of two interpretations, viz:- (i) that a minor is absolutely incompetent to contract, in which case his agreement is void ab initio; or (ii) that he is not liable on the contract only in the sense that he is not liable on the contract though the other party is, in which case there is a voidable contract. Formerly, the Indian courts favoured the second interpretation and it was held that just as in England, even in India, a minor’s contract was voidable at his option. But in 1903 in the case of Mohoribibi v. Dharmodas Ghose [30 IA 114:30 Cal 539 (1903)], the Privy Council ruled that, “the Act makes it essential that all contracting parties should be competent to contract, and especially provides that a person who by reason of infancy is incompetent to contract cannot make a contract within the meaning of the Act. It was accordingly held that a mortgage made by a minor was void, and a moneylender who has advanced money to a minor on the security of the mortgage is not entitled to repayment. 49
Any other rule would have made the law asymmetrical, leaving it to the whim of a child to pick and choose between agreements made by him as to which he will and which he will not enforce. A child may show poor judgement in making a particular contract, and it is a protection against his own ignorance and immaturity - not merely fraudulent manipulation by others that the law affords. The general presumption that every man is the best judge of his own interests is suspended in the case of children [A.T. Kronman, p.786] The law dealing with minor’s agreements is based on two principles, viz: (i) that the law must protect the minor against his own inexperience, which may enable an adult to take unfair advantage of him, or to induce him to enter into a contract which, though in itself is fair, is simply imprudent [for ex: if the minor for a fair price buys something which he cannot afford]; and (ii) that the law should not cause unnecessary hardship to adults who deal fairly with minors [Trietal, p.416]. In modern society, it does not seem possible and much less desirable for law to adhere to the categorical declaration that a minor’s agreement is always “absolutely void”. Minors are appearing in public life today more frequently than ever before. A minor has to travel, to get his dresses tailored, or cleaned, to visit cinema halls and deposit his cycle at a stand. He has to deal with educational institutions and purchase so many things for the facility of life and education. If, in any one of these cases, the other party to the contract could brush aside the minor on the ground that the engagement is void, the legal protection against contractual liability would be too dear to minors. Keeping in mind this fact, even the Privy Council changed its stand latter to a more equitable one. For example, in Srikakulam Subrahmanyam v. Kurra Subha Rao [ILR 1949 Mad 141 PC], in order to pay off the promissory note and the mortgage debt of his father, the minor son and his mother sold a piece of land to the holders of the promissory note in satisfaction of the note and he was also able to pay off the mortgage debt, and regain possession of the land. Afterwards the minor brought an action to recover back the land. It was found as a fact that the transaction was for the benefit of the minor and the guardian (his mother) had the capacity to contract on his behalf. Lord Morton said that, section 11 and the Mohoribibi case leave no doubt that a minor cannot contract and that if the guardian had taken no part in this transaction it would have been void. But, the contract being for the benefit of the minor and within the power of the guardian was held to be binding upon him. Effects of Minor’s Agreement A minor’s agreement being void, ordinarily it should be wholly devoid of all effects. If there is no contract, there should, indeed, be no contractual obligation on either side. Consequently all the effects of a minor’s agreement must be worked out independently of any contract. 50
1. No Estoppel against a Minor If a minor procures a loan or enters into any other agreement by representing that he is of full age, is he estopped by sec.115 of the Indian Evidence Act, 1872 from setting up that he was a minor when he executed the mortgage? In other words, can he be precluded from disclosing his true age in any subsequent litigation resulting from the contract? The point was raised but not decided in Mohoribibi’s case, where the Privy Council said, “the Courts below seem to have decided that this section does not apply to infants; but their Lordships do not think it necessary to deal with that question now. They consider it clear that the section does not apply to a case like the present, where the statement relied upon is made to a person who knows the real facts and is not misled by the untrue statement. There can be no estoppel where the truth of the matter is known to both the parties, and their Lordships hold, in accordance with English authorities, that a false representation, made to a person who knows it to be false, is not such a fraud as to take away the privilege of infancy”. There were later many conflicting decisions on whether a minor could be estopped by a false representation as to his age. But the point has been settled in Sadik Ali Khan v. Jai Kishore [AIR 1928 All P.C.152], where the Privy Council observed that, ` a deed executed by a minor is a nullity and incapable of founding a plea of estoppel’. The principle underlying the decision being, `there can be no estoppel against a statute’. Thus, the position now is, that even if a minor has entered into a contract by misrepresenting his age, he can at any later stage plead ‘minority’ and avoid the contract. Minority in India is a fact and not a privilege (as in England) and this fact can be proved at any stage of the proceedings, regardless of the surrounding circumstances. 2. No Liability in Contract A minor’s agreement is of course, in principal devoid of all legal effects. “A minor is in law incapable of giving consent, and, there being no consent, there could be no change in the character or status of the parties [Padma Vithoba v. Mohd. Multani, AIR 1963 SC 70]. In England, as early as in 1665 in Johnson v. Pye [2 ER 1091] it was held that, “an infant who obtains a loan of money by falsely representing his age cannot be made to repay the amount of loan in the form of damages for deceit”. 3. No ratification A minor’s agreement being void ab initio, there can be no ratification of the agreement on his reaching the age of majority. Ratification can only be of acts which are ‘valid in law’ at the time of commission and also at the time of ratification. Since an agreement entered into by a minor, during his minority is not valid in law, he cannot on his reaching the age of majority ratify it - as in the eyes of law the agreement does not exist at all. 4. Limited application of restitution If a minor obtains property or goods by misrepresenting his age, he can be compelled to restore it, but only so long as the
same is traceable in his possession. This is known as the equitable doctrine of restitution. Where the minor has sold the goods or converted them, he cannot be made to repay the value of the goods, because that would amount to enforcing a void agreement. So also, the doctrine will not apply where the minor has obtained cash instead of goods. In Leslie (R) Ltd v. Sheill [(1914) 3 KB 607] a well known authority on this issue, it was held that, “.... the money was paid over in order to be used as the defendant’s own and he has so used it and, suppose, spent it. There is no question of tracing it, no possibility of restoring the very thing got by the fraud, nothing but compulsion through a personal judgement to repay an equivalent sum out of his present and future resources .... I think this would be nothing but enforcing a void contract”. Section 41 of the original Specific Relief Act, 1877 authorised the courts to order any compensation that justice required to be paid by the party at whose instance a contract was cancelled. The first landmark case decided under this section was Mohoribibi’s case where it was held that, “This section no doubt gave a discretion to the court; but the court of first instance and subsequently the Appellate Court, in the exercise of such discretion, came to the conclusion that under the circumstances of this case justice did not require them to order the return by the respondent of the money advanced to him with full knowledge of his infancy, and their Lordships see no reason for interfering with the discretion so exercised”. Second landmark case on this issue was Khan Gul v. Lakha Singh [AIR 1928 Lah 609], where the defendant while still a minor, fraudulently concealing his age, contracted to sell a plot of land to the plaintiff. He received the consideration of Rs.17,500 and then refused to perform his part of the bargain. The plaintiff prayed for recovery of possession or refund of consideration. There could be no question of specific enforcement, the contract being void ab initio. The only question therefore was : “Can a minor who has entered into a contract by false representation refuse to perform the contract and at the same time retain the benefit he may have received therefrom? The court held that, “..... There is no real difference between restoring the property and refunding the money, except that the property can be identified but cash cannot be traced .... It must be remembered that, while in India all contracts made by infants are void, there is no such general rule in England. There should therefore be a greater scope in India than in England for the application of the equitable doctrine of restitution”. Referring to sections 39 & 41 of the Specific Relief Act, 1877, the court further said : “The doctrine of restitution is not however confined to cases covered by those sections. The doctrine rests upon the salutory principle that an infant cannot be allowed by a court of equity to take advantage of his own fraud”. The court therefore ordered the refund of the money. The Law Commission of India, in its 9th report also supported this view. The matter now is codified in section 33 of the new Specific Relief Act, 1963. The net result of the amendment is as follows :
(i)
Where a void or voidable contract has been cancelled at the instance of a party thereto, the court may require him to restore such benefits as he has received under the contract and to make any compensation to the other party which justice may require; and
(ii)
Where a defendant successfully resists any suit on the ground that the contract, by reason of his being incompetent, is void against him, he may be required to restore the benefits, if any, obtained by him under the contract, but only to the extent to which he or his estate has benefited thereby.
But the court will not compel any restitution by a minor even when he is a plaintiff, where the other party was aware of the ‘minority’ so that he was not deceived [Bhim Mandal v. Mangaram Corain, AIR 1961 Pat 21] or where the other party has been unscrupulous in his dealings with the minor [Mohd. Said v. Bishamber Nath, AIR 1924 All 156] or where the other party lays no material before the court for coming to the conclusion that justice requires return of the money paid to the minor [Kampta Prasad Singh v. Sheo Goapl Lal, (1904) 26 All 342] etc. Section 33(1) of the Specific Relief Act, 1963, does not alter the earlier law. If the minor comes to the court as a plaintiff, he can be compelled to disgorge his gains under the agreement. Sub-section (2) however makes this difference that if a minor is brought before the court as a defendant, he can be compelled to account for such portion of the money or other benefits received by him as has gone to benefit him personally, such as education or training or has resulted in an accretion to the estate. Effect of Contracts Beneficial to Minors The law declared in Mohoribibi’s case that a minor’s agreement is “absolutely void” has been generally followed, but it has been growingly “confined to cases where a minor is charged with obligations and the other contracting party seeks to enforce those obligations against the minor” [Raghavachariar v. Srinivasa (1916) 40 Mad 308]. It was further held in the same case that, “what is meant by the proposition that an infant is incompetent to contract or that his contract is void is that the law will not enforce any contractual obligations of an infant”. Thus, a minor is allowed to enforce a contract which is of some benefit to him and under which he is required to bear no obligation. In the above case, a full bench of the Madras High Court unanimously decided, that, a mortgage executed in favour of a minor, who has advanced the whole of the mortgage money, is enforceable by him or any other person on his behalf. This and a number of later cases proceeded on the principle that the minor has already given the full consideration to be supplied by him and there is nothing that needs to be done by him under the contract. He is now a mere promisee and prays the court for recovering the benefit stipulated. But where the contract is still executory or the consideration is still to be supplied, the principle in Mohoribibi’s case would thwart any action on the contract. For example, in Raj Rani v. Prem Adib [AIR 1949 Bom 215], the plaintiff, a minor, was allotted by the 51
defendant, a film producer, a role in a film. The agreement was made with the father. The defendant subsequently allotted that role to another artist and terminated the contract with the plaintiff’s father. It was held that, neither the plaintiff nor her father could sue on the promise. If it was a contract with the plaintiff, she being a minor, it was a nullity. If it was a contract with her father it was void for being without consideration. The promise of a minor girl to serve, being unenforceable against her, cannot furnish any consideration for the defendants promise to pay her a salary. The Indian Apprentices Act, 1850 provides for contracts in the nature of contracts of service which are binding on minors. The Act was passed, as the preamble shows: “For better enabling children, and specially orphans and poor children brought up by public charity to learn trades, crafts and employments, by which, when they come to full age, they may gain a livelihood”. Section 9 of the Act requires such contracts to be made by a guardian on behalf of the minor. Another contract which is prima facie for the benefit of the minor, is a contract of his/her marriage. “It is customary amongst most of the communities in India for parents to arrange marriages between their minor children and the law has to adapt itself to the habits and customs of the people” [Khimji Kuverji v. Lalfi Karamsey, AIR 1941 Bom 129]. It is therefore well established that, “while the contract of marriage could be enforced against the other contracting party at the instance of the minor it cannot be enforced against the minor”. A minor has the option of retiring from a contract in beneficial nature on attaining majority provided that he exercises the option within a reasonable time. Liability of Minor for Necessaries Section 68 of the Act provides for the liability for necessaries supplied to persons incompetent to contract as: “If a person incapable of entering into a contract, or any one whom he is legally bound to support, is supplied by another person with necessaries suited to his condition in life, the person who has furnished such supplies is entitled to be reimbursed from the property of such incapable persons”. This section is applicable only to the supply of ‘necessaries’, but this term has not been defined any where in the Act. To ascertain the meaning of the word ‘necessaries’, we may turn to the judicial decisions to determine its meaning and scope. For example, in Chappel v. Cooper [(1844)13 M & W 252] : “Things necessary are those without which an individual cannot reasonably exist. In the first place, food, raiment, lodging and the like. About these there is no doubt. Again, as the proper cultivation of mind is as expedient as the support of the body, instruction in art or trade, or intellectual, moral and religious education may be necessary also ..... Then the classes being established, the subject and extent of the contract may vary according to the state and condition of the infant himself. His clothes may be fair or coarse according to his rank, his education may vary according to the station he is to fill; and the medicines will depend on the illness with which he is afflicted, and the 52
extent of his probable means when of full age ... But in all these cases it must first be made out that the class itself is one in which the things furnished are essential to the existence and of reasonable advantage and comfort of the infant contractor. Thus articles of mere luxury are always excluded, though luxurious articles of utility are in some cases allowed”. Thus, “What is necessary” is a relative fact to be determined with reference to the fortune and circumstances of the particular minor. Hence an article (for ex : a Gold Watch) may be an article of necessity in one case and an item of luxury in another, depending on the status of the minor. The importance of making this differentiation is that, the seller would be able to recover the cost of the watch in the first case and he will have to suffer a loss in the second case, i.e., the seller cannot recover the cost of (merely) luxurious items. Even when the cost is awarded, he can recover it only from the property of the minor. A minor, in India, can never be made personally liable for any goods supplied to him. If he does not have property sufficient to satisfy the debts, the seller will have to suffer a loss. To render a minor’s estate liable for necessaries two conditions must be satisfied, namely: (i) the contract must be for goods reasonably necessary for his support in his station in life; and (ii) he must not have already a sufficient supply of these necessaries. The supplier thus has to prove, “not only that the goods supplied were suitable to the condition in life of the infant, but that he was not sufficiently supplied with the goods of that class”. This principle was laid down in Nash v. Inman [(1908)2 KB 1], where an undergraduate in Cambridge University, who was amply supplied with proper clothes according to his position, was supplied by the plaintiff with a number of dresses, including eleven fancy waist coats. The price was held to be irrecoverable. Status of Minor in Certain Other Indian Laws Just as the Indian Contract Act has made special provisions relating to a minor, certain other laws in force in India have also made certain provisions for minors either confering some benefits or special privileges on them or prohibiting them from entering into certain transactions. Some of these provisions are discusssed below. Minor as a Shareholder Under the Indian Companies Act, a minor is barred from holding any shares in his own name. Even if his name is entered in the register of members, he will not be treated as a member and his name will be struck off from the register. But a guardian can purchase shares on behalf of a minor, which he will then hold as a trustee for the minor. Minor as a partner Under section 30 of the Indian Partnership Act, a minor can be made a partner to the benefits of a firm, with the consent of all the partners. A minor partner is entitled to a specified share of the profits but cannot be made liable for the partnership losses.
Within six months of his attaining majority or his becoming aware of his status as a minor partner firm whichever is later, he is required to elect from two options : whether he would like to continue as the partner of the firm or else would like to opt out. If he decides to opt out, then he ceases to be a partner from the day of the election and would no longer be entitled to the share in partnership profits. If he decides to continue as a partner, then his decision will have a retrospective effect i.e., he will be deemed to be a full fledged partner from the day he had first entered the firm (as a minor). He then becomes liable for all the acts and losses of the firm during this period. This retrospective effect seems to be against the spirit of contract Act, since in effect it means that the minor had entered into a valid contract of partnership during his minority. This is in conflict with sec.11 of the Contract Act, which specifically lays down that a minor’s contract is void ab initio. This anomaly is extremely unfortunate and may have arisen because the Indian Partnership Act follows the English Partnership Act to the dot, and in England unlike India a minor’s contract may be valid, void or voidable depending on the nature of the contract. The legislature in framing this section seems to have failed in taking notice of this basic difference between the contract laws of these two countries. Minor as a transferee Under the Transfer of Property Act, 1872, Ss 13, 14 and 127 deal with transfer of property for the benefit of a minor. Ss 13 and 14 deal with the rule against perpetuity and state that property can be transferred to an unborn person via the media of a living person i.e., first the property goes to a person living at the time of transfer and after his death to a person who is unborn at the time of the first transfer. This (unborn) person should be atleast conceived at the time when the first interest comes to an end and he acquires full interest in the property on his attaining majority. Section 127, deals with onerous gift to a minor person. An onerous gift is one which has both burden and benefit attached to it (for ex: a mortgaged house). In such cases the minor is given an option on his attaining majority either to accept the gift or to reject it. If he accepts the gift, he will be liable for the burdens attached to the gift, but if he rejects it then he cannot be made liable for any obligations arising out of the gift. A minor has to make his election within a reasonable time of his attaining majority.
Minor Under Insolvency Act A minor in India cannot be declared insolvent or bankrupt, nor can his properties be attached. Minor under various Labour Laws: Under the Factories Acts 1948 (sec 67); Mines Act 1952 (Sec 40) and Plantation Act 1951 (sec 25) a minor above the age of, 14, 18 and 12 years (since withdrawn by Amemdment Act, 1986) can be employed as factory, mines and plantation worker respectively. These provisions seem to be in conflict with the Contract Act. In order to make a minor a worker at that age requires a contract of employment. Does it mean that a minor above the age as mentioned earlier in those respective industrial legislations, can enter into a valid service contract as is prescribed in England? Or does it mean that the minor at that age could be a worker on the basis of a contract made between the minor’s guardian and the occupier of the Factory/Mines/ Plantation Unit? The former course of action is more logical than the latter because the agreement relates to services of the minor in person. As such, the occupier shall be liable to pay the minor worker personally and not through the guardian. Though the law relating to a minor in India and his/her position vis-a-vis a contract, is not based upon the Common law in England but in some cases as above, it may be necessary to refer to English law. So, let us examine the English law in this regard. POSITION IN ENGLAND Till recently persons below the age of majority were called as ‘infants’. But now the term ‘minors’ is generally used to describe persons who are below the age of 18 years [sec.1 of Family Law Reform Act, 1969]. Contracts made by minors are governed by the rules of common law as altered by the Infant’s Relief Act, 1874 and Minors’ Contracts Act, 1987. The Infant’s Relief Act, 1874 declares the following categories of minors’ agreement to be “absolutely void” : (i) agreement for repayment of money lent or to be lent; or (ii) agreement for goods supplied or to be supplied (other than necessary); and (iii) agreement for accounts stated. Apart from the above three categories, the rest of the categories of contracts entered into by minors may be either valid contracts or voidable contracts depending on the subject-matter of the contract.
Minor as a Trade Union Member
Valid Contracts
A minor over the age of 15 years but below 18 years can be a member of a registered trade union, and can enjoy all rights and privileges available to such members. But a minor cannot form a registered trade union, though there is a proposal to the effect that minors should be allowed to form their own trade unions and to get it registered as this would help in a better protection of their rights.
Under certain circumstances the agreement entered into by a minor is deemed to be a valid contract. Some of these situations are discussed below. (1) Necessaries A contract for necessaries is binding “not for the benefit of the tradesman who may trust the infant, but for the benefit of the infant himself” [Ryder v. Wombwell (1868)L.R.4 Ex.32]. It 53
is assumed, rightly or wrongly, that the tradesman would not give credit to the minor unless the law imposed liability. It should be noted, that parents are not liable on their child’s contract unless the child acts as their agent [Blackburn v. Mackey (1823)1 C & P.1], and that in English law a minor’s contract cannot be validated by the consent or authorisation of his parent or guardian. Necessaries include goods supplied and services rendered to a minor. He is only bound by a contract for necessaries if it is on the whole for his benefit; not if it contains harsh and onerous terms. Nor is he bound by an indivisible contract comprising of necessaries and non-necessaries [Stock v. Wilson [1913] 2 KB 235]. (2) Service Contracts A minor is bound by a contract of service if it is on the whole for his benefit, though some of the clauses of the contract be to his disadvantage. In deciding whether a service contract is on the whole beneficial, the court is entitled to look at surrounding circumstances. For example, a service contract with a minor may contain a covenant in restraint of trade, such a covenant, if otherwise valid, does not invalidate the contract if the minor could not have got work on any other terms. But it would invalidate a service contract with a minor if it was of a kind that was not usually found in service contracts in that trade and locality. These principles also apply to contracts connected with service contracts. Thus they determine the validity of contracts to carry minors to work, of compromises of industrial injury claims, and of agreements to dissolve service contracts. These principles also determine the validity of contracts under which a minor makes a living by the exercise of some profession, ex: as an entertainer or author or athlete. Voidable Contracts Under four different circumstances, a minor’s contract is voidable i.e., it binds both parties but the minor can escape liability by repudiating before majority or within a reasonable time thereafter, but the other party can never repudiate it. These cases are: 1. Contracts concerning land A lessee who is under age is liable for rent unless he repudiates it. The same principle applies to purchase of freehold land, letting or sale of land by a minor, whether the terms of conveyance be advantageous to him or not. 2. Shares in a Company A minor who agrees to subscribe for shares in a company or buys shares which are not fully paid, is liable for calls unless he repudiates. A mere plea that he has not ratified the transaction does not relieve him from liability [North Western Railway v. M’ Michael, (1850) 5 Ex.114]. Once he repudiates he ceases to be liable and can have his name removed from the company’s register.
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3. Partnership A minor can become a partner and is to some extent bound by the partnership agreement. He cannot be sued during minority by persons who give credit to the firm, or be made liable for its losses. But he is liable if after attaining majority fails to put an end to the partnership. He is not entitled to any share in the profits or assets of the partnership until its liabilities have been paid off. 4. Marriage Settlements Formerly it was thought that a marriage settlement by a minor was binding to the extent to which it benefitted him; but was not otherwise binding unless ratified after majority [Simon v. Jones (1831) 2 Russ & Rly. 365]. The present view is that all such settlements bind the minor unless he repudiates it [Duncan v. Dixon (1890) 444 Ch.D 211]. A voidable contract can be repudiated during minority but such a repudiation can be withdrawn by the minor before, or within reasonable time on attaining majority. If he repudiates during minority itself, he needs to take no further steps to escape liability on reaching full age. If the minor does not repudiate during minority, he must do so within a reasonable time on reaching full age; even if he did not know of his right to repudiate, and even if his obligation under the contract had not yet matured. In Edwards v. Carter [(1893)A.C. 360] it was held that a settlement could not be repudiated nearly five years after the majority of the settlor, although he was far most of that time ignorant of his right to repudiate. Before the Minor’s Contracts Act 1987, a minor could be held liable to restore certain benefits received by him under a contract which did not bind him. Such liability was imposed in equity if the minor was guilty of fraud, and at common law in certain cases of quasi-contracts. Section 3(1) of the 1987 Act now gives the court a discretion to order the minor to transfer to the adult party any property acquired by the minor under such a contract, or any property representing it. Section 3(2) of the Act, provides that nothing in section 3 “shall be taken to prejudice any other remedy available to the adult party to the contract” : thus in cases which fall outside sec. 3(1), or in which the court declines to exercise its discretion under that sub-section, it remains open to the adult to seek restitution under the old rules of equity or common law. DISTINCTION BETWEEN THE INDIAN LAWAND ENGLISH LAW a) Nature of minor’s contract In India, any agreement with a minor is void ab initio under all circumstances. In England, a contract with a minor may be valid, voidable or void depending on its contents.
b) Liability for necessaries In India, a person who has supplied necessaries to the minor can be reimbursed from the property of the minor only [Sec.68]. In England, the minor is personally liable for the necessaries supplied to him, because a contract for necessaries is a valid contract. c) Insolvency proceedings In India, a minor cannot be declared insolvent. In England, a minor can be declared insolvent for trade debts. d) Service Contracts In India, a minor cannot enter into any contract. However, it has been seen earlier that industrial laws in India, by and large, provide for young workers above 15 years of age. This indicates that a service contract is valid. In England, a service contract with a minor is a valid contract. In conclusion it may be said that the basic difference between the Indian and English Law with respect to the law relating to minors is that, in India minority is a ‘fact’ which is treated as law. Hence, the protection granted to a minor is absolute and extends to all situations regardless of his duplicity in the transaction. (eg: misrepresentation of his age). But in England, minority is a ‘privilege’ which is granted to the minor only in certain situations. Hence, the protection granted is conditional or restricted and depends upon the subject matter of the contract. All the remaining differences in the treatment of a minor’s contract follow naturally from this fundamental difference. AMERICAN POSITION Under the American Law, those below the age of “majority” [18 in most jurisdictions, 21 in some] are responsible for their torts and crimes, but are allowed to disaffirm the contracts they make. To disaffirm, the minor simply indicates (even in an informal way) that he or she no longer wants to be bound by the contract. If the minor reaches majority, the period of disaffirmation continues for a reasonable period of time and even thereafter unless the other side relies on the infant’s apparent `ratification’ of the contract. The minor (sometimes called infant) may not disaffirm a contract for ‘necessaries’ [i.e., food, clothing, shelter etc.] nor one signed by the infant’s legal guardian. In all jurisdictions special statutes deprive infants of the power to disaffirm certain contracts: bail bonds, military service, bank accounts etc. All the states in America hold the view [either by application of statute or Common Law principle] that the infants must return the consideration they received from the other side if it is possible to do so. In some of the states, there seems to be a definite leaning towards holding an infant liable for benefits received even though they are not necessaries and even though the benefits cannot be returned in kind. In Porter v. Wilson [106 N.H. 270] the New Hampshire court, stating this rule cited with approval a passage from ‘Williston on Contract’ : “In some states the ordinary rule prevailing in regard to necessaries has been extended so far as to hold an infant bound by his contracts,
where he fails to restore what he has received under them to the extent of the benefit actually derived by him from what he has received from the other party to the transaction. This seems to offer a flexible rule which will prevent imposition upon the infant and also tend to prevent the infant from imposing to any serious degree upon others”. Though this rule requiring the minor to account for any benefit he has received, may be the minority opinion there is a growing feeling in the States that this is definitely a better rule. The reason for this changed opinion has been well stated by the Court of Appeals of Ohio in Haydocy Pontiac Inc. v. Lee [19 Ohio App. 2d1 217] “at a time when we see young persons between 18 and 21 years of age demanding and assuming more responsibilities in their daily lives; when we see such persons emancipated, married, and raising families; when we see such persons charged with the responsibility for committing crimes; where we see such persons being sued in tort claims for acts of negligence; when we see such persons subject to military service; when we see such persons engaged in business and acting in almost all other respects as an adult, it seems timely to re-examine the case law pertaining to contractual rights and responsibilities of infants to see if the law as pronounced and applied by the courts should be redefined”. Despite this and other decisions of a like nature, the general opinion relating to a minor’s contract is that, he is liable (i.e., personally) on contracts for necessaries but on others he is not. This position of a minor seems to be analogous to the position of a minor in England where also a minor can be made personally liable on some contracts, whereas on others he cannot be held liable at all. Concluding Remarks One can only speculate on the reasons as to why in India a minor’s agreement is treated as void ab initio [so much so that even for the supply of necessaries, it is only his property which can be made liable and not the minor himself] whereas, both in England and America a minor’s contract may be valid or void depending on the nature of the contract. One of the plausible reasons may be the difference in the social and cultural environment between India and the other two countries. Here, till the child is married he/she remains under the effective control of the parents (in general) regardless of his age and earning capacity. So also, we do not find parents encouraging their children (below 21 years) to take independent decisions in matters concerning them. Right from what the child should eat, wear etc..... to what he should study and where, is decided for the child by the parents. It maybe this over protective attitude towards our children, which finds a reflection in our Contract Act also. In contrast, in the West, a child is encouraged to take independent decisions from an early age, so that the child is able to act more naturally and independently as compared to his counterpart in the east. This attitude of imposing responsibilities on a child from an early age is reflected in the Contract Acts of UK & USA. After all, law for the most parts is a reflection of social norms and ideals. 55
2.3(B) UNSOUND MIND
Drunkards
Section 11 of the Act specifies that, every person is competent to contract .... who is of sound mind. Thus, ‘unsound mind’ is a disqualification which would if proved make the contract void ab initio. Unsoundness of mind maybe either temporary or permanent and may occur due to numerous reasons. Some of the categories of persons who may suffer from ‘unsound mind’ are : a) Persons with an advanced age or illness affecting mental ability b) Person under the influence of alcohol and drug c) Persons having mental incapacity on account of attacks of lunacy
The second part of section 12 says : ‘a person who is usually of sound mind, but occasionally of unsound mind, may not make a contract when he is of unsound mind’.
Each of these, will now be dealt in brief. Aged persons Old age may not necessarily result in senility or diminished mental capacity, but it may. When an old person’s mental faculties weaken, law throws a protective cloak around him, to prevent any unscrupulous person (generally someone close to such old person, maybe a relative, or his doctor or a friend) from taking undue advantage of the person. A contract entered into by such an old person may be avoided on any one of the following two grounds, viz: a) Undue Influence Such contracts can be avoided under sec.16 of the Act provided that the old person could prove that the other party to the contract was in a position to unduly influence his decision. For example, in Abdur Rauff v. Aymona Bibi [1937 A. Cal.492], an aged father executed deeds of gift and a wakfnama at a time when he was in a weak state of mind as the result of a long drawn out illness. These transactions were brought about at the instance of his son and had the effect of depriving the other members of the family of their just share of the inheritance. As it was proved that the son was in a position to dominate the will of the father and that he used that position to his own advantage, the deeds of gift and the wakfnama were set aside. Once ‘undue influence’ is pleaded the defendant has to prove : (i) that no undue influence was used; (ii) that the contract was fully explained to the plaintiff; and (iii) the plaintiff freely consented to the transaction. If undue influence is proved, the contract becomes voidable and can be rescinded at the option of the aged person but not at the option of the other party to the contract. b) Unsound mind The second ground on which an aged person (or someone on his behalf) can avoid a contract is by proving, that at the time the contract was entered he (i.e., the old person) was not in possession of his full mental faculties, as a result of which he was unable to grasp the full consequences of his act. If ‘unsoundness’ can be proved to the satisfaction of the court, then the contract is treated as void ab initio. 56
A person under the influence of alcohol, drugs or such other intoxicating substances, is presumed for the purposes of Contract Act to come under this definition of ‘occasionally of unsound mind’. If it can be proved that at the time when the plaintiff had entered into the contract he was so intoxicated that he had no control over his mental faculties and ‘was incapable of understanding it and of forming a rational judgement as to its effects upon his interest’, the agreement he has entered into may be declared by the Court as void ab initio, regardless of whether the defendant was aware of the plaintiffs’ state of intoxication or not. It is interesting to note that this part of the section is given in a negative proposition though the former part is in positive form. It is because here the court presumes that the person has a sound mind, and hence the agreement valid. Anyone challenging this presumption must prove mental incapacity by proving beyond doubt that at the time of entering into the agreement the person was so intoxicated that he/she could not understand the personal benefit, only in that case the agreement can be negatived. [Prove negation of mental capacity to negate the agreement]. So the proposition is negative. The English law relating to contracts, with drunkards is different from the Indian Law. In England, if a person enters into a contract while drunk, he may, when sober, elect to avoid the contract or to affirm it [Mathews v. Baxter, (1873) LR 8Ex 132]. Thus, under the English Law, a contract with an intoxicated person is merely voidable at his option and not absolutely void as in India. Lunatics Whenever a person is incapable of forming a rational judgement in his best interests, we call him jurisprudentially insane or legally insane. In medical science, insanity is a disease of mind which impairs the mental faculty of a human being. It may have various grades and stages but at all these grades and stages a person is not necessarily incapable of forming judgments in his own interest. As for example, mental obsession is a disease and therefore may come within the scope of medical terminology of insanity, but in such cases the person is not necessarily incapable of forming judgments in his best interests and as such will not be jurisprudentially insane. Any impairment of cognative faculty which injures the capacity of reason comes within the medical definition but not the jurisprudential one. But if the cognitive faculty is so damaged as to render the person incapable of understanding the nature and consequences of his act, the insanity is said to be jurisprudential. In Q.E. v. Keder Nasayer Shah [(1896)23 Cal 604] the Calcutta High Court explained the jurisprudential insanity as one, ‘which materially impairs the cognitive faculties of mind’ so much so that it would make the person ‘incapable of knowing the nature of the act’. In civil laws the test is whether the person can form a rational
judgement as to his interest in the given situation, say in case of contract - in case of the given contract. In case of criminal law the test is even more rigid. In order to get an exemption under criminal law such impairment of cognitive faculties of the accused should be such that the accused has become incapable of knowing the nature of his act, and that he does not understand that what he is doing is wrong or contrary to law. For long Indian criminal courts used to apply McNaghten’s rule [State v. McNaghten (1833)10 Clark & Finnelly 200] which prescribed that, “the accused in order to get exemption from criminal responsibility on the ground of insanity, must prove that, owing to a defect of reason, due to a disease of mind, he did not know the nature and quality of his act, or, if he did know this, that he did not know that he was doing wrong”. The civil court on the other hand does not apply this test. In other words, the civil court applies a test of rational judgement in the interest of the self. In both the cases, however the origin of `insanity’ is taken as 'sane’ i.e., impairment of cognitive domain which injures the faculty of reasoning. For obvious reasons the degree of test in criminal law is tougher than in civil law, though the methodology is almost the same. Section 12 of the Contract Act specifies the meaning of ‘sound mind’ for the purposes of contracting as: A person is said to be of sound mind for the purpose of making a contract if, at the time when he makes it, he is capable of understanding it and of forming a rational judgement as to its effect upon his interests. A person who is usually of unsound mind, but occasionally of sound mind, may make a contract when he is of sound mind. A person who is usually of sound mind, but occasionally of unsound mind, may not make a contract when he is of unsound mind. This section consists of three different parts . First Part : This lays down the general principle for competence to contract. A person may enter into a contract if he, (a) is capable of understanding the full import of the contract; (b) anticipates the effect of the contract on his interests; and (c) exercises a rational judgement keeping in mind all the circumstances. It has to be noted here, that law only wants the person to fully understand the consequences of his action before undertaking it. If a person voluntarily and with full understanding enters into a contract which may not be in his best interest, the law will not interfere to save him from his own folly. For example, A freely and voluntarily wants to sell his house worth Rs.1,00,000/- to B who is a friend for a mere Rs.25,000/-. In the absence of other vitiating factors (like coercion, undue influence etc) law will not interfere with this transaction. The sale is perfectly valid, though the price is much below the market value. In such cases, A is deemed to be the best judge of his interests. Second Part : There are certain persons who are usually of unsound mind i.e., they do not normally fulfil the criteria of
‘sound mind’ given in first part of sec.12. The unsoundness of mind may be due to any reason (for ex: genetic disorder, psychotic disorder, congenital diseases etc). It is the fact of unsoundness which is important and not the cause of it. A contract entered into by such persons is void ab initio, unless it can be proved that at the time when the contract was entered into he was of sound mind i.e., ‘he was capable of understanding the consequences of his act and to exercise a rational judgement’. It is interesting to note that the construction of this second part is positive in character though that of the third part is negative. This has something to do with the presumptive character and the burden of proof. Suppose, a lunatic who was in an asylum during January to September and then again between November-December of the same year contracts of marriage in the month of October. He can enter into the contract in the month of October provided that he is of sound mind during that period. Here anyone who is inducing the court to believe that, the person attained a ‘lucid interval’ (excepting in congenital lunacy in all other types of insanity there are strikes of attack of insanity from time to time. The interval between two strikes is known as‘lucid interval’ when the person attains clear understanding just like a normal man and his cognitive domain functions properly) during the month of October has to prove that the person at that time could take a conscious resolution about his interest. On his proving that fact the court shall validate the marriage. Therefore the general presumption is that the person is ‘unsound’ and the agreement ‘invalid’. On proving the soundness of mind, the validity of the agreement shall be declared. This is known as proof-positive i.e., to take a positive conclusion. The positive structure of the law indicates a leaning towards this burden of proof and presumption. Generally speaking in an adversorial system (we follow in India the common law adversorial system) a person who goes to the court (i.e., the plaintiff) must prove his case. But here, the person who induces the court to believe that the insane person had attained a lucid interval has to prove that assertion whether he be the plaintiff or the defendant. Third Part : The last part (as already discussed above) applies to those who are usually of sound mind but may suffer from occasional unsoundness of mind (may be due to emotional shock, alcohol, drugs etc.) A contract entered into by such persons is valid, unless it can be proved that at the time, when the contract was entered into he was of ‘unsound mind’ i.e., he was incapable of either understanding the consequences of his act or of exercising a rational judgement. If he can prove the ‘unsoundness’ the contract would then become void ab initio. A person may have temporary unsoundness of mind due to several reasons. It may be on account of mental pressure, or addiction, or pressures of age, or on account of impulses. This is therefore a temporary phenomenon. As for example, A who signed a promissory note challenging the validity of it on the ground that he had made it while his mental faculties were impaired on account of drunkenness. In such a situation, the person has to prove that the consumption of liquor was so high 57
that the cognitive faculty of mind was impaired, during which time he had signed the promissory note. The proof over here is of a negative character, i.e., the person pleading the unsoundness has to conclusively prove the absence of soundness, in order to obtain a decision about the absence of a contract. The general presumption is that a person is of sound mind and the contract valid. Only on proving the negation is the agreement negated. It is also to be noted, that though the third proposition is written in a negative form but the proposition is written in a particular negative form using the phrase ‘may not’. If this phrase ‘may not’ is used in a particular sense it may mean that some may enter into the contract. This construction is inconsistent and incongruent. Therefore, the word ‘may’ in the negative form has to mean ‘must’. Thus, though the proposition apparently in this particular negative form, it really means a universal negative construction - meaning thereby, that persons with occasional unsound mind must not enter into a contract when the mind is unsound. Therefore, any agreement made when the mind is unsound is invalid. Inder Singh v. Parmeshwardhani Singh [AIR 1957 Pat. 491] is a case which deals with the scope and extent of sec.12. Here, a property worth Rs.25,000/- was agreed to be sold by a person for Rs.7000/- only. His mother proved that he was a congenital idiot, incapable of understanding the transaction and that he mostly wandered about. Holding the sale to be void, Sinha J. held, “According to this section, therefore, the person entering into the contract must be a person who understands what he is doing and is able to form a rational judgement as to whether what he is about to do is to his interest or not. The crucial point, therefore, is to find out whether he is entering into the contract after he has understood it and has decided to enter into that contract after forming a rational judgement in regard to his interest .... It does not necessarily mean that a man must be suffering from lunacy to disable him from entering into a contract. A person may to all appearances behave in a normal fashion, but, at the same time he may be incapable of forming a judgement of his own, as to whether the act he is about to do is to his interest or not. In the present case (he) was incapable of exercising his own judgement. In England, a person of unsound mind is competent to contract, although he may avoid his contract if he satisfies the court that he was incapable of understanding the contract and the other party knew it. The contract is only voidable at his option and not void ab initio as in India. 2.4 LEGAL INCAPACITY Apart from the Indian Contract Act, there are certain other laws which impose partial or total restrictions on a person’s right to enter into a contract. Some of these laws are discussed below. 2.4 (A) OF NATURAL PERSONS The contractual capacity of natural persons is sometimes subjected to reasonable restrictions imposed by various laws of the land. In general, these restrictions apply to a person placed in special circumstances. Some of these laws which limit the contractual capacity of an individual are discussed below. 58
Insolvency Act An insolvent person cannot enter into any contract, especially into contracts relating to his property. In general, there is no prohibition against a contract by an insolvent after the insolvency proceedings have commenced but before adjudication. Insolvency does not determine a contract, nor per se operate as rescission thereof [Rama Raju v. Official Receiver, (1964)A.Ap.299]. Once a person has been adjudged an insolvent, his property vests in the Official Receiver. This vesting of property is for the benefit of the creditors and so does not purport to affect the transactions between the insolvent and other persons except in so far as they affect the administration of the insolvent’s estate for the benefit of the creditors. As far as the parties to the transaction are concerned the transaction is binding on them. Prison Laws In some countries, a convict cannot enter into a contract under the prison laws of that country. In India, there is no such prohibition imposed on the convicts. The Contract Act itself specifies in section 11 that, “Every person is competent to contract who is of the age of majority according to the law to which he is subject, and who is of sound mind, and is not disqualified from contracting by any law to which he is subject”. Thus, it is seen that there is no express bar on convicts entering into a contract. Despite this, certain limitations do come in the way of a convict wanting to contract. Every letter which he writes or every deed he executes is only with the express permission of the jailor and these documents are subject to the jailor’s scrutiny. Under these circumstances, the concept of ‘freedom of contract’ is negated as the convict is not free in the real sense of the word, to enter into any contract he wants, with whoever he wants to and on whatever terms and conditions which he wishes. His will (to contract) is subject to the jailor’s wish. Though no express bar is laid down on a convict entering into a contract, restrictions by implications are definitely imposed. Alien Enemy A person can enter into a contract with any person he wants to, regardless of whether the other party to the contract is a citizen of India or not. But this freedom of contract with aliens is available only during the times of peace. Once a war is declared, any contract between the citizens of the warring countries comes to an end. This provision is present (either through express statute or by means of judicial interpretation) in almost all the countries of the world. The embargo on contracts imposed during war time is as a matter of public policy, and it is felt that in the interest of the nation, an individual’s private right to ‘freedom of contract’ must be sacrificed. Once the war comes to an end, the freedom of contract is either restored (fully or partially) or completely suspended depending on the government’s policy. 2.4 (B) OF LEGAL PERSONS There are a number of bodies, organisations associations of persons, objects (ex: idols) etc. on which law throws a ‘cloak
of humanity’ and treats them as ‘persons’ for certain limited purposes. These artificially created persons are known as ‘legal or juristic persons’. The rights and liabilities to which these legal persons are subjected to are prescribed and proscribed by law itself. We would now consider the limits imposed on the contractual capacity of some of these legal persons.
the memorandums are formulated. What is now done is that the clause (ii) of the object clause is broadly phrased that it is able to cover almost any activity. Hence whatever activity is undertaken by the company can never be ultra vires as it is never beyond the objects and powers of the company.
COMPANIES
The term winding up of a company means the end of a company’s affairs and operations. All the assets of the company are sold and debts are paid out of the proceeds. If there is any surplus left it is divided among the different members of the company in proportion to the interest they hold in the company. Winding up may be one of the following kinds : (i) Compulsory winding up under the order of the court (Sec.433) (ii) Voluntary winding up by the members or creditors (sec.484) (3) Winding up subject to supervision of the court.
A company registered under the relevant company law assumes a separate legal personality distinct from the persons forming or running the company. In the guise of this legal personality a company can enter into a contract in its own name, and can sue or be sued on such contracts. But this power of the company to enter into a contract is not an absolute one but a restricted one. The restrictions on the contractual capacity of a company can be imposed through the ‘object clause’ of the memorandum or during the winding up procedure, as discussed below. Limitation through Memorandum A company can enter into a contract only within the scope and powers set out within its memorandum of association, or within such powers as are reasonably incidental to or consequential upon the operation that it is authorised to perform. Section 13 of the Companies Act provides that in the case of companies to be registered after 1965, the object clause must state separately: (a) Main objects - to be pursued by the company on its incorporation and objects incidental or ancillary to the attainment of main object. (b) Other objects - all other objects which have not been specifically stated in the above clause. If a company enters into a contract which is beyond its powers, then, such a contract is void ab initio as being ultra vires its powers. Such contracts cannot be validated even by the unanimous consent of all the shareholders of the company. This doctrine of ultra vires was firmly established in the case of Ashbury Railway Carriage Co. v. Riche [(1875)LR 7 HL 653]. Here, the objects of the company as stated in the memorandum was ‘to make, sell or lend on hire, railway carriages and wagons, and all kinds of railway plant, fittings, machinery and rolling stock; to carry on the business of mechanical engineers and general contractors; to purchase, lease and sell mines, minerals, land and buildings; to purchase and sell as merchants, timber, coal, metals or other materials and to buy and sell any such materials on commission or as agents. The directors of the company agreed to assign to a Belgian company a licence which they had bought for the construction of a railway line in Belgium. It was held that, as this agreement related to the construction of a railway, a subject matter not included in the memorandum, was ultra vires and that not even the subsequent assent of the whole body of shareholders could make it binding. Therefore, an action brought by the Belgian company to recover damages for breach of contract necessarily failed. At present, however, this doctrine of 'ultra vires’ has become practically obsolete, because of the ingenious manner in which
Limitations during winding up
Once a company goes in for winding up, the assets of the company are taken control of by the liquidator of the company appointed either by the court or by the company itself. The powers of the Board of Directors is terminated. No suit or legal proceeding pending against the company can be proceeded with after the order of winding up without the leave of the court. Any debts payable in future become immediately payable on the issue of the winding up order. The only contracts which can be entered into during this period are for the sale of the companies assets, or realization of debts etc., and only the liquidator of the company has the power to act on behalf of the company and he has to exercise this power in a manner which he feels would be in the best interest of all parties concerned. Idols It is a unique feature of Hindu law that when property is dedicated to ‘debutter’ it is not the dedicated property which is personified but it is the deity, the idol, the principal part of the endowment, which is personified as a legal person and it is the deity which stands as the material symbol and embodiment of the pious purpose of the ‘debutter’ to which the settlor intended. In 1888 West, J. observed in the case of Manohar v. Lakshmi [ILR 12 Bom 247] “Hindu law recognises not only corporate bodies with rights vested in the corporation apart from its individual members but also juridical subjects or persons called foundations": An idol as a juristic person embodies the following characteristics, viz: (a) since ownership in the primary sense connotes the capacity to enjoy and deal with property at one’s pleasure, a deity or idol cannot hold and enjoy property like a human being, the deity is not the owner of the dedicated property in the primary sense. (b) Ownership to the deity is attributed in the secondary and ideal sense. This is a fiction of law but not a mere figure of speech; it is a legal fiction - else the deity cannot be described as an owner even in the secondary sense. 59
(c) The fictitious ownership imputed to the deity is either based upon or conferred by the express intentions of the founder, that is to say, the dedicated property cannot be made use of for any purpose other than that which is indicated by the founder. (d) The actual possession and management of the debutter property, vests in a human agency who is variously called as the shebait, dharmakarta, or manager of the debutter. This manager has to use the property in accordance with
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the wishes of the founder. He can alienate or transfer the property only in the following two cases: (i) for legal necessity; and (ii) for the benefit of the endowment An alienation made for any other purpose is not binding and an alienee who does not make proper and bonafide inquiries is not protected. Such an alienation is voidable during the lifetime of the manager but becomes void on his death.
3. CONSIDERATION SUB TOPICS 3.1 Consideration: A definitional understanding 3.2 Why consideration? The theoretical base. 3.3 No consideration no Contract 3.4. Adequacy of consideration 3.5 Role of a third party in consideration 3.6 Past consideration 3.7 Promissory Estoppel 3.1 CONSIDERATION : A DEFINITIONAL UNDERSTANDING The English Common law of contract historically grew out of actions of 'debt' and 'assumpsit'. In the former the plaintiff could succeed only on the proof of a ‘quid pro quo’ and in the latter the plaintiff could succeed if he had undertaken some ‘charge’ i.e., suffered some detriment in reliance of the defendant’s promise. Thus grew a definition of consideration in Carrie v. Misa [(1875)LR 10 Ex 153 at p.162], “A valuable consideration, in the sense of the law, may consist either in some right, interest, profit or benefit accruing to the one party, or some forbearance, detriment, loss or responsibility given, suffered or undertaken by the other”. Thus the common law took a turn from the complete moral Roman Code of pacta sunt servanda. A word given must be performed. Consideration cannot be the reason for performing the contract. Carrie v. Misa assimilated the moral approach of Roman Code with utilitarian approach. The definition conceptualises both the aspects. As such, the nineteenth century moralists who attached obligation in the form of consideration, extended their logic of assumpsit by emphasising the idea of ‘detriment’ with which one buys the promise from the other party. On the other hand, the political economists emphasised the structure of ‘right’ acquired from the promise. It is argued that the basis of contract is mutual benefits for both the parties in relation to their earlier position. Consideration is ‘gain’ in absolute terms and, as such, through contract, social wealth of a country has to increase. American realists turned to the 'law merchant' to build up their theory of bargain and a definition of consideration accordingly. s71 of the Restatement (second) defined consideration as follows: (1) To constitute consideration, a performance or a return promise must be bargained for. (2) A performance or return promise is bargained for if it is sought by the promisor in exchange for his promise. (3) The performance may consist of: (a) an act other than a promise, or (b) a forbearance, or (c) the creation, modification, or destruction of a legal relation. (4) The performance or return promise may be given to the promisor or to some other person. It may be given by the promisee or by some other person”. The historical developments and needs of the early colonists in USA compelled the settlers to resort to more practical and universal ‘law merchants’ instead of the common law. As a
result, the overtone of the moralist obligation thesis did not cloud the American understanding of consideration as the basis of contract. In comparison, the ‘utilitarian’ approach to consideration in Indian law is quite understandably nearer to the American defintion. According to Sec. 2(d) of the Indian Contract Act consideration means, “when at the desire of the promisor, the promisee or anyother person (i) has done or abstained from doing, or (ii) does or abstains from doing, or (iii) promises to do or abstain from doing, something, such act, or abstinence or promise is called a consideration for the promise”. The Indian definition conforms to the two basic characteristics of consideration as enunciated by Lord Mansfield. According to him ‘consideration was only evidentiary’ and ‘that the existence of a previous moral obligation was sufficient’. The Indian definition emphasised the functional character of consideration in the form of ‘act, abstinence or promise’ and not the substance of it through ‘right, benefit or duty’. The nearness of the Indian definition to the American approach is evident; both are evidential, both are relationally direct and both are positive in character. But the American definition emphasised ‘bargain’ and the Indian definition still has the moralist code of ‘assumpsit’. As such, in Indian definiton, ‘the act, abstinence or promise’ is to be done ‘at the instance’ of the promisor. A positive legal structure requires a causal relation. Every contract must be based on consideration (i.e., the answer to the question why a person enters into a given contract). But a Common law culture asks for a moral base of human behaviour because the Common law tradition is built up on the citadel of canonical laws. Definition of a legal proposition is related to deeper theoretical understanding of the need for consideration. 3.2 WHY CONSIDERATION? : THE THEORETICAL BASE Contract is the legal means of enrichment with cause. Through contract individuals may increase their world of rights and duties. Through contracts a human being, as an economic rational entity, can possess, own, dispossess, disown and dispose of any economic substance, in exchange of what the economic entity indicates. This is the way in which economic activities originated and survived in the world. As such, in the economic and social relation the ‘means of exchange’ has become the focal point. According to Anson “at an early stage in the history of the action of assumpsit, there must have been some speculation as to whether all promises were binding, even if gratuitous, but the exact origin of consideration is by no means clear”. The first step out of the canonical code was taken by Lord Mansfield when he emphasised on the evidential exposition of a moral obligation in 1756. In 1778 Justice Skymer,E.B took a further positive step in Rann v. Hughes 61
[(1778), 4 Brown PC.27] requiring consideration in every contract. According to him “It is undoubtedly true that every man is by the law of nature bound to fulfil his engagements. It is equally true that the law of this country supplies no means nor affords any remedy, to compel the performance of an agreement made without sufficient consideration. Such an agreement is ‘nudum pactum ex quo non oritur actio; and whatsoever may be the sense of this maxim in the civil law, it is the last mentioned sense only that it is to be understood in our law .....”. It is really difficult to understand the subsistence of a contract without consideration in law of nature as understood by Western philosophers to be ‘reason which cannot be selfdestructive’. In fact in ‘debt’ the Roman Law prescribed ‘quid pro quo’ which fits well with consideration principle to subsist mercantile contracts. In fact contract is the legal base in attempting maximisation of utilities in a society. It is quite understandable that judges of a positive economic society would discover a satisfactory theory of consideration in order to submit contracts because consideration only can provide a positive legal base for the realm of contracts. For a few centuries British judges tried to continue with the moral base of ‘assumpsit’ but this had to be abandoned because the thesis could not provide the minimum political economic input necessary for a legal structure in a positive framework. Ultimately British judges come to the conclusion that ‘consideration is necessary for the formation of every single contract’. Professor Braucher of USA built up an alternative but complementary thesis to assumpsit. According to him, “the requirement that a promise or performance must be bargained for (emphasis added) benefits the community by providing opportunities for freedom of individual action and exercise of judgment and as a means by which productive energy and product are appropriated in the economy”. In USA this bargain theory is “the generally accepted idea of consideration”. This concpet of bargain is formulated in the application of practical reasoning in reality by O.W. Holmes. According to Holmes the “root of the whole matter is the relationship of conventional inducement, each for the other, between consideration and promise. Many sociologists attribute the historical reasons for the emphasis given to the bargain theory. In his History of American Law, Professor Lawrance Friedman suggested that the colonists brought considerably less of the Common law to America than is usually supposed. Instead, many turned to the bargain oriented customs and practices of the law merchant, which had not yet been fully absorbed in the Common law. Economic growth and sustenance was the conscious objective during the period in the land far away from the mother lands of the colonists. The contract as a bargain process was used as an important means to that end. According to R.E. Scott & D.L. Leslie (Contract: Law and Theory, p.33) “as an operating principle, the bargain theory of consideration (1) provided a natural formality to channel human conduct and ensure deliberation ; (2) protected and structured the important market 62
transaction; (3) extended legal protection by supporting the executory exchange, a promise for a promise, and shielding the creative or idiosyncratic bargainee from later claims that the agreed exchange was disproportionate ; and (4) permitted fully a development of remedies that protected the plaintiff’s expectation interest that is the value to the plaintiff of the agreed exchange”. In the common law explanation of consideration there is an approximation between the subjective moral base and objective ‘indebitous reliance’, and hence a confusion as well. As for example, English courts “will not ask whether the thing which forms the consideration does in fact benefit the promisee or a third party, or is of any substantial value to any one. It is enough that something is promised, done, forborne, or suffered by the party to whom the promise is made as consideration for the promise made to him” (Anson, p.63). The bargain theory does not have any such difficulties. It is in consonance with the natural instincts and behaviour of human being though apparently it looks only of limited import. As such, section 25 of the Indian Contract Act, stipulated the general Common law principle ‘an agreement without consideration is void’. But the definition of consideration in Sec. 2(d) of the Indian Contract Act, more appropriately fits with the bargain concept than the common law principle of assumpsit. According to the Indian definition, consideration is either an act, or promise or forbearance which provides subsistence to the promise given. Ancient Indian philosophy created a different structure or legal order based upon obligation. As such, even in a private relational affair, a social view would have been taken consistent with the moral code. The British rule had to ultimately introduce British Common law principles in India but in a codified form because the framers of Indian Codes were utilitarians and followers of Benthem. Besides a Code was necessary to protect the mercantile interest in India. 3.3 NO CONSIDERATION, NO CONTRACT In English Common law a contract can either be made under seal or for consideration. Seal is required only in the case of a gratuitous promise. The validity of the contract under seal is due to its form and the seal. The most important example of a contract under seal is a ‘Deed’. A deed is required to be in writing in a form and written or printed on specified paper or parchment. It is done between parties by being ‘signed, sealed and delivered’. The deed is written in contractual form in definite paper with stamps and the Court allows its seal to validate the document and the transaction. Initially a ceremony was attached to it but presently such ceremonies are matters of the past. The delivery may be conditional on the fulfilment of which the document is delivered. Gift or gratuitous payment to some charity are common examples of contract under seal. In India, the law of contract does not provide any special groups of contract to be allowed ‘under seal’. As such, according to Indian law, all contracts must have consideration. According to
Sec.25 of the Indian Contract Act, all agreements without consideration are void ab initio. Contracts with considerations may either be in writing or orally made. According to English Common law the following contracts are bound to be in writing according to statutes: (a) negotiable instruments; (b) marine insurance; (c) credit agreements like lease, hire purchase, loan agreements; (d) a bill of sale; (e) a guarantee agreement; and (f) sale or disposition of immovable properties under the Property Act. In these agreements the validity of the contract does not depend on the consideration but it depends upon the form in which the contract is to be made and allowed. In India, under the Stamp Act certain agreements must be put into writing and registered under the law in force and the written document must bear specified stamp duties. According to the Negotiable Instrument Act and the Stamp Act, all negotiable instruments must be in writing and adequately stamped. All contracts relating to transfer of property under the Transfer of Property Act must also be made in writing. The Insurance Act provides for all insurance agreements (indemnity contracts and life assurance) to be in writing and to be adequately stamped. Unlike English law, Indian law of Contract does not require a contract of guarantee to be in writing. In India, all contracts, whether in writing and registered or orally made, require consideration for its validity. Exceptions are specified in sec. 25 only as follows: (a) It is expressed in writing and registered under the law for the time being in force for the registration of documents, and is made on account of natural love and affection between parties standing in a near relation to each other. (b) It is a promise to compensate, wholly or in part, a person who has already voluntarily done something which the promisor was legally compellable to do. (c) It is a promise, made in writing and signed by the person to be charged therewith, or by his agents generally or specially authorised in that behalf, to pay wholly or in part a debt of which the creditor might have enforced payment but for the law for the limitation of suits. (d) According to sec.185 no consideration is necessary to create an agency. An agreement without consideration is void Beside the above four exceptions all agreements require consideration to be enforceable by law. A purely gratuitous promise has no legal force. A promise for donation is a gratuitous one and not enforceable. A mere moral duty to perform a promise given to a party does not constitute consideration [See, Goapal Co. Ltd v. Hazarilal Co. AIR 1963 MP 37]. In Kirksey v. Kirksey [8 Ala 131] the defendant wrote to his sister-in-law, the plaintiff - “If you come down and see me, I will let you have a place to
raise your family and I have more open land than I can tend, and on account of your situation and that of your family, I feel like I want you and the children to do well”. The plaintiff on those words left her home and moved her family to the residence of the defendant who gave her the house and the land only to request her to leave after two years. The court held that her leaving her place with her family was not a consideration against the defendant’s promise to give house and land. It was only a gratuitous promise and not binding. Sometime litigation arises on account of complicated questions of law as to what constitutes a forbearance worth being called a consideration. Can a cause of action to which there is a complete defence, be of any value in the eye of law? Suppose a man bargains for an amount in consideration of his abandonment of such a cause of action, is it a good consideration? It is not enrichment without any cause. On the otherhand, “if an intending litigant bona fide forbears a right to litigate a question of law or fact which it is not vexatious or frivolous to litigate, he does give up something of value”. It is already a settled principle that a duty which is created under a general law or by a specific obligation, a promise to discharge that duty cannot be a consideration. A person served with a subpoena is legally bound to attend and give evidence in a court of law, and a promise to compensate him for loss of time is void for want of consideration. Exception I : Natural Love and affection A promise made on the basis of natural love and affection is binding though there is no consideration provided the promise is (1) written and (2) registered under the law - the Registration Act. In Poonoo Bibee v. Fyez Buksh [(1874)15 B.L.R. App 5] a registered promise to give his earnings to his wife, was held to be written under Sec.25(1). In Rajlukhy Dubee v. Bhootnath [(1900)4 CWN 488], a hindu husband executed a registered deed in favour of his wife, whereby after refering to quarrels and disagreement between the parties, the husband agreed to pay for a separate residence and maintenance, and there was no consideration moving from the wife. The recitals of the promise made clearly show that the agreement was not based on natural love and affection. Hence the Calcutta High Court held the agreement void on account of absence of consideration. A, the husband, promises to give his property to his wife. The agreement is registered. This agreement is binding because, the promise is made between parties standing in a near relation to each other and obviously on the basis of natural love and affection. The formal requirement of the agreement being in writing and registered under the law in force is also fulfilled. Now suppose A proves that ‘B’ used to have a relation with C before marriage and was keeping the illicit connection even after marriage, A can certainly make a plea that the instrument is not valid because there is lack of natural love and affection. Natural love and affection is a two way traffic. As such, if it can be proved that the husband or the wife, as the case may be, is not faithful at the time of making the promise, the instrument is unenforceable. Such a promise must be made on the basis of natural love and affection between the parties. 63
The ‘nearness’ of relation is again a matter of contention. A blood or social relation is only a proof of near relation unless proved otherwise. ‘Nearness of relation’ and ‘natural love and affection’ both must co-exist in such types of agreements. Where the relation is ‘near’, natural love and affection can be presumed unless otherwise proved. It is not necessary that this nearness of relation is to be found only in blood or marital relation. A friend may be a near relation of a friend. Exception 2: Compensation for voluntary services This exception came out of the Common law principle of equity. The person who has ‘voluntarily done something’ which the promisor was ‘bound to do’, requires an equitable treatment for what he has done voluntarily. In Raja of Venkatagiri v. Sri Krishnayya [50 Bom. L.R. 517] X agreed to give his son in adoption, if Y agreed to advance money to defray the expenses of defending any suit challenging the adoption. There was a challenge to the adoption and Y advanced money towards the expenses incurred. After Y’s death his son advanced money to the adopted son against which the adopted son issued a promissory note on the assurance that if the adopted son fails to succeed in the Privy Council, the Note would not be enforced. When the adopted son succeeded in the Privy Council, demand was made against the Note. On the refusal of payment against the note, Y’s son filed a suit to realise the money against the loan. It was held that the promissory note did not have consideration and the payment by Y’s son was not voluntary but was paid due to the undertaking made by Y in the original contract. In Sindhia v. Abraham [(1895)20 Bom. 755] the court explained the necessary conditions as “where a person without the knowledge of the promisor or otherwise than at his request does the latter some service, and the promisor undertakes to recompense him for it”. Exception 3: Promise to pay time barred debt A barred debt is a good and valued consideration of a promise to pay the debt. But the debt must be valid and payable to the promisor in the absence of application of law of limitation. But a debt which is not binding on account of any reason of invalidity, even without application of law of limitation cannot be the basis of a promise validating a time barred debt. As such, a loan given to a minor cannot afterwards be promised to be paid on attaining majority. In such a case the debt does not subsist. A debt subsists even when its payment is not legally compellable due to application of the law of limitation. As such, a promise to pay such a debt is a good consideration. A christian son has no pious obligation. So a pro-note executed by the son for the debts due from the father is without consideration and void. In Tulsi Ram v. Some Singh [(1981)A.D. 165] it was held that two time barred pro-notes were endorsed stating those were valid for three years, shall not validate those notes under Sec.25(3). It requires specific promise to pay. In order to be within apply Sec. 25(3) the following conditions are required to be fulfilled :(i)
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there must be a debt which the creditor but for the application of law of limitation, could have enforced;
(ii)
there must be a clear promise to pay for the above debt; and
(iii) such a promise is required to be in writing signed by the debtor or his duly appointed agent. According to Sec.18 of the Limitation Act, an acknowledgement of the debt may also be a method of extending liability of the debtor after the limitation period. Similarly a promise under Sec. 25(3) also makes a barred debt binding. The difference between the two provisions is that the acknowledgement is required to be made in writing before the debt becomes barred by limitation. But a promise under Sec.25 (3) is required to be made in writing only after the debt becomes bad in law, on application of limitation. An unconditional acknowledgement is consistently held to imply a promise to pay for the purpose of Sec.19 of the law of limitation. But promise under Sec.25(3) is required to be clearly in writing; no implied promise is sufficient [Giridharilal v. Bishnuchand (1932)54 All 506]. Promise to pay a debt, clearly means an ascertained sum of money to be paid. Any promise to pay an unascertained sum, like a ‘promise to pay the amount that may be found due to the arbitrator’ is not a promise to pay a debt under Sec. 25(3). [Sheobachan v. Madhu Saran 1952 All 73] Another important issue is required to be kept in mind. A promise to pay a debt after an insolvent obtained his final discharge is not a promise of paying time barred debt. This promise of paying a debt after securing its discharge is a promise without consideration, and hence void [Naoraji v. Kazi Sidick (1896) 20 Bom 636]. Exception 4: Appointment of an agent According to Sec 185 of the Indian Contract Act, ‘no consideration is necessary to create an agency’. A Common law principle is that no consideration is necessary for reposing any authority on another person. But it is a very questionable proposition. A gratuitous employment or authority does not require the agent to do anything. Exception 5: Gift According to Explanation 1 to Sec. 25, a gift actually made is valid. Promise for a donation is not a gift. As such a promise for a donation is invalid for want of consideration. 3.4 ADEQUACY OF CONSIDERATION NEED CONSIDERATION BE ADEQUATE? According to Anson’s Law of Contract (p. 99) ‘consideration need not be adequate to the promise, but it must be of some value in the eye of law’. This basic principle of the common law system is different from the Roman Law of Sale. In the Continental system which is based on Roman Law, ‘the price had to be a fair and serious one’. If the price is not a fair one, the seller could rescind the contract unless the buyer was willing to come upto the fair price. The principle of Laesio enormis does not form part of Common Law. In Haigh v. Brooks [(1839) 10 A & E 309] the consideration of a promise to pay certain bills was the surrender of a document by way of a guarantee. The document turned out to be of doubtful validity. The Court held
that doubt on the worth of the document could not be a defence to an action on the promise. The Indian legal position is based on the Common law principle as provided in Explanation II of Sec. 25. According to the provision an agreement to which the consent of the promisor is freely given is not void merely because the consideration is inadequate. Of course the inadequacy of the consideration may be considered in determining the question of ‘free consent’. This Explanation II to Sec. 25 gives two general principles of the Common law: (a) consideration need not be adequate; and (b) inadequacy can be a ground to examine whether consent is free or not. In Grarely v. Barnard [(1874) 18 Eq. 518] it was observed that, the Court is not a valuer and it will not inquire into the adequacy of the consideration. It is enough, according to the Court, if the consideration has some value. In fact, according to Indian Law ‘abstaining or promising to abstain’ by the promisee is an adequate consideration for the promise. Though American law of contract is also based on the common law tradition, the bargain theory on consideration explains ‘assumpsit’ with more mercantile rationale than the customary moral explanation supplied by the Common law principle. Academicians in USA are ‘divided on the question whether nominal consideration should be sufficient to enforce a promise’. The conflict is quite vivid between two groups of academicians, one lead by Fuller and the other Havighurst. Fuller emphasised ‘form’ which relate to the manner in which the promise was made. According to him ‘form’ served three functions, viz., (1) evidentiary, (2) cautionary and (3) channeling. According to him, decision upholding nominal consideration is to be valid because it would seem to be that the desiderata underlying the use of formalities are here satisfied by the fact that the parties have taken the trouble to cast their transaction in the form of an exchange”. Here according to Fuller ‘form’ provides a means to give a ‘legally effective expression of intention’ [41 Colum L.R. 806]. Havighurst on the other hand, stated that courts usually do not enforce a contract for nominal consideration. According to him ‘if consideration is present as a natural element in the transaction, it suffices’. Havighurst argues ‘this does not suggest that the reasons for the requirements of consideration and of form are similar’. Fuller emphasises the argument of ‘private autonomy’ as the power to bring about changes in their legal relations. The court while enforcing the contract gives legal sanctions to rights and duties already established by the parties. Patterson on the otherhand refutes the argument. According to him ‘that a contract is binding upon a party because it expressed his will, is wholy inadequate because it does not explain why he may not will today the exact opposite of what he willed yesterday”. Intent of the party is not sufficient to enforce a contract. The Court has to look for something more. There must be a satisfactory answer to the question, why should promises be enforced? This question is a part of the wider issue
'why should public institutions like, courts, indulge in the area of private relations?' Private parties are free to create alternative arrangements themselves. Cohen tries to conceptualise the various possible answers. According to him, “The simplest answer is that of the institutionists, namely, that promises are sacred per se, that there is something inherently despisable about not keeping a promise, and that a properly organised society should not tolerate this .....”. But such an answer seems to him inadequate though it may have certain truth. Cohen argued “No legal system does or can attempt to enforce all promises. Not even the Canon law held all promises to be sacred and when we come to draw a distinction between those promises which should be and those which should not be enforced, the institutionist theory, that all promises should be kept, gives us no light or guiding principle [46 Harv. L. Rev. 572-74]. A nominal promise for illustrative purpose is put in an American Law Review thus : A wishes to make a binding promise to his son B to convey to B blackacre, which is worth $ 5000. Being advised that a gratuitous promise is not binding, A writes to B an offer to sell Blackacre for $ 1. B accepts. B’s promise to pay $ 1 is sufficient consideration. This is Common law “Blackacre - for - a - dollar hypothetical”. As a strategy to avoid the delivery requirements of gift law, the purpose of nominal consideration is understandable. But a modern lawyer is not satisfied with such a contradictory of moral fabric. It is for this reason the Court is rendering a decision on the enforceability of a promise; it should advance some `social interest’ which conforms to the ethical standard of that society’ (Murphy et al, 347). Havighurst explained that in the absence of a satisfactory standard an attempt was made by Common law courts to argue `indebitous reliance’. According to him these explanations ultimately weakened ethical norms. There is a lack of case law on the validation of nominal consideration. But the debate on the question of ‘adequacy of consideration’ is still very strong in USA. The two opposite opinions are quite visible, one arguing the traditional ‘assumpsit’ principle which relies on evidentiary, cautionary and channeling arguments; the other arguing ‘invalidity of institutionalism because of weakness in the arguments. The 'bargain' theory of consideration calls for adequacy of consideration; a nominal consideration is invalid on this logic. In India the law is made abundantly clear by the explanation II of Sec. 25 which suggested that merely for inadequacy, a consideration is not invalid. But inadequate consideration can be argued in cases of absence of free consent. On account of validation of promises without consideration in Sec. 25(1) the contradictory moral argument of ‘blackacre-a-dollar’ does not arise in India. In a situation of bargain, inadequacy of consideration or a very high consideration can be questioned on the ground of absence of free consent. As such, if the price is extra ordinarily high, it can be a ground of restrictive trade practice. Similarly too low a price given by the creditor to the share cropper is an undue influence or unconsionable gain. 65
CONSIDERATION MUST BE REAL According to the Common law principle consideration may not be adequate but must be real. It means that the consideration must be ‘something which is of some value' in the eye of law in different ways. ‘It is enough that something is promised, done, foreborne or suffered by the party to whom the promise made to him’. In general, a waiver of any legal right at the request of another party is a sufficient consideration for a promise’. In Hamer v. Sideray [124 NY 538] the promise of the uncle to give $ 5000 to the nephew if he refrains from drinking, using tobacco and playing cards or billiards for money until he becomes 21 is questioned after the death of the uncle. The court held that surrender of a right though it is beneficial to the promisee himself, is a sufficient consideration. Consideration must not be confused with motive. According to Anson ‘consideration must be given in return for the promise; but the motive of the promisor must be to obtain a legally recognizable return for the obligation incurred’. An act impossible in itself cannot be a valid consideration. As for example, ‘a covenant in a charter party that a ship would sail on a date which was already past at the time of contract was held to be void of unreality of consideration furnished’ (see Anson p.102). Too vague a consideration is also not permissible. An agreement to reserve a passage to moon in a possible flight is invalid because according to the state of knowledge of the day, the consideration is absurd. According to the definition of consideration in sec.2(d), an abstinence (forbearance) is also a good consideration. As such, a promise to forbear a suit on claim, even for a shorter time, can be a valid consideration, at the desire of the promisor. Compromise is a very common transaction in which sometimes consideration may apparently seem to be doubtful. As for example, a cause of action not yet decided either way may be only a probability. Sometimes the level of probability may also be very low, if there is any. In such a case can there be a valid consideration? Is it ‘not really getting something out of nothing?’ The answer to this question is “that abstaining or promising to abstain from doing anything which one would otherwise be lawfully free to do or not to do is a good consideration”. Every man who honestly thinks he has a claim deserving to be examined, and brings that before the proper court, can also forbear to continue the litigation as a consideration for a promise of compromise. ACCEPTING LESSOR AMOUNT AS CONSIDERATION Though consideration may not be adequate and the Common law court does not enter into the question of valuation of consideration, a part performance against the promise to accept as full satisfaction, is not a sufficient consideration to support the promise. The promisor can nevertheless insist subsequently to perform the contract in entirety. This is established in the Primel case (Anson, 111). Primel brought an action on a bond against Cole for payment of £ 8-10s. Cole pleaded that on the Primel promise of treating the payment in full and final payment against the same debt, he paid £ 5, 2s 2d. The court held the 66
following promise of part performance to be treated as full performance was no satisfaction. The creditor has the right to enforce the full payment. But the Court held that the creditor could have accepted in full satisfaction ‘gift of a horse, hawk or robe’. The possible explanation is that the utility of the horse, hawk or robe could be more beneficial to the creditor than the money in respect of some circumstances. In Vanbergan v. St Edmund’s Properties Ltd [(1933) 2 KB 223] it was stated that a new element cannot be introduced merely to oblige the debtor and without any independent benefit to the creditor. It may be noted that the common law courts continuously went on deciding on debt cases against the interest of the debtor. A promise not to sue if the principal amount is paid does not preclude the creditor to subsequently claim the interest because the promise does not have any corresponding benefit/interest to the creditor. While explaining this principle, Jessel M.R. observed in Couldery v. Bartrum [(1881)19 Ch.D 394] that “a creditor might accept anything in satisfaction of his debt except a less amount of money. He might take a horse ..... but ..... he could not take 19s 6d in the pound”. The rigidity of the rule that a gratuitous promise is not enforceable for want of consideration and that a part payment cannot be accepted in full satisfaction of the debt led to the equitable principle of promissory estoppel in the twentieth century in clear terms. 3.5 THIRD PARTY’S ROLE IN CONSIDERATION Two basic principles determine the position of a third party in a contract, viz., (i) Consideration must move from the promisee; and (ii) Two persons cannot impose a liability on a third party by their contract. These two principles must not be confused. The first principle is based upon the general principle of consideration and the second upon the privity of contract. But both these principles speak about the place of interest of the third party in a contractual framework. (i) Consideration must move from the promisee: According to Anson’s Law of Contract, (p.77) “a party who wishes to enforce a contract must be able to show that he himself furnished consideration for the promise of the other party”. In Tweddle v. Atkinson [(1861)1B & S.393] H and W married. After the marriage X and Y their respective fathers promised that each would pay a sum of money to H and that H should have power to sue for the sums. After the deaths of X and Y, H sued the executors of Y for the money promised. It was held that no action would lie because no consideration has moved from H the promisee, and so the promise was gratuitous to him. Though the consideration must move from the promisee, it need not necessarily flow to the promisor. As such a guarantor becomes liable to pay as soon as the bank advances the money to the principal debtor. Though essence of consideration is ‘the detriment suffered by the promisee’ but the promisee may confer a benefit to the promisor without having suffered any
detriment. In Boltan v. Madden [(1873)L.R 9 Q.B.55] the plaintiff and defendant were subscribers to a charity and entitled to vote on the disposition of its funds. The plaintiff promised to vote at one meeting for a person whom the defendant wished to benefit for a similar reciprocal promise by the defendant. In an action to enforce defendants’ promise it was argued that there was no consideration for the promisee as the plaintiff had ‘incurred neither trouble nor was he prejudiced’. The Court rejected the plea on the ground that the ‘consideration moved from the plaintiff simply because he had at the defendant’s request conferred benefit at a third party’. In India according to Sec 2(d) consideration may move from the promisee or any other person at the instance of the promisor. One may notice the imprint of the principle laid down in Dulton v. Poole [(1688)2 Lev 210]. In this case, a father was about to fell timbers on his estate so as to provide a marriage portion for his daughter. The eldest son at that time assured the amount to be paid to her. On this promise the father did not proceed with the cutting of timbers on his estate. On the death of the father, the estate with timbers descended to the eldest son. But the eldest son now refused to pay the promised amount to his sister on the plea that no consideration had moved from her. It was held in this case that the daughter could maintain an action because “having regard to the near relationship between the plaintiff (daughter) and the party from whom the consideration moved (father), the plaintiff might be considered a party to the consideration. That is to say, a stranger to the consideration could, by construction of law, be regarded as a party to it, if he was closely related to the person from whom the consideration actually proceeded”. In Tweddle v. Atkinson, this principle was overruled. But according to Indian Law, the rule in Dulton v. Poole is quite evidently covered. At the instance of the promisor consideration may move from a third party. As such the `forbearance’ of the fahter could be justified consideration of the son’s promise to his sister. The principle laid down in Tweddle v. Atkinson that third party cannot sue on a contract is a confirmed common law principle in England which was followed later on in several cases like Dunlop Pneumatic Tyre Co. Ltd v. Selfridge & Co. [1915 AC 847] and Scruttons Ltd v. Midland Silicones Ltd [1962 AC 446]. One can of course distinguish Dulton and Twiddle. In Dulton the felling of timber was to provide ‘marriage portion’ for the daughter. As such father’s forbearing to do’ this was in fact an injury to the daughter against which the son promised to pay the amount. In Tweddle the son-in-law did not offer any other benefit against the promise of the father-in-law. The promise of the father-in-law was obtained against the promise of the father. In India, of course, Common Law is not applicable because of the clear provision of the Contract Act in Sec.2(d). In Chinmaya v. Ramayya [(1881)4 Mad 137] A by a deed of gift, made over certain property to her daughter with a direction that the daughter should pay an annuity to her uncle, A’s brother. The daughter’s refusal to pay after A’s death on the plea that no consideration moved from the uncle, was not accepted by the Court. It was held that consideration indirectly moved from
the brother. Privy Council refused to apply the Common Law in promises connected with marriage under Muslim Law. In Khwaja Muhammad v. Husaini Begum [(1890)37 1A 152] the father-inlaw promised to pay the bride Rs.500 for her ‘betel-leaf expenses’ (Kharcha-i-pandan) every month in perpetuity from the date of marriage. She used to live with her husband till 1896 when she left the husband’s family and started living separately in Muradabad. The payment was stopped. The Privy Council noted that the ‘betel-box expenses’ as a promise of personal expenses of the bride was customary practice amongst Mohamedan families. The Privy Council affirmed the decision of the High Court holding that she had a clear right to sue under the agreement. In Narayani Devi v. Tagore Commercial Cooperation Ltd [AIR 1973 Cal 401] Calcutta High Court, of course, made a cautionary remark. It was stated that “even though under the contract Act the definition of consideration is wider than in English law, yet the Common law principle is generally applicable in India with effect that only a party to the contract is entitled to enforce the same”. This is in fact more a ‘concept of privity’ than that ‘a consideration to be moved from the promisee’. (ii) Privity of Contract: Two persons cannot by any contract impose liability upon a third party. In Dunlop Pneumatic Tyre Co Ltd v. Selfridge & Co Ltd [(1915)AC 847] the plaintiff sold a number of their tyres to Dew & Co on terms that Dew & Co would not re-sell them below certain scheduled prices and that, in the event of a sale to trade customers, they would extract from the latter a similar undertaking. Dew & Co sold the tyres to Selfridge & Co, who, by their contract with Dew, undertook to observe the restriction and to pay to M/S Dunlop the sum of £ 5 for each tyre sold in breach of this agreement. Selfridge infact sold two tyres to its customers at a lower price. Dunlop brought an action against Selfridge for recovering two sums of £ 5 each as liquidated damages. It was held that there was no privity of contract between the plaintiff and the defendant. The plaintiff cannot claim any enforceable right in the absence of any contractual relation between them. This principle of privity of contract is still binding. Of course according to the 'Resale Prices Act 1964' in England, there has to be compulsory registration by a supplier of goods of ‘any scheme which imposes resale price maintenance, i.e., fixed or minimum prices to be charged on the resale of the goods, and for the examination of the scheme by the Restrictive Practices Court’. The doctrine of privity means that a third party cannot acquire rights or be subjected to a liability under a contract to which he is not a party. A rigid application of the rule may create many legal and equitable dilemmas. As for example in Shanklin Pier v. Detel Products Ltd [(1951) 2 KB 854] the plaintiff employed contractors to paint a pier and instructed them for his purpose to buy and use paint manufactured by the defendants. The instruction was given in reliance on the representation made by the defendants to the plaintiff that the paint would last for at least seven years. The contractor purchased the paint from the defendant and used it. In fact, it only remained for a few months. 67
The plaintiff sued for damages and the defendant’s plea was absence of privity. In this case the Court applied the logic of collateral agreement between the plaintiff and the defendant. Same logic is applied in case of guarantee given by the manufacturer, hire purchase agreement, agency contract, and corporate agreements. Similarly in the following situations the privity of contract is not applied. (a) Contract relating to land : It was held in Tulk v. Moxhay [(1848)2 Ph.774) that if a restrictive convenant is attached to a land by its freehold owner, the convenant would bind all subsequent owners. In fact, in land contracts, the convenant attached to the land shall go with the land. No buyer subsequently could plea that in so far as he is concerned, there is no privity of contract. (b) Charter party contracts: In Stratheonia Steamship Co. Ltd v. Dominian Coal Co. Ltd [(1926) AC 108] the respondents had a long term time charter-party of a ship. The owners sold the ship which eventually came in the hand of the appellants. They did not honour the agreement and took a plea that there was no privity of contract between them. It was held that the decision of the Courts in Nova Scotia granting the respondents an injunction to restrain acts inconsistent with the charter party should be affirmed. “Where a man .... acquired a property from another, with knowledge of previous contract, lawfully and for valuable consideration made by him with a third person .... the acquirer shall not ..... use and employ the property in a manner not allowable to the giver or seller”, Lord Bruce held. But the principle decided in Stratheonia has a limited application. It only applies `where there is actual knowledge of the subsequent purchaser at the time of purchase of the Charter’s rights. Charter’s right is to be ensured only by way of injunction and not by way of specific performance. (c) Accrued benefit to third party : Inspite of Lord Denning’s view that privity of contract was only a procedural plea which could be overcome ‘if the third party joins the promisee as a party to the action’, the House of Lords confirmed the rule that no stranger to the contract could sue, unless it is qualified by equity principle. [Beswick v. Beswick (1968) AC 58]. In this case Peter Beswick, owner of a small business, wishing to retire, transferred the business to his nephew, who would pay an annunity of £ 5 a week to Beswick's widow. After his death the nephew failed to honour the condition. The widow brought an action against him in her personal capacity as a beneficiary and also in her capacity as administrator of her deceased husband’s estate. The House of Lords held that although she was not entitled to enforce the obligation in her personal capacity since she was a stranger to the contract, she could, as personal representative of her husband, obtain specific performance of the promise. Of course, specific performance, as a remedy, has limited application. It is allowed only when damages are inadequate to compensate the loss. (iv) Trust : The promisee may “create a trust of the right either at the time when he enters into a contract or thereafter, to which he is entitled in favour of a third party (see 15 Harvard Law Review, p.767). This right is enforceable in equity. In Re Flarell 68
[(1883)25 Ch.D 89] partnership articles provided that, in the event of the death of one of the partners, his widow should be entitled to the payment of an annuity out of the firm’s net profits each year. It was held that the executors of the deceased partner were trustees for the widow under the contract and that she was entitled to be paid the promised sum. (v) Third party insurance : Contract of insurance made for the benefit of third party is valid if a trust is created. Of course, this is now enforced under statutory laws. (vi) Commercial practice : Banker’s irrevocable credit facilitates finance contracts for the sale of goods and under commercial banking practices are binding. Similarly under commercial practice, negotiable instrument bind the promisor to all subsequent holders and holder-in-due course. The principle of privity of contract has been severly criticised. In USA's law of Contract, 'privity of contract' is not relied on as an important principle though the basic feature of contract that parties to the contract create laws and obligations for themselves, is still a valid proposition in an open economy. A rigid application of this principle may create many misgivings in rational application of law. As for example, what is the liability of the manufacturer for his products; what is the responsibility of a trustee; what legal duty should a mercantile agent perform and what is his responsibility ? In course of time, we invented product liability, equitable duty of a trustee or application of estoppel in merchantile agreements. All these legal principles are indirect derivation from the privity of contract, some in the positive way and some in the negative. According to Anson ‘abolition (of the principles of privity) is desirable because it is doubtful whether the doctrine serves any useful function whatsoever’. This is a practical solution of the problem of third parties having interest in a contract, but it does not negative the basic logic in the law of contract. Contract cannot be a weapon to affix liability on a third party. To this extent privity of contract has a decisive role. In case of conferring right, a third party may be included as a ‘necessary party’ in the contract in equity. That will solve the problem of third parties. 3.6 PAST CONSIDERATION Another age-old Common law principle on consideration is that ‘consideration must not be past’. Anson explained this principle thus : “if A saves B from drowning, and B later promises A a reward, A cannot rely on his action as consideration for B’s promise for it is past in point of time”. A past consideration does not create any legal relation and as such, parties are not bound by the promise. It is like a promise without a consideration. But past consideration must not be confused with executed consideration. Consideration may be executory in nature, i.e., it is a promise for a promise. But in the case of an act for a promise, the consideration has to be executed. Suppose A promises to draw a picture of B’s wife for which B promises to pay him a sum of money. It is a promise
for a promise. The promise of paying the sum is the consideration on A’s promise of drawing the picture.
In Anson’s Law of Contract (pp.114-115) two criticisms are levied against the principle of promissory estoppel, viz.,
But suppose A declares a reward for finding his lost dog, one can accept the promise only by finding the lost dog. As such, here the consideration has to be executed in order to make the promise a contract. An executed consideration, therefore, is a valid consideration. An act done earlier or a forbearance made on an earlier occasion cannot be turned into a consideration for a promise made afterwards. There are only three exceptions to this rule; viz., (a) acts done at the instance of the promisor may be made a supportive consideration for a future promise. As for example, X requests Y to secure a pardon for him from the President. Suppose in doing so Y meets certain expenses upto Rs.10,000/- for the trouble. This is a valid consideration [See Astley Industrial Trust Ltd. v. Grimston Electric Tools Ltd. [(1965) 109 SJ 149]. Similarly a journey undertaken by the plaintiff at the request of the defendant on which defendant promises to pay an amount, is a valid contract though the consideration is past. In India sec.25(2) is based on this principle, though it is shown as a contract valid without consideration. (b) A time barred debt may validly form consideration of a promise to pay the debt. In India sec.25(3) provides the same principle but as if such a promise is without any consideration. (c) A negotiable instrument in the form of a bill may be valid if it is drawn on the basis of an antecedent debt or a consideration sufficient to support a simple contract. For example, if A negotiates a cheque to his banker with which A has an overdraft, the banker becomes a holder for value of the cheque, as the debt of A to the bank is the consideration for the instrument.
(a)
that it violated the rule laid down by the House of Lords in Jordan v. Money [(1854) HLC 185] which stipulated that only a representation of existing or past fact, and not one relating to future conduct, will ground as estoppel.
(b)
that the dictum of Denning was inconsistent with the decision of the House of Lords. Lord Cair described the principle thus “it is the first principle upon which all courts of Equity proceed, that if parties who have entered into definite and distinct terms involving certain legal results - certain penalties or legal forfeiture - after by their own acts or with their own consent enter upon a course of negotiation which has the effect of leading one of the parties to suppose that the strict rights arising under the contract will not be enforced”.
3.7 PROMISSORY ESTOPPEL Justice Denning applied this principle in Central London Property Trust Ltd v. High Trees House Ltd [(1947) KB 130]. The plaintiff company let a block of flats to the defendant company for a nintynine years’ term at a rent of £ 2500 per year. In 1940, during the war time, the plaintiff found letting out of the flats very difficult and the plaintiff company agreed to reduce the rent to £ 1250 p.a. In 1945 after the war was over, the situation changed and flats were rented out in full. A receiver for the debenture holders of the plaintiff company brought an action claiming full original rent for the future starting from last two quarters of 1945. Justice Denning held that the action of the plaintiff should succeed. But the ‘most interesting part of the judgment lies in his contention that, had the plaintiff sued for the full rent between 1940 to 1945, they would have been estopped by their promise from asserting their strict legal right to demand payment in full’. A conventional Common law court could have applied here the old Primel rule. This how Justice Denning introduced Promissory estoppel. Of course Justice Denning’s decision attracted much criticism.
Accordingly, promissory estoppel is to be applied according to the above two cases, only in representation to existing or past facts. In order to apply it, the estoppel must be specifically pleaded between parties who stand together in a contractual or other similar legal relationship when one of them makes to the other a promise to waive, suspend or modify his strict legal rights. Subsequently in a number of cases estoppel was applied. Anson’s Law of Contract explains five principles (pp.115-121) for the application of promissory estoppel. (i) The promise must be clear and unequivocal. No estoppel can arise if the language of the promise is indefinite or not precise [See Woodhouse (1972) AC 741] (ii) It only applies to the modification or discharge of the existing obligation, and not to the formation of a new contract. Lord Denning puts the principle thus: “Seeing that the principle never stands alone as giving a cause of action in itself, it can never do away with the necessity of consideration when that is an essential part of the cause of action. The doctrine of consideration is too firmly fixed to be overthrown by a side-wind”. It is a `shield and not a sword’. (iii) It must be inequitable for the promisor to go back on his promise and insist on his strict legal right. In D & C Builders v. Rees [(1966)2 Q.B. 617] the defendant owed £ 482 to the plaintiffs, a small firm of builders, in respect of work done for him. He delayed payment for several months, and then offered them £ 300, stating in effect that if they did not accept this sum they would get nothing. As the plaintiffs were in desperate financial straits, they accepted the £ 300 in full settlement of the debt. They then sued the defendant for the balance. Lord Denning took the view that in the situation it was not inequitable for the plaintiff to go back on their promise; the settlement was not truely voluntary. (iv) The promisee must have ‘altered his position’ in reliance on the promise made to him [McCathie v. McCathie (1971) N.Z.L.R. 1126]. It must be shown that the person 69
to whom the representation is made, acted to his detriment in reliance on it. It means if the promise is allowed to be revoked or not applied, then the promisee shall be in distinct disadvantage because the promisee has already been prejudiced. (v)
Promissory Estoppel only serves to suspend, and not wholly to extinguish the existing obligation; the promisor may, on giving due notice, resume the right which he has waived and revert to the original terms of contract.
Pomeroy in his ‘A Treatise on Equity Jurisprudence’ (5th Ed; p.180) explained promissory estoppel thus : The vital principle [of equitable estoppel] is that he who by his language or conduct leads another to do what he would not otherwise have done, shall not subject such person to loss or injury by disappointing the expectation upon which he acted”. Similarly in Dickerson v. Colgrove [100 US 578] the judge defined it as “a promise which the promisor should reasonably expect to induce action or forbearance of a definite and substantial character on the part of the promisee and which does induce such action or forbearance is binding if injustice can be avoided only by enforcement of the promise”. Equitable estoppel thus arises from the conduct of the party. In Kedarnath v. Gorie Mohamed [ILR 14 Cal 64 (1887)] the defendant signed his name in the subscription book agreeing to subscribe Rupees hundred towards construction of Howrah
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Municipal Town Hall. Based upon those promises the plan was approved and the contract was given. On his refusal to pay the plaintiff appellant filed a petition with the Small Causes Court. The Small causes Court held the promise to be without consideration, and hence void. On appeal the judge held that the promise in effect could stand as follows: “In consideration of your agreeing to enter into a contract to collect the money to pay up for it”. It was held to be a good contract with consideration. The best reason to decide the case perhaps would be application of promissory estoppel. Since the plaintiffappellant undertook the liability to pay for the construction based on the promise of the subscribers, they are bound to pay for it. But had the liability not been undertaken in placing the contract with the contractor, the promise of donation would be rightly without consideration, and hence void. In Mckeon v. City of Council Bluffs (206 lowa 556) it was held that estoppel can never arise unless there has been reliance. In USA charitable subscription is held binding on public policy argument in many cases without requiring the showing of consideration or a detrimental reliance. In Salsbury v. Northwestern Bell Telephone Co. [(1994) 221 N.W. 609] it was held that ‘charitable subscriptions often serve the public interest by making possible projects which otherwise could never come about ..... However, where a subscription is unequivocal the pledger should be made to keep his word”.
4. CASE LAW Chinnaya v. Venkataramaya, [ILR 4 Mad 137 (1881)] An old lady, gave as gift certain lands to her daughter (the defendant in this case). One of the terms of the registered gift deed was, that, an annuity of Rs.653 should be paid every year to the plaintiff, who was the old lady’s sister. The defendant on the same day executed an ‘Iqrarnama’ in favour of the plaintiff, promising to give effect to the stipulation. The annuity was however not paid, and the plaintiff sued to recover it. Here, the only consideration for the defendant’s promise to pay the annuity was the gift of certain lands by the old lady to the defendant. So, the defendant contended that the plaintiff had furnished no consideration. It was held that, the failure to keep the promise would deprive the plaintiff of an amount which she was already receiving, and it is a legal common parlance that if a promise causes some loss to the promisee, that is sufficient consideration for the promise. Thus, the plaintiff had given a consideration, and was hence entitled to the annuity. Cowern v. Nield, [1911-13 All ER Rep 425] A minor was carrying on business as a hay and straw merchant. He received a cheque from the plaintiff for the supply of clover and hay. He delivered the clover which was rejected as bad, and, he failed to deliver the hay. The plaintiff’s action for recovering back the amount of cheque failed. It was held that, contracts which can be brought within certain categories and are also for the benefit of the infant can be supported. A trading contract does not come within any of these categories. The only contracts of an infant which can be enforced are those relating to the infant’s person, as contracts by which he provides himself with clothes, food or lodging or contracts of marriage, apprenticeship and service. Dunlop Pnuematic Tyre Co. Ltd v. Selfridge & Co. Ltd, [(1915) A.C. 847] The plaintiffs sold a number of tyres to one D, on the condition that D will not sell them below the scheduled price. D in turn sold the tyres to the defendants on the same condition, and further said that they would have to pay M/s Dunlop £ 5 for each tyre sold below the scheduled price. The defendants sold 2 tyres below the price, and the plaintiff filed (this) suit to recover £ 10 as damages and also asked for an injunction to restrain the defendants from further breach of agreement. The main issue was, could Dunlop sue the defendants, though they had furnished no consideration for the defendant’s promise. It was held that, under English Law certain principles are fundamental, viz : (1) only a person who is a party to the contract can sue on it; (2) if a person, with whom a contract not under seal has been made is to be able to enforce it, consideration must have been given by him to the promisor or to some other person at the promisor’s request ; and (3) a principal not named in the contract may sue upon it if the promisee really contracted
as his agent and not on his own. Here, D was acting on his own, in his capacity as a principal, he agreed to give the defendants a discount on his own, and Dunlop’s were in no way involved in the contract between D and the defendants. Hence, the plaintiffs were held not entitled to sue on the contract. Kedarnath Bhattacharjee v. Gorie Mohammed, [ILR 14 Cal 64(1887)] A town hall was proposed to be constructed at Howrah, provided sufficient funds could be generated. The municipality set about the task by public subscription. The defendant signed his name in the subscription book promising Rs.100/-. On the faith of the promised subscriptions, the plaintiff entered into a contract with a contractor for the purpose of building the hall. The defendant failed to pay the amount. His main contention was that there was no consideration for his promise. He was held liable for the amount. It was held that, the promise was, ‘In consideration of your agreeing to enter into a contract to erect, I undertake to supply money for it’. Plaintiff’s entering into contract with the contractor was entered into at the desire of the defendant (the promisor) so as to constitute consideration u/s.2(d) of the Act. Lampleigh v. Brathwait, [80 ER 255] The defendant, having committed a murder, requested the plaintiff to labour and to do his endeavour to obtain pardon from the King. The plaintiff did his best to obtain the King’s pardon, riding and journeying at his own expense. Afterwards the defendant promised the plaintiff to give £ 100 and then refused to pay. He was however held liable. The court observed: “A mere voluntary courtsey will not have consideration to uphold as assumpsit. But if the courtsey were moved by a request of the party that gives the promise, it will bind, for the promise, though it follows, yet it is not naked, but it couples with the suit before”. Note : ‘Assumpsit’ is a form of action (now abolished) from which the law of contracts originated. M. Ramiah v. Sankaranarayana, [AIR 1958 Ker 246] Three depositors of a bank refrained from demanding payment of their deposits, although they had matured and become payable, as the director of the bank had given them a written agreement, undertaking personal liability to return the amount with interest at 6% within 12 months. This forbearance to withdraw the amount press for its repayment was held to be sufficient consideration for the agreement within the meaning of sec.2(d). Mohori Bibee v. Dharmodas Ghose, [PC(1903)30 IA 114] The respondent, a minor, had mortgaged his house in favour of the plaintiff, a money-lender, to secure a loan of Rs.20,000. A part of this amount was actually advanced to him while considering the proposed advance, the money lender’s attorney 71
received information that the defendant was still a minor. Subsequently, the minor instituted this suit, stating that he was under-age when he executed the mortgage, and the same should, therefore be cancelled. The plaintiff contended that: (1) as the respondent had fraudulently misrepresented his age, the mortgage should not be cancelled; and (2) even if it was cancelled, the respondent should be compelled to repay the advance paid to him. The Privy Council granted the cancellation of mortgage under sec.39 of the Specific Relief Act, 1877. They further held that restitution of any benefit accruing under a contract, arose only in case of voidable contracts, and, not to contracts void ab initio. Hence, the money lender was held not entitled to return of the advance paid to the minor. Smith et al v. River Douglas Catchment Board, [(1949)All ER 179] The defendants had agreed with certain land owers adjoining a stream, to improve the banks of the stream and to maintain them in good condition. The land lords on their part paid proportionate costs. Subsequently, one of the land lords sold his land to the first plaintiff, who in turn sold it to the second plaintiff. There
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was negligence on the part of the Board in maintaining the banks, which burst and the land was flooded. Both the plaintiffs were strangers to the agreement with the Board, but even so the Court of Appeal allowed them to sue the Board for breach of contract, for the whole arrangement was for the benefit of the land owners whoever they might be and not merely the parties to the agreement. Tweddle v. Atkinson, [(1861),1 B & S. 393] The plaintiff was to marry the daughter of one G, and in consideration of this intendend marriage, G and the plaintiff’s father, entered into a written agreement, whereby each one of them agreed to pay certain sums of money to the plaintiff, before 21-8-1855. This agreement was ratified by the plaintiff and his wife. As neither G nor his executor had paid the agreed sum, plaintiff filed the suit to recover the amount. The main issue was, could a stranger to the consideration of contract sue a party to the contract? It was held that, consideration must move from the party entitled to sue upon the contract. A person cannot be a party to the contract for the purpose of suing upon it for his own advantage and not be a party to it for the purpose of being sued. Hence the action was held not maintainable.
5. PROBLEMS 1. Raj had given a promissory note for money his father had lent him. When sued on the note by his father’s executor he pleaded that he had just grounds to complain about his father’s distribution of property among his children; and that his father, admitting this, had promised that if Raj stopped complaining he would discharge Raj from his liability on the promissory note. Discuss the validity of Raj’s contention. 2. Mrs. Menon deserted her husband on 24.1.52 and on 26.4.52, they both signed a maintenance agreement having the following three clauses : (i)Mrs.Menon will be paid Rs.500/- pm so long as she continued to lead a chaste life ; (ii) she would support herself out of this sum and further indemnify her husband against any debts which may be incurred by her in future; (iii) she shall not commence/ prosecute her husband under any matrimonial proceedings (except for dissolution of marriage) so long as he was regular in his payments, but if failed to pay her the maintenance regularly she was entitled to pursue any remedy available to her. In October 1955 the divorce was made absolute. In this proceeding she also claimed for maintenance @ Rs.500/pm for the period between September 54 (when he stopped paying) to October 55. The husband disputes the claim on the ground that there was no consideration for his promise. Clause (ii) he says is worthless and (iii) unenforceable. Decide. 3. A the commander of a ship ‘Jalrani’ promised to pay his seamen an additional amount of Rs.1000/- each, if they would do some extra work and see to it that the ship reached port safely. On reaching ashore, B a seaman filed a suit against A for the promised sum. Decide. 4. Parties to the contract agreed that the plaintiff surveyors would plan and supervise some alterations estimated to cost some Rs.60,000/-, for a fee of Rs.3000/-. Later the defendant decided to make the alterations more extensive and the total cost was Rs.2,25,000/-. The plaintiff’s supervised the work and claimed an additional fee (in fact a scale fee) of Rs.25,000/-. The defendant refused to pay. Decide. 5. If in the above problem, on the plaintiff’s broaching the matter of additional fee, the defendant had agreed to pay Rs.15,000/-, and then refused to pay it, would the decision of the case differ.
6.
Akshay had given Sandeep a promissory note for Rs.12,000/which he owed to Sandeep’s brother. On Sandeep’s death, his wife took possession of the bond as his executrix. She felt that Akshay had been badly treated, and frequently stated that she would never enforce the bond, repeating this particularly when Akshay’s prospective parents-in-law expressed concern about his financial position. In reliance on her statement, Akshay married, and then sought a declaration that the debt owned by him to Mrs.Sandeep was now abondoned, and a release from the promissory note. Mrs. Sandeep resists the declaration. Decide.
7.
Karan wanting to take possession of Sunil’s property plied him with drinks, and while Sunil was under the influence of alcohol made him sign the ‘deed of transfer’ in his favour. On realising what he has done, Sunil comes to you for advice.
8.
Mrs.Pillai suffers from periodic attacks of insanity. She had a 32yr.old son Ravi who is a congenital idiot. Ravi sold of his property worth Rs.1,00,000/- to Surya for Rs.25,000/only. On becoming aware of this, Mrs.Pilai filed a suit to have the sale declared void. Surya resisted the suit on two grounds :- (1) He was not aware that Ravi was a congenital idiot; (2) Mrs. Pillai was suffering from an insanity attack when she filed the suit and so the suit should be dismissed. Decide.
9. The plaintiff’s father entered into a contract of service on his behalf with the defendant Mr. Kapoor who was a renowned (stage) director. The plaintiff was a minor at the time of contract, which provided that he should attend rehearsals punctually whenever required, and in return he would be paid Rs.2000/- pm for a period of 2 years. Originally the agreement was made orally, but later reduced to writing and signed by plaintiff, his father and the defendant. The defendant stopped paying the promised sum after a period of 6 months, and the plaintiff filed a suit. The defendant contended that as the plaintiff was a minor, the agreement was void and so unenforceable. 10. In the same fact situation above, would the decision differ if the plaintiff had attained majority at the time of filing the suit.
[Note: Specify your Name, Address and I.D. No. while sending your answer papers]
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6 SUPPLEMENTARY READINGS 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Avtar Singh, Law of Contract, (1985), Eastern Book Co. Lucknow. Anson, Law of Contract, (1984), English Language Book Society and Oxford University Press, London. Atiyah, P.S., Introduction to Law of Contract, (1986), Claendon Press, Oxford, London. Cheshire and Fifoot, Law of Contracts, (1987), Butterworth, London. Crandall T.D and Whaley D.J., Cases, Problems and Materials on Contracts, (1987), Brown & Company, Boston. Joga Rao, S.V., Cases and Materials on Contract, (1991), NLSIU Publication, Bangalore. Kromman, A.T., ‘Paternalism and the Law of Contract’, (1988)92 Yale LJ p.763. Pollock and Mulla, Indian Contract and Specific Relief Act, (1986), J.L. Kapur (ed.), N.M. Tripathi Pvt. Ltd., Bombay. Puri and Ponuswamy, Cases and Materials on Contract, (1974), Eastern Book Company, Lucknow. Summers, R.S., & Hillman, R.A., Contract and related obligations: Theory, Doctrine and Practice, (1987), West Publishing Co., St.Paul, Minnesotta. 11. Subrahmanyan, E.S., Law of Minors, (1968), Law Book Company, Allahabad. 12. Trietal, G.H., Law of Contract, (1966), Stevensons, London. 13. Venkatesh Iyer, Reprint, Law of Contract, (1987), Asia Law House, Hyderabad.
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Master in Business Laws Law of Contracts Course No: I Module No: III
FREE CONSENT AND PUBLIC POLICY
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 75
Materials Prepared By: 1. 2.
Mr. S.V. Joga Rao, B.Com., M.L., M.Phil. Prof. N.L. Mitra, M.Com., LL.M., Ph.D.
Materials Checked By: 1. 2.
Ms. Sudha Peri, LL.M. Mr. Suprio Dasgupta
Materials Edited By: 1. 2.
Dr. P.C. Bedwa, LL.M., Ph.D. Mr. T. Devidas, LL.M.
© National Law School of India University
Published by: Distance Education Department National Law School of India University, Post Bag No. 7201 Nagarbhavi, Bangalore - 560 072
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INSTRUCTIONS Basic Readings The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics included in the course. Experts in the area have collected the basic information and thoroughly analysed the same in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative provisions are also included. Care has been taken to communicate basic information required for decision making in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading information provided are to be selected by making marginal notes using markers. The first reading, therefore, necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the implications of those informations. In the second reading the reader has to critically analyse the material supplied and jot down in a separate note book points stated in the material as well as the critical comments on the same. A third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections at every stage.) Supplementary Reading Several supplementary readings are suggested in the materials. It is suggested that the reader should register with a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the National Library, any University Library where externals are registered for the purpose of library reading, any commercial library or any other public library run by Government or any private institution. Readers in Metropolitan and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary, and kept in the course file. Supplementary readings are also required to be read more than once and marginal notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the payment. Case Law The course material includes some case materials generally based upon decided cases. These cases are to be studied several times for, (a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/ appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence. Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the experts’ comment to the students. Through these exercises one can build up an effective dialogue with the experts of the Distance Education Department (DED). Problems and Responses After reading the whole module which is divided into several topics and sub-topics the reader has to solve the problems specified at the end of the module. The module is designed in such a manner that a reader can take about a week’s time for completing one module in each of the four courses. It is expected that after finishing the module over a period of a week the student solves these problems from all possible dimensions to the issue. No time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has already prepared. After completing the exercise the student is directed to send the same to Course Coordinator for evaluation. Though there is no time stipulation for sending these responses a student is required to complete these exercises before he/she can be given the certificate of completion to appear for final examination. 77
Free Consent & Public Policy TOPICS 1.
Free Consent: Meaning and Dimension ................................................................
79
2.
Coercion .....................................................................................................................
81
3.
Undue Influence ........................................................................................................
83
4.
Fraud .........................................................................................................................
87
5.
Misrepresentation .....................................................................................................
88
6.
Mistake ......................................................................................................................
90
7.
Role of Public Policy in Contracts .........................................................................
96
8.
Void Agreements .......................................................................................................
101
9.
Concluding Remarks ...............................................................................................
102
10. Bare Text of the Relevant Sections of the Act ......................................................
103
11. Case Law ...................................................................................................................
105
12. Problems ....................................................................................................................
106
13. Supplementary Readings .........................................................................................
107
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1. FREE CONSENT: MEANING AND DIMENSION SUB TOPICS 1.1 Introduction 1.2 Free Consent: scope and ambit 1.3 Consequences of the absence of free consent
d. to examine the scope and significance of 'freedom of contracting parties and public policy notions'; and e. to analyse the policy and judicial interpretation of statutory provisions pertaining to 'Void Agreements' enshrined in Sections 23-30 of the Indian Contract Act, 1872.
1.1 INTRODUCTION Having examined the nature and significance of contractual obligations in a commercial or industrial society, rules relating to the formation of contract and its select essential elements like consideration and capacity of contracting parties in the earlier modules, it is proposed to deal with the remaining essentials namely, 'Free consent' and 'Public policy' in this module. The objectives of this module are a. to examine the significance of 'Free consent' as an essential ingredient in constituting a valid contract; b. to examine the scope, ambit and interpretation of various factors which vitiate free consent in the light of common law perspectives, statutory principles and judicial decisions of both English and Indian origin; c. to critically analyse the statutory remedies;
1.2 FREE CONSENT: SCOPE AND AMBIT According to Section 10 of the Indian Contract Act, 1872 (hereinafter 'the Act') 'Free Consent' is an essential ingredient required to constitute a valid contract. The expression 'consent' is defined in section 13 which reads: "Two or more persons are said to consent when they agree upon the same thing in the same sense". According to Sec. 14 the consent is said to be free, when it is not caused bya. Coercion (S. 15); b. Undue Influence (S. 16); c. Fraud (S. 17); d. Misrepresentation (S. 18); and e. Mistake (Ss. 20, 21 and 22) A Flow Chart regarding Consent follows:
FLOW CHART ON CONSENT Consent Not vitiated by
Coercion (S. 15)
Undue Influence (S. 16)
Misrepresentation
Innocent (S. 18)
Mistake (Ss. 20, 21 & 22)
Fraudulent (S. 17)
of law Indian Law (ignorance not an excuse)
Foreign Law (ignorance treated as mistake of fact)
of fact Private right
as to nature of facts
Existence
With regard to the significance of 'consent' late Lord Hannen in Raffles v. Wichelhaus [(1913) 3 KB. 564] observed that: "It is essential to the creation of a contract that both parties should agree to the same thing in the same sense. Thus if two persons enter into an apparent contract concerning a particular person or ship and it turns out that each of them, misled by a similarity of name, had a different person or ship in his mind, no contract would exist between them". The expression 'same thing' occurring in section 13 indicates the whole content of the agreement, whether it consists wholly or in part, of delivery of material objects or payment or other executed acts or promises. [Pollock & Mulla, p. 134]
as to identity of contracting parties
Title
Identity
Price
as to subject matter of contract Quality Quantity
Mere consent is not enough to constitute a valid contract; it should be free and voluntary, so that the contracting persons can subject themselves to the binding obligations that are created by the contract. Normally, whenever the consent is vitiated the contract is void; the possible exception is, it would result in a voidable contract. A voidable contract is an agreement which is enforceable by law at the option of one party whose consent is vitiated [Sec. 2(i)]. In other words, in a given contractual relation if the consent is not free, it is upto the aggrieved contracting party to decide about the future. If the party decides in favour of enforcement, the agreement becomes 79
enforceable, thereby resulting in a valid contract; otherwise the agreement becomes unenforceable. In the case of other essential elements like consideration, the statute itself declares that if there is no consideration, an agreement is void ab initio, with certain exceptions. But in the case of free consent, the law in its wisdom felt that it should be left to the aggrieved party to decide, by exercising the right of choosing either of the options, namely, to enforce the agreement or to avoid it. According to English law the foundation of a contract is upon the 'privity of contract' between the parties. In Cundy v. Lindsay [(1878) 3 App. C 459] and Bailley's Case [(1898) 1 Ch 110], the Court held that the absence of a free consent vitiates the fundamental basis of the contract. Since, through contract, parties create their own rights and obligations, it is necessary that the parties to the contract, agree upon the same thing in the same sense, out of their own volition. Parties must have absolute freedom to mutually assess their own interests, and, to make appropriate promises. Such rational appreciation is not merely vitiated by the incapacity of the parties i.e. on account of the party being a minor or of unsound mind; it may also be vitiated by the parties not consenting to the same thing in the same sense. 1.3 ABSENCE OF FREE CONSENT: CONSEQUENCES Free consent is an essential element of a contract. Therefore, if there is no free consent there should be no contract. But, in fact, the law does not provide so. According to Sec. 19, if the consent is vitiated by coercion, fraud or misrepresentation perpetrated by one party over the other, the suffering party may avoid the contract. Such contracts which are vitiated by coercion etc. are only voidable in nature, and not void. Similarly use of undue influence makes the contract voidable u/sec. 19(a). But, according to sec. 20, a bilateral mistake of essential facts relating to an agreement makes the agreement void. Under sec. 22, a unilateral mistake does not make the contract voidable, merely because it was caused by one of the parties to the agreement being under a mistake of fact. Thus, the consequences of the absence of free consent is as follows: (a) In the absence of free consent due to coercion, fraud or misrepresentation the contract is voidable at the option of the suffering party (S. 19); (b) In the absence of free consent due to use of undue influence, the contract is voidable at the option of the party whose consent was so induced [S. 19(a)]; (c) In the absence of free consent on account of bilateral mistake of essential facts or of foreign law (if knowledge of foreign law is essential), the agreement is void ab initio (Ss 20, 21)
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(d) a unilateral mistake added with some other vitiating factors may make the contract voidable or void depending upon the circumstances (S. 22). Thus it is clear that, absence of free consent due to any one of the several vitiating factors does not make the contract void ab initio; it only creates a special right in favour of the party who has already suffered on account of the compulsion of giving the consent due to various circumstances as explained in coercion, undue influence, fraud or misrepresentation. This apparently seems to be a peculiar logic, because the two statements ‘free consent is an essential element of contract’ and ‘absence of free consent does not vitiate the contract ab initio’ seem to be irreconcilable, but it is not so. If, in absence of free consent, a contract is made void ab initio, the party influencing the consent will not have any obligation of performance. This is a situation of ‘double jeopardy’. An example will make it clear. Suppose A has forced B to sell his land to A by threatening to kidnap B’s son if B does not give his consent, here B’s consent is vitiated by coercion. Now suppose after the making of the contract, A comes to know that the land is going to be acquired by the government, A may refuse to give the money and take the land if the contract is made void ab initio. Here, B suffers twice - firstly his consent is forcefully taken, and secondly, he is not going to get the advantage of the price stipulated by B for the land in case of evaluation of compensation. One of the cardinal principles of law is that, the law has to save parties from double jeopardy. As against B’s double jeopardy, if the contract is made void ab initio, A can derive double benefit. Firstly, he has obtained the consent by force, and secondly, he himself pleading coercion gets out of it. Law cannot allow this contradictory behaviour of a party and, that is why in evidence we have the principle of “Estoppel’ (sec. 115 of Indian Evidence Act). A person cannot be allowed to exercise coercion in order to obtain consent, and then take a plea that since there was use of coercion, he/she is not obliged to perform the contract. Therefore, the law has created an additional right in favour of the party who had already suffered, to elect, either to abide by the contract or to avoid the contract. On the other hand it has rigidified the obligation of the party inflicting the vitiating factor on free consent by saddling him with the obligation to performing the contract. Thus, the suffering party has an additional right and the dominating party has an extraordinary obligation. This makes the contract voidable at the option of the party suffering from absence of free consent. In this manner the law equates the position of the parties to the contract. In bilateral mistakes however, if the fact is essential, or knowledge of foreign law is essential, mistake of such fact or foreign law shall make the agreement void ab initio, i.e., such an agreement does not attain the status of a contract at any stage.
2. COERCION SUB TOPICS 2.1 Definition 2.2 Distinguished from duress 2.3 Subjective and objective elements in coercion 2.4 Burden of proof 2.5 Ex-territoriality 2.1 DEFINITION Section 15 defines ‘coercion’ as committing or threatening to commit any act forbidden by the Indian Penal Code or the unlawful detaining, or threatening to detain any property, to the prejudice of any person whatsoever, with the intention of causing any person to enter into an agreement. Consent is said to be vitiated by coercion, when it is obtained by force or pressure exerted by either of the following methods: a. committing or threatening to commit any act forbidden by the Indian Penal Code or b. unlawfully detaining or threatening to detain any property. This externally manifested act has to be committed with a view to causing prejudice to any person whatsoever, with an intention of forcing him to enter into an agreement. . 2.2 DISTINGUISHED FROM DURESS Duress is the English version of coercion. In Cumming v. Ince. [(1947) l QB 112] it was decided that duress means and includes actual or threatened physical violence to, or unlawful constraint of, the person of the contracting party. In Latter v. Bradell [(1981) 50 LJQB 448] a housemaid was ordered by her mistress to submit to a medical examination on a suspicion of pregnancy which turned out to be unfounded. She cried and protested, but submitted to the examination. Her claim for damages failed, because she had consented to the examination. Such a rigid approach to duress, therefore, creates a situation where a threat to prosecute the other contracting party for a criminal offence does not amount to duress. Of course in equity a relief can be given. The concept of coercion is much wider than duress. A comparative analysis of the two is as follows: a. Coercion may be aimed at any person, even a stranger (this can be deduced from the words 'to the prejudice of any person whatsoever' occurring in Sec. 15) and also against goods, for example, 'unlawful detention'. However, according to English law, duress must be aimed against the contracting party or members of his or her family; b. In the case of coercion, the scope is so wide that it may proceed from any person meaning thereby even a stranger to the contract. But English law mandates that it should proceed from either the contracting party or members of his or her family.
c.
Coercion under Indian law does not require any immediate violence, whereas for duress under English law it is necessary to show that the act must be such as to cause immediate violence.
2.3 SUBJECTIVE AND OBJECTIVE ELEMENTS IN COERCION It can thus be inferred from the definition that to constitute 'coercion', there is a requirement of both objective and subjective elements, namely, externally manifested act (which includes threat) and the prejudicing of any person thereby to enter into an agreement. One without the other would not result in coercion. For example, X threatens to assault Y (objective element), with a view of causing him to enter into a particular agreement. The crucial question at this juncture is whether the externally manifested act which is forbidden by law, did in fact influence or prejudice Y’s mind (subjective element) or not? If Y is not prejudiced, the mere fact that he entered into an agreement, does not entitle him to exercise any option subsequently. Similarly in a given fact situation, a particular act may prejudice a person’s mind but unless and until the act is either prohibited by the Indian Penal Code [IPC] or amounts to unlawful detention of property, or threat to detain property, it does not amount to coercion. It is quite pertinent here to refer to Ranganayakamma v. Alwar Chetty under [(1889) 13 Mad 214] threat of preventing the body from being removed for cremation. In this case, a young girl aged 13 years was forced to give her consent under threat of preventing the body from being removed for cremation to the adoption of a boy to her husband who had just then died. In a suit to set aside the adoption, the court had no hesitation in holding that the consent was not a free consent but one induced by coercion, within the meaning of Sec. 15 since any person who obstructs a dead body from being removed would be guilty of an offence under Sec. 297 of IPC. In another landmark case Chikkam Ammiraju and others v. Chikkam Seshamma and others [(1917) 41 Mad 33] a release deed was obtained by a person from his wife and son under a threat of committing suicide. In a suit to set aside the transaction, the Court was divided as to whether the threat amounted to coercion, since suicide was not an offence punishable by the IPC. On Letters Patent Appeal two of the three judges held that though suicide was not punishable under the IPC, yet it was one forbidden by IPC since an attempt to commit suicide was punishable. The reason why suicide was left without any punishment was obvious for the dead could not be punished and therefore, the consent obtained by such a threat to commit suicide was one obtained by coercion. 2.4 BURDEN OF PROOF In a plea of coercion, the same adversorial procedure of burden of proof is followed in so far as the objective part of coercion is 81
concerned. Anyone going to the court and asking the court to believe that coercion has been perpetrated is required to prove the act of coercion, i.e., the act which is forbidden by IPC, or the unlawful detention of property or the threat of such detention of property. But in so far as the subjective part of coercion is concerned, the burden of proof is negative and it swings back to the defendant, who has to prove - (a) that such an act was not intended for the purpose of obtaining consent; and (b) such an act in fact did not influence the other party to give consent. Here the quantum of time difference between the act of coercion and of the actual consent given has an inverse relation to the probity of subjective force, i.e., if the interval of time is short or proximate there is a high probity of subjective force; on the other hand if the interval of time is long and the distance between force and consent is more, the probity of subjective force is low. Performance of such a contract after the alleged coercive act is lifted out of taint makes both the parties bound by the contract. It means that the option of avoiding the contract must be exercised as soon as, or very closely after, the ‘coercive’ act is done. If more and more time is allowed to elapse without the plaintiff seeking redressal, especially after the coercive force is lifted, it would make his case weak. 2.5 EX-TERRITORIALITY Generally speaking, the Indian Contract Act applies to all contracting parties provided the place of contract is in India,
82
or, where the place of contract is not in India, the parties agree to be governed by Indian law. In view of the explanation given to sec. 15 and the illustration given thereunder, it is clear that sec. 15 has a global reach. The explanation provides that ‘it is immaterial whether the IPC is or is not in force in the place where the coercion is employed”. It means that the plaintiff has only to prove that the act of coercion complained of is an act prohibited by IPC. In order to substantiate his claim he does not have to show that at the place of coercion the IPC was in force. Illustration given to the section is as follows: A on board an English ship on the high seas causes B to enter into an agreement by an act amounting to criminal intimidation under S. 506, IPC. Here, the ‘high sea’ is beyond the territory of India and so Indian law is not applicable there, and, since it is an English ship English law is the law applicable between the parties. In England, there is no criminal intimidation equivalent to what is covered by Sec. 506 IPC. A afterwards sues B at Calcutta for breach of contract and B pleads coercion, and thereby seeks to avoid the contract. The decision is that A had employed coercion and so B can avoid the contract. This shows that if the parties are in India, or the property relating to the contract is in India, an Indian court can admit a suit pleading absence of free consent due to coercion, even though the place of coercion is much beyond the normal jurisdiction of the lndian courts. Sec. 15 therefore has an extra-territorial application.
3. UNDUE INFLUENCE SUB TOPICS 3.1 Definition 3.2 Undue influence vis-a-vis coercion 3.3 Essential elements (a) Position of domination (b) Fiduciary relations (c) Contracts with persons having impaired mental capacity 3.4 Burden of Proof (a) General (b) For Pardanashin Woman 3.1 DEFINITION The doctrine of undue influence under the Common Law was evolved by the courts in England for granting protection against transactions procured by the exercise of insidious forms of influence, either spiritual or temporal. In the words of Sir Frederic Pollock, undue influence means "any influence brought to bear upon a person entering into an agreement, or consenting to a disposal of property which, having regard to the age and capacity of the party, the nature of the transaction, and all the circumstances of the case, appears to have been such as to preclude the exercise of free and deliberate judgement" [Venkatesh Iyer, p. 201]. Lindley L.J. in his judgment in Allcard v. Skinner [(1887) 36 Ch. D. 145] has stated in the following terms the object of the doctrine of undue influence. "To protect people from being forced, tricked or misled in any way by others into parting with their property is one of the most legitimate object of all laws and the equitable doctrine of undue influence has grown out of and been developed by the necessity of grappling with insidious forms of spiritual tyranny and with the infinite varieties of fraud. This is not a limitation placed on the action of the donor, it is a fetter placed on the conscience of the recipient of the gift and one which arises out of public policy and fair play". Section 16 defines Undue Influence as: (1) A contract is said to be induced by ‘undue influence’ where the relations subsisting between the parties are such that one of the parties is in a position to dominate the will of the other and uses that position to obtain an unfair advantage over the other. (2) In particular and without prejudice to the generality of the foregoing principle, a person is deemed to be in a position to dominate the will of another (a) where he holds a real or apparent authority over the other, or where he stands in a fiduciary relation to the other; or (b) where he makes a contract with a person whose mental capacity is temporarily or permanently
(c)
affected by reason of age, illness or mental or bodily distress; or where a person who is in a position to dominate the will of another, enters into a contract with him, and the transaction appears, on the face of it or on the evidence adduced, to be unconscionable: the burden of proving that such contract was not induced by undue influence shall lie upon the person in a position to dominate the will of the other.
According to clause (1) of Section 16, if the following two conditions are fulfilled, the contract is said to be vitiated by undue influence: (a) where the subsisting relations are such that one party is in a position to dominate the will of the other; and (b) such person uses that position to obtain an unfair advantage over the other. 3.2 UNDUE INFLUENCE VIS-A-VIS COERCION According to Anson, the term ‘undue influence’ has sometimes been used by the courts to describe the equitable doctrine of coercion. The distinction that makes undue influence different from coercion remains in the character of force used. In case of coercion, as we have already seen, one party uses a force forbidden by IPC or that party confines or threatens to confine property, in order to put an external pressure by force on the mind of the other party to come to terms. In England of course, the property element is not taken into consideration in ‘duress’, i.e. confining of property or threat to confine property does not constitute duress in the legal sense. Of course, Williams v. Bailey [1866 L.R.I H.L. 200] was one case where the mortgage of a property was set aside by the court as being made under duress. Here, the defendant’s son forged his (father’s) signature on several promissory notes in order to collect money from the Bank. The banker made it clear to the defendant that the Bank had the power to prosecute his son for forgery. In order to protect his son from prosecution the defendant had to execute the mortgage. This case, decided in equity, extended relief because the contract was entered into because of one party’s threat to prosecute the other on a criminal offence. By and large, both in India and England a criminal force, applied or threatened for purpose of obtaining consent, constitutes coercion. In undue influence, on the other hand, the force that is used by one party is not a patent one (i.e., an obvious one) as used in coercion, but it is a latent one (i.e. a hidden one) which emanates out of the comparative position of the parties, one being in a dominant position as compared to the other. The force used here is more directly psychological and moral, rather than external and physical. But the end result in both the cases is the same, i.e., in both the cases one party dominates the will of the other. In coercion it is done by a physical force, whereas in undue influence it is done by a psychological force possible because of the physical relation between the parties. In coercion 83
a physical force is required to be converted into a psychological force which is termed as the subjective force in coercion. In undue influence, however, that psychological force is directly applicable. An example will make it clear. In the poem ‘Do Beegha Jameen’ [Two Beeghas of land] Tagore has given a classical example of undue influence. According to the story, the feudal Lord of the village (Babu) asks his tenant (Upen) to sell his land to him (i.e. Babu) stating that, ‘I shall purchase that land’. This makes the intention of the landlord very clear. Here, the relation between the parties was such that one could dominate the will of the other. But a modern landlord in Bombay can engage a few mercenaries or goondas, to compel the tenant to leave the house. Here, the psychological force is a derivative one, which is patently created by an external force. This is coercion. In the earlier example the psychological force is latent in the relation between the parties. Similarly, in coercion, undue influence has to occur. As has already been said, unless the psychological force is created by a physical force there is no coercion; mere use of objective force is not enough. Once that psychic force is present the position between the parties becomes such that the person causing coercion is in a position to dominate the will of the other. Therefore, in every coercion there is undue influence, but the converse is not true, because in undue influence, there is never any necessity for the use of criminal force; the psychological and moral force is enough to constitute undue influence. To sum up, in coercion there is a patent force and in undue influence there is latent force. In coercion, a party by virtue of use of force becomes dominant over the other, whereas in undue influence the relation between the parties is such that one can automatically dominate the will of the other. In coercion, an unconscionable gain is not essential, but in undue influence, an unconscionable gain is necessary to shift the burden of proof. But, the remedy available against the use of either force is based upon the same philosophy, viz., of law being against the use of any kind of force in the realm of contract. 3.3 ESSENTIAL ELEMENTS According to Anson, the two situations in which an undue influence may occur are: (1) where the party charged to have exercised undue influence in the sense of domination over the other party; or (2) where there is an abuse of the duty of care and confidence which may be imposed on one party towards another as a result of a particular relationship which emerges from the special circumstances of their association. Anson further suggested that in the former, evidence of express influence must be adduced by the parties seeking to impeach the transaction, whereas, in the latter, undue influence is presumed by the law in the absence of evidence to the contrary [Allcard v. Skinner (1887) 37ChD 145]. (a) Position of domination When can we say that in a given relationship one person is in a position to dominate the will of the other? Normally, it is difficult 84
to say or generalise unless it is proved factually. However, taking into consideration the object of 'undue influence’ and the need for protecting innocent persons, the English Common Law Courts have evolved a presumption to that effect in the following relationships. The list is merely illustrative in nature: a. parent and child b. guardian and ward c. trustee and beneficiary d. solicitor and client e. doctor and patient f. spiritual advisor and disciple Apart from the above mentioned relationships, there may be infinite varieties of human relationships in which one person is in a position to dominate the will of another [Rama Pattar v. Manikkam (1934) 58 Mad 454]. As rightly pointed out by the Privy Council in Poosathurai v. Kannappa Chettiar, AIR 1920 PC 65 "it is a mistake to treat undue influence as having been established by a proof of the relations having been such that the one naturally relied upon the other for advice and the other was in a position to dominate the will of the first. Upto that point ‘influence’ has been made out; such influence may be used wisely, judiciously and helpfully. But, both under the law of India and the law of England, more than mere influence must be proved so as to render the influence, in the language of the law, "undue”. That is the reason why, unless and until it is shown that the influence is exercised to obtain unfair advantage, such influence does not amount to 'undue influence’. The leading case on this vitiating factor is that of Allcard v. Skinner [(1887) 36 Ch.D. 145]. In 1862, the plaintiff Ms. Allcard joined a sisterhood of which the defendant was the religious superior. The plaintiff in course of time made several gifts to the sisterhood and transferred to it the bulk of her properties. In 1879, the plaintiff left the sisterhood and in 1885 she repudiated these transactions of gift and brought the suit. The court was of the opinion that, the relationship between the defendant and the plaintiff was such as to raise the presumption of undue influence, but held that, in view of the plaintiff's conduct subsequent to 1879 when she left the sisterhood down to 1885, taking into account the period of time that had elapsed and also the fact that during all this interval, she had independent and disinterested advice, her conduct must be construed as an election to affirm the gifts made by her. This case is an authority on two points, namely: (i) that a contract induced by undue influence is only voidable and therefore could be affirmed expressly or by conduct. (ii) that the party in such cases should seek to avoid the transaction at the earliest possible point of time and could succeed in doing so only if the parties could be restored to their original position. According to clause (ii) of sec. 16, in addition to the principle enshrined under clause (i), a person is deemed to be in a position to dominate the will of another
(a) if he holds real or apparent authority; or (b) if he stands in a fiduciary relation to the other; or (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.
It was held that the purchase must be set aside. The defendant, having been asked to give advice, stood in a confidential relationship to T, and this prevented him from becoming a purchaser of the property, without the fullest communication of all material information which he had obtained as to its value.
Undoubtedly, a person in authority would be able to dominate the will of the other. For example, persons like income-tax officers, police officials and advocates etc. belong to this category of persons of real authority. This kind of authority may either be conferred by a statute or by a contract. Apparent authority means ‘show of authority’, which in reality does not exist.
(c) Contracts with persons having impaired mental capacity
(b) Fiduciary relations Whenever any relation is founded on trust, faith or confidence, such a relation is known as ‘fiduciary relation’. While examining the parameters of fiduciary relationship in a given fact situation Scrutton L.J. in Moody v. Cox & Hatt [(1917) 2 Ch. 71] went on record by saying: "Generally when you have made a legal contract and correctly expressed it in writing, and it has not been obtained by any misstatement of facts, innocent or fraudulent, the contract stands, and the fact that one party or the other knows facts about which he says nothing, which made the contract an unprofitable one to the other party, is of no legal consequence. But there are certain relations and certain contracts in which a higher duty is imposed upon the parties and they must not only tell the truth, but they must tell the whole truth so far as it is material, and they must not only not misrepresent by words, they must not misrepresent by silence if they know of something that is material. Some of those cases depend on the relationship between the parties, and, generally speaking, are cases where the relation is such that there is confidence reposed by one party and influence exercised by the other. In that class of relation of parties you may get the duty, first of all, that the party who has the influence must not make a contract with the party over whom he has influence unless he can satisfy the Court that the contract is an advantageous one to the other party". This principle applies to every case where influence is acquired and abused, where confidence is reposed and betrayed. Thus in Tate v. Williamson [(1866) L.R. 2 Ch. App. 55], an Oxford undergraduate, T, aged twenty-three, was being pressed to pay his college debts, which amounted to some £1000. Being estranged from his father, he asked his great-uncle to advise him how he should find the means to pay. The great-uncle was unable to advise in person owing to ill health, but he deputed the defendant, his nephew, to do so. Conversations took place between T and the defendant in which T expressed the desire to sell part of his estate, upon which the defendant offered to buy it for £7000. Before the sale was completed, the defendant obtained a report from a surveyor on the property, and this valued it at £ 20000. The defendant did not disclose this fact to T but proceeded with the purchase. Excessive drinking led to T's death one year later.
Similarly, under sub-clause (c) of Section 16, a person is deemed to be in a position to dominate the will of the other, if such person enters into a contractual relation with another whose mental capacity is temporarily or permanently affected by reason of age, illness or mental or bodily distress. In fact, this clause takes within its fold a wide range of circumstances wherein the presumption plays a significant role. For example, a poor Hindu widow, who was in great need of money to establish her right to maintenance, was persuaded by a money lender to agree to pay 100% rate of interest. The court did not hesitate to declare this as an instance of undue influence exerted upon a person in distress. In fact this clause takes within its fold the principle of unconscionable bargain. 3.4 BURDEN OF PROOF (a) General Clause (3) of Section 16 speaks about 'burden of proof'. According to it, where a person who is in a position to dominate the will of another, enters into a contract with him, and the transaction appears, on the face of it or on the evidence adduced, to be unconscionable the burden of proving that such contract was not induced by undue influence shall lie upon the person who is in a position to dominate the will of the other. While examining the scope and ambit of ‘burden of proof’ the Madras High Court in P. Saraswati Ammal v. Lakshmi Ammal alias Lakshmi Kantham [AIR 1978 Mad. 361] observed that: "The primary ground on which the plea of undue influence is founded is based on relationship. It is axiomatic that mere proof of relationship, however near it may be, is not sufficient for a court to assume that one relation was in a position to dominate the will of the other. Such bonds of kinship which are universally felt should not be mistaken as equivalent to saying that one kinsman could unduly influence the other in the circuit of such bondage. Even if any advice is given it may be influence but not undue influence. The important and salient feature which ought to be established on materials pleaded and acts established is that the ‘bargain is tainted by undue influence, and it is so unconscionable that it could reasonably be said that the person sought to obtain unfair advantage for himself and so as to cause injury to the person relying upon his authority or aid’. It is only after such particulars are made available and a reasonable proof thereof has been given, the onus probandi would shift to the so called ‘person of domination’. Until then the burden is on the complainant to establish it so”. 85
According to Anson, in case of a special relationship emerging out of the special circumstances attending the association of parties, the burden of proof lies on the defendant. Lord Selborne held in Earl of Aylesford v. Morris [1873 L.R. 8 Ch. 484 at p.490] that "........ raise from the circumstances and conditions of the parties contracting - weakness of one side, usury on the other, or extortion or advantage taken of that weakness - a presumption of fraud. Fraud here does not mean deceit or circumvention; it means an unconscientious use of the power arising out of these circumstances and conditions; and when the relative position of the parties is such as prima facie to raise this presumption, the transaction cannot stand unless the person claiming the benefit of it is able to repel the presumption by contrary evidence, proving it to have been in point of fact, fair, just and reasonable’. (b) Pardanashin Woman A ‘Pardanashin Woman’ is one who is considered to be ‘secluded from ordinary social intercourse'. There is no statutory definition to this effect. She enjoys a cloak of legal protection. If any other person enters into a contract with a pardanashin woman, the presumption of undue influence arises. In Kalibaksh Singh v. Ram Gopal Singh [(1913) 41 I A. 23] the Privy Council observed that, "In the first place, the lady was a pardanashin lady, and the law throws around her a special cloak of protection. It demands that the burden of proof shall in such a case rest, not with those who attack, but those who found upon the deed, and the proof must go so far as to show affirmatively and conclusively that the deed was not only executed by, but was explained to, and was really understood by, the grantor. In such cases it must also, of course, be established that the deed was not signed under duress, but from free and independent will of the grantor".
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Summing up, it can be stated that in the case of pardanashin woman, there is a prima facie presumption of undue influence. At this juncture one particular fact needs to be clarified. Namely, sub-clause (c) of clause (iii) of Section 16 speaks only about presumption about "person’s position to dominate the will of the other" in the light of select relationships, but in the case of 'pardanashin woman’ the presumption, though not statutory in nature would deal with undue influence itself. Justice Subba Rao in Kharbuja Kuer v. Jangbahadur Rai (AIR 1963 SC 1203), held that, "The burden shall always rest upon the person who seeks to sustain a transaction entered into with a paradanshin lady to establish that the said document was executed by her after clearly understanding the nature of the transaction. It should be established that it was not her physical act but also her mental act. The burden can be discharged not only by proving that the document was explained to her and that she understood it but also by other evidence direct and circumstantial". The protection afforded to pardanashin ladies can be extended to other ladies of similar class who though not technically pardanashin are similarly placed in that they are illiterate and sometimes old and sick and have lack of understanding and appreciation of the transaction without independent advice and are helpless and thus exposed to the danger of enmeshment into unfair deals. The emphasis should be on the factual understanding of the transaction entered into and not the disability presumed in the case of pardanashin ladies on the ground of mere status. The protection given to the ‘pardanashin’ extends to illiterate rustic village woman [Pollock & Mulla, p. 171].
4. FRAUD SUB-TOPICS 4.1 Definition and essential elements 4.2 Constituent elements of fraud 4.1 DEFINITION AND ESSENTIAL ELEMENTS The ‘Writ of deceit’ of the law of torts applied in a contractual situation which ultimately results into a fraud, which gives a party the right to demand and recover damages. In English law ‘fraud’ was defined in a landmark decision of the House of Lords in Derry v. Peek [(1889) 14 App. Cases 337] which runs as follows: Fraud is proved when it is shown that a false representation has been made 1. knowingly, or 2. without belief in its truth, or 3. recklessly careless whether it be true or false. In this case the established facts were: A Company’s prospectus contained a representation that the company had been authorised by a special Act of Parliament to run trams by steam or mechanical power. The authority to use steam was, in fact, subject to the approval of the Board of Trade, but no mention was made of this. The Board refused consent and consequently the company was wound up. The plaintiff, having bought some shares, sued the directors for fraud but they were held not liable in view of their honest belief. Section 17 of the Contract Act defines fraud. The analysis of Section 17 reveal the following essential ingredients: a.
there should be a suggestion as to a fact;
b. the fact suggested should not be true; c.
the suggestion should have been made by a person who does not believe it to be true; and
d. the suggestion should be made with intent either to deceive or to induce the other party to enter into the contract. 4.2 CONSTITUENT ELEMENTS OF FRAUD Thus Indian law very much resembles the British law of deceit which is generally based upon the three basic principles: (i) making a false statement knowingly, that the statement made is not true which amounts to suggestio falsi. In Davis v. London Prudence and Marine Insurance Co. [(1878) 8 ch. D. 469], it was held that a statement which is believed to be true when made, and which is subsequently discovered to be false by the party making the statement, will be considered to be fraudulent, if the mistake is not communicated to the other person before he acted on it. (ii) The representation must be made with an intention to deceive the other party, i.e. with an intention of obtaining
wrongful gain from or to inflict wrongful loss on another. In Paul Hacel v. Walter [(1832) 3 B and A.D. 114], a representation was made by the defendant that he could accept the bill, knowing fully well that in fact he had no such authority. The bill being dishonoured at maturity would make the defendant liable to compensate the loss of an endorsee who had given value for the bill on the strength of the defendant’s representation. (iii) Though mere suppression of a fact is not a fraud, but where an oral statement is warranted, a suppression would indicate a falsehood the knowledge of which is with the defendant. Such a suppression also constitutes fraud. A suppresio veri in such a case amounts to a suggestio falsi if not an allegatio falsi. Silence is not fraud Under the common law system there is no general duty imposed on one party to a contract, to apprise the other of facts unknown to him and which might affect his inclination to enter into the contract (Anson, 227). This principle is generally known as ‘caveat emptor’. In Keats v. Lord Cadogan [(1851) 10 C.B 591], the plaintiff sued the defendant demanding damages on account of fraud because the defendant was aware while letting his house that the plaintiff would want to occupy it immediately and that the house was in a ruinous condition and therefore unfit for occupation. According to Jervis, C.J., mere silence does not constitute misrepresentation. Of course in some cases there may be a duty of disclosure. As for example, if the parties to the contract are so related that there is a duty of utmost ‘good faith’ [uberrimae fidei] like family relations, doctor and patient, advocate and client, and so on, parties are bound to disclose what they think to be of material importance for taking a decision on a contract. Explanation to sec. 17 of the Contract Act puts forth the Indian position clearly. It states that mere silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud unless the circumstances of a case are such that regard being had to them, it is the duty of the person keeping silent to speak, or unless his silence is in itself equivalent to speech, as already suggested earlier in ‘suppressio veri, suggestio falsi’. Misrepresentation to induce the contract In order to establish fraud it must be shown that the misrepresentation had in fact induced the other party to conclude the contract. Lord Blackburn had said that "if it is proved that the defendants with a view to induce the plaintiff to enter into a contract made a statement to the plaintiff of such a nature as would be likely to induce a person to enter into a contract, and it is proved that the plaintiff did enter into a contract, it is a fair inference of fact that he was induced to do so by the statement.” 87
5. MISREPRESENTATION Misrepresentation in Common Law In English Common Law negligent misrepresentation made by a party also entitles the other party to rescind the contract as in the case of fraud. After passing of the Misrepresentation Act of 1967, a party suffering from negligent misrepresentation may now claim damages [Hadley Byrne’s Case (1964) A.C. 465]. In this case the House of Lords extended liability for damages to negligent misstatement and held that duty of care could exist where there was a special relationship between the persons making the statement and the person to whom it was made. Innocent misrepresentation on the other hand could not be pleaded as a defence or be made a ground of rescission in Common Law. Of course the rigour of this Common Law principle was softened by the application of equity and allowing the party suffering from innocent misrepresentation to rescind the contract. The following are the four principles of general rule on misrepresentation in Common Law. (i) Misrepresentation as to contractual terms: If the misrepresentation relates to a term of contract which is not a condition the injured party can only claim damages but cannot rescind the contract. In case the contractual term is a condition misrepresentation may empower the injured party to rescind the contract. (ii) Mistake: An innocent misrepresentation induces the other party to the contract to commit a mistake. If such a mistake happens to be related to an essential term or condition of the contract the agreement is void, so that either party can, on returning whatever gaoms he got under the contract recover back had given. (iii) Contracts uberrimae fidae: In contracts of insurance etc. innocent misrepresentation or non disclosure are good grounds of rescission, under Common Law. (iv) Limited duty of disclosure: Where there is a limited duty of disclosure failure to disclose is a good defence, and rescission is allowed. In fact the common law principle of contractual misrepresentation giving rise to rescission, is a product of equitable doctrine. As a normal rule rescission must be communicated to the other party but where a seller of goods has a right to avoid the contract for fraud or misrepresentation and he sufficiently exercises his election at once on discovery of the fraud or misrepresentation by taking all possible steps to regain the goods a formal notice may not be insisted upon. In Car and Universal Finance Co. Ltd. v. Caldwell [(1961) 1 QB 525], the defendant was fraudulently induced to sell a motor car to a purchaser in return for a cheque. When the cheque was dishonoured the defendant immediately informed the police and the automobile association. The purchaser deliberately absconded and could not be traced. He subsequently sold the car to the plaintiff who bought it in good faith. The Court of Appeal held that the defendant had effectively rescinded the contract, though he could not communicate the notice of 88
rescission to the purchaser. The title to the car had vested in the defendant on rescission and so the plaintiff had no claim to the vehicle. Indian law on Misrepresentation Section 18 of the Contract Act defines ‘Misrepresentation’. It means and includes: a. When a person positively asserts that a fact is true when his information does not warrant it to be so, though he believes it to be true; b. Any breach of duty which brings an advantage to the person committing it by misleading the other to his prejudice. Sometimes this is also called as ‘constructive fraud’. c. 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. It is now pertinent to note the distinction between fraud and misrepresentation. a. Basically fraud requires an intention to deceive, whereas misrepresentation may be innocent. b. Fraud in addition to rendering the contract voidable, is a cause of action in tort for damages. Simple misrepresentation is not a tort but under section 75 of the Contract Act, “a person who rightfully rescinds a contract is entitled to compensation for any damage which he has sustained through the non-fulfilment of the contract." c. Lastly, a person complaining of a misrepresentation can be met with the defence that he had, “the means of discovering the truth with ordinary diligence", but excepting in case of fraud by silence, it does not lie in the mouth of the person committing fraud to say that his victim was too easily deceived or had the means of discovering the truth "Fools have to be protected against knaves" [Venkatesh Iyer, p. 227]. Remedies Before we take up the examination of the most significant of the vitiating factors, namely, mistake, it is desirable to learn about the consequences of such contract wherein the consent is vitiated by coercion, undue influence, fraud or misrepresentation. In this regard section 19 provides that, when consent to an agreement is caused by coercion, fraud or misrepresentation, the agreement is a contract voidable at the option of the party whose consent was so caused (section 19A specifically deals with undue influence). However, a fraud or misrepresentation which is not the direct cause of the consent given by the other party would not render a contract voidable. Similarly, if such consent was caused by misrepresentation or by silence which is fraudulent within the meaning of section 17, the contract nevertheless is not voidable, if the party whose consent was so caused had the means of discovering the truth with ordinary diligence. Section 19 also provides that, a party
to a contract, whose consent was caused by fraud or misrepresentation, may, if he thinks fit insist that the contract shall be performed, and that he shall be put in the position in which he would have been if the representations made had been true. Thus, basically, section 19 confers the right of rescission on the party whose consent is vitiated. However, the right of rescission in such cases is always subject to section 64 of the Contract Act which recognises the concept of restitution. According to section 64, 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 promisor. The party rescinding a voidable contract shall, if he has received any benefit thereunder from another party to such contract, restore such benefit, so far as may be, to the person from whom it was received. At the same time, S. 75 recognises a right to claim compensation on the part of the person rescinding the contract, provided he rightfully rescinds it.
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6. MISTAKE SUB-TOPICS: 6.1 Mistake in Common Law 6.2 Mistake in Indian Law 6.3 Mistake of both the parties 6.4 Mistake of fact and law 6.5 Mistake of essential fact (i) Nature and content of the promise (ii) Identity of the parties (iii) Mistake as to subject matter. 6.1 MISTAKE IN COMMON LAW Unlike other vitiating factors of consent like coercion, undue influence, fraud and misrepresentation, mistake attacks the very root of the contract. In the other vitiating factors the vitiating element is external either in the form of force, status or intentional or non-intentional misrepresentation by one party over the other. But mistake relates to internalities of the contract. Therefore, the very foundation of privity of contract is questioned. In Bell v. Lever Bros Ltd. [(1932) A.C. 161], the respondent entered into two agreements with the appellants, the first one being a service contract by which appellant Bell & Snelling were appointed to the Board of the Niger Co., a subsidiary of Lever Bros. for a period of 5 years at a salary of £ 8000 and £ 6000 respectively. The second agreement was a compensation contract by which Lever Bros. promised to pay a compensation of £ 30,000 and £ 20,000 respectively in the event of the respondents been asked to retire before the expiry of the service period. While in service Bell and Snelling secretly entered on their own account into speculative transactions in Cocoa, a course of conduct which would have given the Lever Bros. the right to dismiss them without paying compensation. It was in ignorance of this fact that Lever Bros had entered into the compensation contract and paid the sum therein promised. They now sought rescission of the contract and recovery of the money on the ground that it had been paid under mistake of fact. While delivering his judgement Lord Atkin observed: "If mistake operates at all, it operates so as to negate or in some case to nullify consent". Thus in Common Law mistake either negatives the consent or nullifies it. In the first it negatives the consent because there is no real consensus between the parties and therefore, there is no basis for the contract. In the second, it nullifies the consent because of an error in consent on account of mistake in expression relating to the terms of contract. Of course in both the cases the agreement is void. In Lever Bros. Ltd., the majority decision of the House of Lords posed some apparently contradicting and confusing propositions. Before we go into that let us examine the case from the trial stage. The facts of the case as examined by the jury would reveal that Bell and Snelling did not have in mind their breaches of duty while they entered into the compensation agreement nor had the Lever Bros. contemplated that they had 90
the right to terminate the contract of service of the appellant without paying compensation. The jury observed that there was no fraud on the part of the appellants. Therefore the agreement of compensation was a nullity from the beginning due to the mistake and belief of both the parties. The Court of Appeal upheld the contention that the agreement was void ab-initio. The House of Lords reversed the decision holding by majority that the contract was valid and binding. The first proposition coming out of this decision is that there is no such doctrine of mistake rendering a contract void ab initio. Lord Denning explained this principle with more clarity in Solle v. Butcher [(1951) K.B. 671)]. According to him "once a contract has been made, i.e., once the parties, whatever their inmost states of mind, have to all outward appearances agreed with sufficient certainty in the same terms on the same subject matter, then the contract is good unless and until it is set saide for failure of some condition on which the existence of the contract depends, or for fraud, or on all such equitable ground. Neither party can rely upon his own mistake to say that it was a nullity from the beginning, no matter that it was a matter which to his mind was fundamental, and no matter that the other party knew that he was under a mistake, a fortiori, if the other party did not know of the mistake but shared it". The second proposition is that the agreement is void in law only if some term can be implied in both offer and acceptance which prevents the contract from coming into operation. According to Anson this is a fiction. But as Lord Atkin pointed out it takes us far in the enquiry to establish whether a contract contains such a term. Though there can be no test to be laid down to determine whether a situation would thus arise, Anson marshalled the fact situation into four categories where such a position may arise, preventing the contract from coming into operation. Lord Atkin perhaps covered these issues in nullity of contract. (a) mistake as to existence of the subject matter of the contract; (b) mistake as to title, (c) mistake as to the quality of the thing contracted for; and (d) a false and fundamental assumption going to the roof of the contract. (a) Mistake as to the existence of the subject matter: In Lever Bros Lord Atkin observed: "the agreement of A and B to purchase a specific article is void if in fact the article had perished before the date of sale. In this case, though the parties in fact agreed about the subject matter, yet a consent to transfer or to take delivery of something not in existence is deemed useless; the consent is nullified. It is not difficult to see that such non-existence of the subject matter is a total failure of a consideration. (b) Mistake as to title: According to Lord Atkin "Corresponding to mistake as to the existence of the subject matter is mistake as to title in cases where unknown to the parties, the buyer is already the owner
of that which the seller purports to sell to him. Suppose A agrees to take from B a lease of land of which, contrary to the belief of both parties at the time of contract, A is already tenant-in-tail, the agreement is void for absence of title with the seller. An agreement on a mistaken belief of the title of the seller is a valid contract and the seller is liable to pay damages for not having the title; it is only where the buyer agrees to purchase his own property there can be no warranty and the agreement is a nullity. (c) Mistake as to the quality of the thing: This type of mistake has much more complexity. Such a mistake generally does not affect the contract unless the mistake is of both the parties and as to some quality which "makes the thing without the quality essentially different from the thing as it was believed to be". As for example, F buys from K a car which both believe to be a 1948 model but actually it is 1939 model and very much less valuable. There is no mistake at common law as held in Oscar Chess Ltd. v. Williams [(1957) 1 W.L.R. 370]. Similarly, if A agrees to buy from B '100 bales of Calcutta Kapok, Sree brand', both the parties believe that this particular brand is pure Kapok consisting of Sree cotton. On a subsequent discovery that the Kapok contains an admixture of bush cotton and is commercially inferior, the contract cannot be avoided. [Harison and Jones Ltd v. Bunten and Landcaster Ltd. [(1953) l Q.B. 646]. (d) False and Fundamental Assumption Where in the contract both the parties entered into the agreement on false fundamental assumptions going to the root of the contract the contract may be void. Lord Atkin termed such type of avoidance of as a nullity. In Sheikh Bros v. Ochsner [(1957) A.C. 136], the appellant contracted with the respondent to grant him a licence to cut, process and manufacture all sisal grown on a particular estate in Kenya of which they were the lessee. In return the respondent deposited a certain sum of money, and undertook to deliver each month to the appellants 50 tonnes of sisal fibre, manufactured by him. The estate was in fact not capable of producing such requirement. It was held that the agreement was void on the false fundamental assumptions. 6.2 MISTAKE IN INDIAN LAW Indian Law on mistake is different from the Common law. According to Sec. 20 of the Indian Contract Act mistake has been defined as ‘mistake of both the parties to an agreement on a fact essential to the agreement’ : This mistake makes the agreement void. Thus to be a mistake in Indian Law, (i) it has to be mistake of both the parties, (ii) it must be mistake of fact, and (iii the fact must be essential and not incidental or subsidiary. 6.3 MISTAKE OF BOTH THE PARTIES In order to make the contract void ab initio both the parties must commit the mistake. As for example in Griffith v. Brymer
[(1903) 19 T.L.R. 434] an agreement for hire of a room overlooking the route of Edward VII’s coronation procession was held void because both the parties did not know the cancellation of the procession. In India all mistakes to be covered under Sec. 20 to make the agreement a nullity is required to be bipartite. A single party’s mistake cannot suffice. Mistake of One Party: Whereas in England one party’s mistake can also make the agreement void ab initio subject to the explanation of mistake as given by Lord Denning noted earlier, unilateral mistake in India can result in a nullity under Sec. 22 of the Contract Act which stipulates that a contract is not voidable merely because it was caused by one of the parties to it being under a mistake as to a matter of fact. It means that if mistake is compounded by some other vitiating factors unilateral mistake can also become a ground for nullity. The position may be intricate in the absence of any Indian law on the issue; It is difficult to predict the attitude of Indian judiciary on this matter. Take for example in Cundy v. Lindsay [(1873) 3 A. C. 459] one Blenkarn by imitating the signature of a reputable firm called Blenkiron & Co., induced Lindsay to supply him goods on credit, which he afterwards sold to Cundy, an innocent purchaser for value consideration. In a suit by Lindsay against Cundy for recovery of the goods, the Court of Appeal held that as Lindsay never intended to contract with Blenkarn, there was no contract between them and even an innocent buyer of the goods from Blenkarn did not get a good title and must return them to Lindsay. The English court in this case relied on the principle consensus ad idem, and therefore, mistake of Lindsay as to the identity of the party with whom he was entering into the contract vitiates the very foundation of the agreement and therefore the agreement is a nullity. If there is a nullity of the agreement, a party can take the plea of its own mistake. In Indian situation perhaps the court has to read Sec. 22 with Sec. 17 or 18 and make it as a compounding vitiating factor in which case the court may make the agreement a nullity. In that event the position of Cundy would be very interesting in India according to Indian Law. He is a bonafide purchaser for valued consideration deriving the possession of the goods from a merchant. As such, with Secs. 2, 17 and 18 of the Contract Act the Indian court may read Sec. 27 and 29 of the Sale of Goods Act as well. In that case Cundy obtaining the possession of goods in a sale transactions completed before the nullity of the basic agreement between Lindsay and Blenkarn was declared by the Court will have valid and continuing title. Therefore, Lindsay will not be able to get back the materials from Cundy. Unless such a case came up before the highest judiciary in India it is difficult to predict all consequences arising out of compounding unilateral mistakes. Another interesting case on impersonation is Philips v. Brooks [(1919) 2 K.B. 243]. A man, North, called in person at a jeweller’s shop and chose some articles of jewellery. On some of the articles he made payment by a cheque signing as Sir G.B. a person of credit. Thereupon the jeweller allowed him to take away a valuable ring for which he promised to pay soon. North thereafter pledged that ring to Brooks. In a suit for recovery of the ring the court held that Brooks a pawn broker, had a good title to the ring, because the contract between the 91
jeweller and North was good until the jeweller disaffirmed it. Here in this case the judge applied the principle of fraud and not the principle of unilateral mistake as to the identity of the party contracted with. According to the court the impersonation was made not at the stage of making the contract but only at the stage of delivery of goods. The fraud did not compel the jeweller to enter into the contract because at the stage of contracting, the misrepresentation was not made. The jeweller was ready to sell the goods to any person, unlike in Cundy v. Lindsay where the misrepresentation started at the very beginning of the agreement thus vitiating the very foundation of the agreement. Therefore, in a compounding unilateral mistake the court has to critically look into the fact situation and the stage at which the mistake is committed. The Court has also to look into the role of such mistake in the overall framework of the agreement. In every fraud and misrepresentation there is a mistake on the part of the suffering party. Therefore that does not automatically bring fraud or misrepresentation under mistake. 6.4 MISTAKE OF FACT AND LAW Mistake of the parties must relate to mistake of fact and not mistake of law. Whereas mistake of fact is excusable, ignorance of law is no excuse [Ignoratio juris non excusit]. According to Sec. 21 of the Contract Act a contract is not voidable because it is caused by mistake as to any law in force in India. As for example, A and B make a contract grounded on the erroneous belief that a particular debt is barred by Indian Law of limitation; the contract is not void or voidable. Mistakes which relate to the existence of a subject matter, title of goods, quality of the thing contracted for, terms of contract and identity of the party are mistakes of facts. But often it is difficult to understand and distinguish the mistake of fact from mistake of law. As for example, a debt barred by limitation is apparently shown as a mistake of fact just as a bad debt. But since the bad debt is due to application of law it is considered as mistake of law. Whether a person is a minor or not may be apparently a question of fact but since minority is determined and protected by law the issue on minority is often treated as matter of law. Mistake of Law It is already pointed out that a mistake relating to law is not a mistake. There can be two questions involved - the first, what is a mistake of law and the second, can the question of law be a mixed question of law and fact? According to Sec. 21, mistake of law of our country is considered as mistake of law whereas mistake of foreign law i.e. law of any foreign country is a mistake of fact. Mistake of International law in India is considered as mistake of fact because unless specifically adopted, international law does not govern the relation of nationals. Of course there are countries where international law is considered as superior law of the land and hence mistake relating to that is mistake of law. But the whole question on mistake of law or fact is not that simple. On several issues, the line of demarcation between mistake of 92
law and fact is very thin. As for example, in the case of liquidation of a bank the liability of the bank to pay off depends upon whether the bank holds the fund as the agent for collection or as a banker. This question is both of fact as well as of law. If the agreement between the parties is clear on the issue the status of the bank becomes a matter of fact. Often the relationship between the banker and the customer determines their legal relation. In such situations the matter is both a matter of fact as well as a matter of law. 6.5 MISTAKE OF ESSENTIAL FACT Mistake must relate to the essential and not an incidental or subsidiary fact. Broadly speaking the following facts are considered to be essential in every agreement: (i) nature and content of the promise itself; (ii) identity of the contracting parties; and (iii) identity and nature of the subject matter. (i) Nature and content of the promise Normally, it is expected that the agreement reflects the intention of the parties. However, the possibilities of gaps cannot be ruled out. The decision of the Court of Appeal in ‘Hartog v. Colin and Shields’ [(1939) 3 All. E.R. 566] has appropriately illustrated this point. In this case, the defendants contracted to sell to the plaintiff 3000 Argentine hare skins, but by a mistake they offered the goods at so much per pound instead of so much per piece. The price per piece was roughly one-third that of a pound. The negotiations preceding the agreement took place on the basis of price per piece and that was also the usual practice of the trade. The buyers sued for the goods. Singleton L.J. observed that it was a mistake on the part of the defendants which caused the offer to go forward in that way, and I am satisfied that anyone with any knowledge of the trade must have realised that there was a mistake. The offer was wrongly expressed and the defendants by their evidence, and by the correspondence, have satisfied me that the plaintiff could not have reasonably supposed that the offer contained the offerors’ real intention. The Calcutta High Court in New Delhi Rubber Works Pvt. Ltd. v. Oriental Fire & General Insurance Co. Ltd., [(1969) 1 Comp. L. J. 153 (Cal)] followed the same principle. The facts in this case were as follows: A policy of insurance, which had expired, covered risks arising out of fire, riot and strike. The Company sent a renewal form to the assured showing the premium for the above risks. The assurance sent a lesser amount sufficient to cover the fire risk only. The company issued a policy in the usual terms covering the risks arising out of fire, riot and strike. The factory was destroyed by fire due to riot. The company contended that as the policy purported to cover the risks of riot and strike also, it was void for mistake. The court held that the defence of mutual mistake can be raised even where the document had become redundant by reason of the occurrence of the loss and there was nothing left to be rectified, for otherwise the assured would in effect be allowed to take advantage of a mistake, which if pointed out, would have been rectified at the proper time.
Defence of ‘non est factum’ The plea of non est factum (that is not my deed) was an ancient common law defence to actions on specialities, permitted at a time when illiteracy was frequent enough to demand special protection. Not withstanding execution, the executant could plead that the deed as executed was not his deed in the sense that it did not represent his intention and was not what he had in mind to do that in truth he did not consent to what he had done. In modern times this plea has been extended to cases other than illiteracy, as justification of this plea has been replaced by ‘want of consent’ as a justification. The intention of the mistaken party became the crucial factor, not the means by which the result was brought about. While for a long time the plea was permitted only where the mistake related to the nature of the document and not to its contents, the distinction is now rejected. No matter what the document in question be; negligence or carelessness on the part of the executant excludes defence of non est factum. In Gallie v. Lee, [(1969) 2 Ch 17] a leading case in this area, the plaintiff Mrs. Gallic a widow of 78 years of age and issueless decided to assign by way of lease her house to her nephew Walter Parkin. The latter had an impecunious friend Lee. One day Lee asked Mrs. Gallie to sign a document alleging that it was a deed of gift assigning the lease to her nephew but which in fact was a deed of sale to Lee. Mrs. Gallie did not read the document as she had broken her glasses and signed it. Lee mortgaged the house subsequently to Anglia Building Society and used the money to pay off his own debts. While responding to the defence of non est factum, Lord Denning M.R. went on record by observing: ‘Whenever a man of full age and understanding who can read and write, signs a document which is put before him for signature ..... a document which it is apparent on the face of it is intended to have legal consequences, then if he does not take the trouble to read it but signs as it is, relying on the word of another as to the character, contents or effect he cannot be heard to say that it is not his document’. Lord Denning also rejected the distinction drawn between the nature of a document and its contents as irrational and held that a mistake as to the contents of the document may be no less fundamental than one relating to the nature or character of a contract. (ii) Mistake as to Identity of contracting parties In our ordinary buying and selling contracts, the question as to who the supplier is or who pays for it is immaterial, provided the supply is effected and payment made. But when the goods are sold on credit, the identity of the buyer assumes importance. In a credit sale, the seller parts with his goods only when he has satisfied himself about the buyer’s honesty and financial capacity to pay for the goods. The identity of the buyer assumes particular importance where the rights of the innocent third parties are also likely to be affected. For example, a person may give a fraudulent name belonging to a person who is known
to be credit worthy and receive goods on credit under a contract. Then he may sell the goods to an innocent third party who purchases them bonafide. The seller after realising his mistake as to the identity of the buyer, may try to recover either the goods or the price from the third party. If the contract with the impersonator is void, the innocent third party could not get any title to the goods; but if it is voidable the third party could get a good title to the goods. And the contract being voidable or void depends on the identity of the buyer. Thus, the importance of the 'identity of the contracting party' even when both the parties to the contract are face to face cannot be overstated [1990 C.U.L.R., p. 33]. In view of the fact that Indian decisions are scanty in this regard, select English judgments have been considered for analysis. Hardman v. Booth (1863) 1 H & C 803 In this case, the plaintiffs meaning to deal with Thomas Gandell & Sons, went to their office and took an order from a person who represented himself to be a partner in the firm. He told the plaintiffs that the goods should be sent in the name of Edward Gandell & Sons. He received the goods, carried them away and sold them to the defendant, a bonafide buyer. The plaintiffs sued the defendant to recover their goods. Pollock C.B. while explaining the principle observed that: "There are some cases in which it is very clear that there is no contract at all; and the present case seems to be one of those cases. It is argued that the contract was made personally with the particular individual who made the communication, it is very true that the words were uttered by and to him; but what they imported was a contract with Gandell & Co., the facts being that he was not a member of the firm, and had no authority to act as their agent, and Gandell & Co, therefore, were not the buyers; and consequently, at no time were there two consenting minds drawn together to the same agreement". Phillips v. Brooks (1919) 2 ICB 243 In this case, a man, called North, entered the plaintiff shop and selected some pearls and some rings worth £ 3000. He produced a cheque book and wrote out a cheque for the amount. In signing it he said "you see who I am. I am Sir George Bullough". The plaintiff after referring to a directory and ascertaining that Sir George Bullough did reside at the mentioned address, let the defendant have a ring. He promised to come for the other articles after the cheque was cleared. Before the fraud was discovered he pledged the ring with the defendants who advanced money bonafide, and without notice. The plaintiff sued the defendants for the ring or its value. On these it was held by Horridge J., that although the plaintiff believed the person to whom he was handing the ring was Sir George Bullough, he in fact had contracted to sell and deliver it to the person who had come into his shop. His intention was to sell to the person present, identified by sight and hearing. The contract, therefore was not void on the ground of mistake, but only voidable on the ground of fraud, 93
and therefore the defendants had acquired a good title to the ring. This decision created an impression that there could be no operative mistake as to identity of the contracting party in contracts inter praesentes because when two parties contract with each other face to face, the proper inference would normally be that each one of them intended to contract with the other and not with some one else [1990, CULR, p 33]. However, Prof. A.L. Goodhart [57 LQR, p 228] has questioned the basic tenet of this decision, in the following words: "Did the shop keeper believe that he was entering into a contract with Sir George Bullough and did North know this? If both answers are in the affirmative then it is submitted that there was no contract. If a blind man makes an offer to A, who is present, in the mistaken belief that he is B, can A, who is aware of the mistake, accept the offer?.... The law must have lost all touch with reality if it holds that under such circumstances there is a contract. Mere presence by itself cannot have so remarkable an effect". Ingram v. Little (1960) 3 All ER 332 In answer to an advertisement of a car being for sale, a swindler called on two sisters who along with a third person were joint owners of the car, and agreed with one of the sisters, E who negotiated on behalf of the owners, to purchase the car for £ 717. On her categorically refusing to accept a cheque in payment, he tried to convince her that he was a reputable person and said that he was Mr. P.G.M. Hutchinson. While the discussion was going on, the other sister went to the local post office and returned to say that she had checked the name and address in the telephone directory. They thereupon decided to accept the cheque, on which the swindler wrote the name and address of Hutchinson, and the owners gave the car to him. The cheque was dishonored and the man, who was not Mr. P.G.M. Hutchinson, disappeared. In an action by the owners to recover the car or its value from a bonafide purchaser to whom the swindler had sold it, within a few days of obtaining it, the court held that the defendant was liable. In the opinion of the court the decision must depend upon the intention of the ladies. The question was with whom did they intend to contract, with the man present in their drawing room or with real Hutchinson? Did the identity of Hutchinson or the physical presence of the man in the room preponderate? Can it be said that the prima facie predominance of the physical presence of the false Hutchinson identified by sight and hearing was over borne by the identity of the real Hutchinson on the facts of the present case? In answer to these questions the court said that there could be no doubt that the offer which the plaintiffs made was one made solely to, and one which was capable of being accepted only by, the honest Hutchinson. So far as the rogue was concerned there was no offer made to him and consequently there could be no contract with him. His right to the car was no more than that of a thief or a finder and he could not convey a good title to the defendant.
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Lewis v. Averay [1971] 3 All ER 907 Lewis a young man was a post graduate student of chemistry. He had a car to sell. A man described in the judgment as "rogue" came along and introduced himself as Richard Green, a famous film actor. He tested and liked the car and offered a cheque. The plaintiff was reluctant to give him the car till the cheque was cleared, but the defendant managed to persuade him otherwise. As a last resort, he demanded proof of identity. The rogue produced a special pass of admission to a film studio which showed his photograph and the official stamp. This convinced the plaintiff and he allowed the car to be taken away against the cheque. The rogue lost no time in selling off the car to an innocent buyer, the defendant in this case. The worthless cheque came back and the plaintiff sued the defendant to recover his car. Lord Denning M.R. held that: "For instance, in 'Ingram v. Little', the majority of the Court suggested that the difference between Phillips v. Brooks and Ingram v. Little was that in Phillips v. Brooks, the contract of sale was concluded before the rogue made the fraudulent misrepresentation, whereas in Ingram v. Little the rogue made the fraudulent misrepresentation before the contract was concluded. My own view is that in each case the property in the goods did not pass until the seller let the rogue have the goods. Again it has been suggested that a mistake as to the identity of a person is one thing; and a mistake as to his attributes is another. A mistakes as to identity it is said avoids a contract, whereas a mistake as to attributes does not. But this is a distinction without a difference. A man's very name is one of his attributes. It is also a key to his identity. If then, he gives a false name, is it a mistake as to his identity? or a mistake as to his attributes? These fine distinctions do no good to the law.... As I listened to the arguments in this case, I felt it wrong that an innocent purchaser (who knew nothing of what passed between the seller and the rogue) should have his title depend on such refinements. After all he has acted with complete circumspection and in entire good faith; whereas it was the seller who let the rogue have the goods and thus enabled him to commit the fraud. I do not therefore accept the theory that a mistake as to identity renders a contract void". Thus, one would infer inconsistency as to judicial interpretation with regard to 'mistake as to identity of contracting parties'. (iii) Mistake as to subject matter Similarly, mistake as to the subject matter also needs to be examined as it would throw light on the presence of consensus ad idem as to the subject matter in question. This kind of mistake takes within its fold the following aspects: (a) Different subject matters in mind: If the parties to the agreement have different subject matters in their mind while contracting, the agreement deserves to be declared as void, for want of consensus ad idem. For instance in Raffles v. Wichelhaus [(1864) 2 H & C. 906] the defendant bought of the plaintiff a quantity of Surat Cotton "to
arrive ex Peerless from Bombay". Two ships with the name Peerless sailed from Bombay, one in October, which the defendant had in mind and the other in December which the plaintiff had in mind. On the ground of mistake as to subject matter, the court held that there was no consensus ad idem. (b) Existence of subject matter: Mistake as to the existence of subject matter might prove fatal to the creation of a valid contract. In Conturiev v. Hastie [(1856) 10 ER 1065], the contract was to purchase Indian corn described as having been shipped from Salomica on board a chartered ship to England. But a fortnight before the contract, the cargo had become damaged owing to heat and had to be discharged at an intermediate port and sold at the best price available. Neither of the parties were aware of this fact at the time of the contract. The court held that the contract was vitiated by mistake. (c) Quality Mistake as to quality of thing contracted for, raises much more difficult questions. In Re Taylor [(1948) 11 Mod L.R. 257], it has been suggested that distinction should be drawn between mistake as to substance on one hand and mistake as to quality
on the other. A mistake of the former type would avoid the contract whereas the mistake of the latter type would not. In Kennedy v. Panama New Zealand and Australian Royal Mail Co. Ltd., [(1867) L.R. 2 Q.B. 580], the plaintiff tool shares in a further issue of capital by the defendant company, relying on a statement in the prospectus that the defendant hand a contract with the New Zealand Govt. for the carriage of mail. As a matter of fact, the contract of the company was with an agent of the New Zealand Govt. which the company generally believed to be valid. Later on, after the agent had entered into the contract with the company, the New Zealand Govt. refused to ratify it. As a result the value of the shares fell greatly, and the plaintiff filed a suit for rescission of the contract. The court held that the contract was valid, as the plaintiff had got the very shares which he had bargained for, and as his mistake did not affect the substance of the whole transaction, the contract could not be avoided. Similarly in Leaf v. International Gallaries [(1950) 2 K.B. 86] E bought from F a picture which both of them believed to have been painted by Constable. Several years later, when E tried to sell the picture he found that it was not painted by Constable at all. The mistake though fundamental did not result in avoidance of contract.
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7. ROLE OF PUBLIC POLICY IN CONTRACTS SUB TOPICS 7.1 Introductory note 7.2 Application of public policy principles to contracts (a) Forbidden by law (b) Defeating the provisions of law (c) Fraudulent (d) Injurious to person and property (e) Immoral (f) Public policy of the State 7.3 Agreements void on account of public policy (a) In restraint on marriage (b) In restraint on trade (c) Restraining legal proceedings (d) Wagering agreements 7.1 INTRODUCTORY NOTE The law of contract gives an opportunity of creating new rights and obligations to every individual. Such rights and obligations ex contractu create rights and obligating in personam. Contract therefore creates a legal infrastructure for a capitalist and mercantile society. In a capitalist framework each individual has absolute freedom to design his or her rights and obligations vis-a-vis other persons in the society, simply through the legal instrument of contract. Thus contract subserves the principle of private interest maximization. Generally speaking the question of public policy cannot operate in the sphere of private interests. The law of contract has to essentially operate within the constitutional framework of a country, and hence the private interest can not conflict with that higher constitutional public interest. A few examples may not be out of place here. No contract can be made between parties, with a view to obstructing the discharge of the State functions, either Executive, Legislative, or Judicial. A contract to opt out of the State jurisdiction of the country is against public policy. Therefore, parties to a contract can not prescribe that they shall be governed by the English law, instead of the Indian law. Any private contract, defacing any part of the constitutional regime is per se void. Similarly, there cannot be a contract with unlawful consideration, or for a criminal purpose. Public laws are always considered to be the higher laws vis-a-vis the contract laws. As such, while interpreting any contract, it has to be so interpreted, that no part of the contract infringes on any public law, viz. constitutional law, criminal law, or administrative law. 7.2 APPLICATION OF PUBLIC POLICY TO CONTRACTS It is evident that contract serves private interests. But it is the responsibility of the state to see that while serving the private interest through contracts, it does not conflict directly or indirectly with any other private or public interests. It means 96
that, while individuals are free to create rights and obligations in between themselves, it is always necessary for the state to protect such new rights and duties of individuals, so as not to affect the existing rights and duties towards the society or the social interest. When an individual crosses that boundary, and interferes with the rights of a third party or the society, such agreements are specifically made void. Some of these public interest policies, which invalidate any private agreement, making them unlawful, are incorporated in Sec 23 of the Contract Act. According to it, the consideration or object of an agreement is lawful unless (a) it is forbidden by any law or (b) is of such nature that, if permitted, it would defeat the provision of any law or (c) is fraudulent or (d) involves injury to the person or property of another or (e) the courts regard it as immoral or opposed to public policy. In each of these cases the consideration or object of an agreement is said to be unlawful. Every agreement of which the object or consideration is unlawful, is void. At this stage it is proper to examine the meaning and scope of illegal and void agreements. It is necessary to bear in mind that in Sec. 23, the expressions like, unlawful or forbidden by law etc. have been used. According to Anson, the subject of illegality is one of great complexity and the effects of illegality are by no means uniform. The reason for this is not hard to find. The extent of illegality is not the same in all cases. Illegal objects may range from those which are tainted with gross moral turpitude e.g., murder, to those where the harm caused is relatively small. It is not surprising, therefore, that there are gradations in the degree of enthusiasm with which the judges are prepared to assist a person who has an illegal object in view or is a party to an illegal transaction. Attempts have been made to distinguish between illegal agreement and void agreements. In the former case, it is said that the law will refuse to aid in any way a person who bases his cause of action upon such an agreement. In the latter case, the law simply says that the agreement will not have any legal effect. Undoubtedly some agreements can be thus classified, but it is both impractical and impossible to apply this classification to the whole subject. Moreover, confusion is created by the fact that the judges have on many occasions treated the terms as interchangeable. It seems better to use the single word illegality, to cover the multitude of instances where the law, either because of public policy or as a result of an express prohibition, denies to one or both of the parties the rights to which he would otherwise be entitled. Let us now examine the interpretation of each clause of section 23 in the light of judicial decisions. (a) Forbidden by law: According to this clause, the consideration or object of an agreement becomes unlawful when it is forbidden by law. Such unlawful agreements are void. For example, in Bhikanbhai v. Hiralal [(1900) 24 Bom 622], the plaintiff was a lessee of certain tolls under the Bombay Tolls Act, 1875. One of the conditions of the lease was that lessee should not sublet
the tolls to any other person without the permission of the collector. A of Rs. 200/- was payable for a breach of condition. The plaintiff contracted with the defendant to sublet the toll to him without obtaining the necessary permission. The question was whether the agreement to sub-lease was void. The court while negating such plea observed that, the object of statute was not to forbid such transactions but only to regulate. As such the transaction may be void as against the collector, but between the parties it stands. (b) Defeating the provisions of any law: In some cases the enforcement of a particular agreement though not apparently or directly forbidden by law, but would, if permitted defeat the provisions of some law. For example, in Ram Sewak v. Ram [AIR 1962 All 177] the agreement between the partners of a firm to conceal income in certain respects so as to evade incometax has been held to be unlawful. (c) Fraudulent: In a given agreement whenever an element of fraud or intention to deceive creeps in, it would become a void agreement. For example, A being an agent for a landowner, agrees for money, without the knowledge of his principal to obtain for B, a lease of land belonging to his principal. The agreement between A and B is void, as it implies a fraud by concealment, perpetuated by A on his principal. (d) Injurious to person or property: If the object of an agreement involves injury to a person or property, per se the agreement becomes unlawful and thereby void. For example, in Kanklal v. Pambayan (AIR 1927 Mad. 531) a bond to pay an exorbitantly high rate of interest, in case the borrower left the lender's service, has been held to be void. (e) Immoral: While explaining the scope of the expression 'immoral' in Gherulal v. Mahadeodas (AIR 1959 SC 781) Justice Subba Rao observed that: "The case law both in England and India confines the operation of the doctrine to sexual immorality. To cite only some instances, settlements in consideration of concubinage, contracts of sale or hire of things to be used in brothel or by a prostitute for purposes incidental to her profession, agreements to pay money for future illicit cohabitations, promises in regard to marriage for consideration or contracts facilitating divorce are held to be void on the ground that the object is immoral. (f) Public Policy: According to this clause, whenever the object of an agreement is opposed to public policy, it becomes a void agreement. The crucial task of a judge in this regard is to interpret what is public policy. In the words of Justice Subba Rao in Gherulal's case. "The doctrine of public policy may be summarised thus: public policy or the policy of the law is an illusive concept, it has been described as an 'untrustworthy guide', variable quality, 'untruly horse', etc; the primary duty of a court of law is to enforce a promise which the parties have made and to uphold the sanctity of contract which forms the basis of society; but in certain cases, the court may relieve them of their duty on a rule founded on what is called the public policy; for want of better words Lord
Atkin describes that something done contrary to public policy is a harmful thing; but the doctrine is extended not only to harmful cases but also to harmful tendencies; this doctrine of public policy is only a branch of common law, and just like any other branch of common law, it is governed by precedents; the principles have been crystallised under different heads and though it is permissible for courts to expound and apply them to different situations, it should only be invoked in clear and incontestable cases of harm to the public; though the heads are not closed and though theoretically it may be permissible to evolve a new head under exceptional circumstances of a changing world, it is advisable in the interest of stability of society not to make any attempt to discover new heads in these days". The following heads of public policy have been consistently invoked and interpreted by the Courts, in this regard. 1. Trading with an enemy. 2. Trafficking in public offices. 3. Interference with administration of justice. 4. Marriage brokerage contracts. 7.3 AGREEMENTS VOID ON ACCOUNT OF PUBLIC POLICY Several agreements are specifically made void on account of public policy. As for example, an agreement in restraint of marriage is against the natural rights of a person, i.e. the right to family. None can deprive another by virtue of a contract to have/not to have family relations. Even in the absence of a clear positive prescription, agreements in restraint of marriage cannot be held valid. Under Sec. 26 of the Contract Act, an agreement in restraint of marriage of any person, other than a minor, is void. Similarly, an agreement in restraint of trade, is totally against the fundamental freedom of trade, commerce, industry and profession. No one, including the State can take away these rights by virtue of a contract. Under Sec. 27 of the Contract Act such agreements are void. Some other agreements declared to be void as being against public policy are discussed below. Void agreements enumerated in sections 24-30 Sections 24-30 deal with specific void agreements. They are as follows: a. Agreements void, if considerations and objects unlawful in part - (S.24) b. Agreements without consideration - (S.25) (has been explained in the earlier module) c. Agreements in restraint of marriage (S.26) d. Agreements in restraint of trade (S.27) e. Agreements in restraint of legal proceedings (S.28) f. Ambiguous agreements (S.29) g. Wagering agreements (S.30) Section 24 merely reiterates the principle enshrined in Section 23. The important feature of this provision is that, in case, if 97
part of the agreement only takes within its fold either unlawful consideration or object, that part alone would become void, provided in such agreements; such demarcation is possible. (a) Agreements in restraint of marriage: According to section 26, every agreement in restraint of marriage of any person, other than a minor is void. It seems that the policy is in favour of discouraging agreements which restrict freedom of marriage. In an earlier case i.e., Rao Rani v. Gulab Rani (AIR 1942 All 351) there was an agreement between two co-widows that if any of them remarried she should forfeit her right to her share in their deceased husband's property. This agreement was upheld, because as the Court pointed out, no restraint on their remarriage had been imposed on either of the widows. The restraint was only with reference to enjoyment of property rights. (b) Agreement in restraint of trade: The basic public policy principle underlying this provision is that, every person shall be given the liberty of trade, occupation etc. so as to exercise his powers either for his own benefit or for community interest. In Nordenfelt v. Maxim Nordenfelt Guns & Ammunition Co. [(1894) A.C. 535] the House of Lords for the first time interpreted this principle. In this case the appellant, Nordenfelt, was a maker and inventor of guns and ammunition. He sold his business to the respondent company for £ 287,500 and entered into a covenant (later to be repeated in a contract of service) that he would not for twenty-five years 'engage... either directly or indirectly in the trade or business of a manufacture of guns, gun mountings or carriages, gunpowder explosives or ammunities or in any business competing or liable to compete in any way with that for the time being carried on by the Company, but expressly reserved the right to deal in explosives other than gunpowder, in torpedoes or submarine boats, and in metal castings or forgings. After some years Nordenfelt joined the business of a rival company dealing with guns and ammunition, and the respondents sought an injunction to restrain him from doing so. It is clear that the restraint entered into by Nordenfelt was of a general, and not merely of a partial, nature, since there was no limit placed on the area to which it was to extend. Nevertheless, the House of Lords held that this did not, of itself, mean that the covenant was void. They were of the opinion that the covenant not to compete with the company in any business competing or liable to compete in any way with that for the time being carried on by the Company was unreasonable, as it attempted to protect not only the business as it was when sold, but any future activities of the company, and it was therefore void; but this clause was distinct and severable from the rest of the agreement. As for the remainder of the restraining condition, in so far as it was for the protection of the business actually sold, it was reasonable between the parties, because Nordenfelt not only received a large sum of money, but also by his reservation retained scope for the exercise of his inventive and 98
manufacturing skill. Moreover the wide area over which the business extended necessitated a restraint co-extensive with that area for the protection of the respondents. Finally it could not be said to be contrary to the public interest since it transferred to an English Company, the manufacture of guns and ammunition for use in foreign lands. The restraint was therefore valid. From the above judgement one can infer the following propositions: (i) All restraints of trade, in the absence of special justifying circumstances, are contrary to public policy and therefore void. (ii) Whether special circumstances do or do not justify the restraint is a question of law, and the court interprets it very strictly. (iii) The restraint can only be justified if it is reasonable (a) in the interest of the contracting parties; or (b) in the public interest. (iv) The burden of proof relating to reasonableness of restraint is on the person who pleads it. According to Sec. 27 of the Contract Act every agreement by which, any one is restrained from exercising a lawful profession, trade or business of any kind, is to the extent of restraint void. Accordingly in India all agreements in restraint of trade whether general or partial, qualified or unqualified are void. As such the Indian Law is different from Law in England. [See Khemchand v. Dayal Das, AIR 1942 Sind 114]. In Sheikh Kalu v. Ram Sharan Bhagat [(1909) 13 CNN 388], 29 out of 30 makers of combs in the city of Patna agreed with the defendant to supply him all the combs manufactured by them, and not to sell their combs to anyone else. But the defendant had the right to reject the goods if he found that there was no market for them in Patna, Calcutta, or elsewhere. The court held the agreement to be void. So also, in case of an employer and employee there cannot be a restraint of trade after the term of the employment is over. In Oakes & Co v. Jackson [(1876)1 Mad 134], an employee of the company agreed not to employ himself in any similar concern within a distance of 800 miles from Madras after leaving the company service. The restraint was held void. The Indian Court is not supposed to go into the question of reasonableness or otherwise. Any restraint on the employee after the tenure of service is void in India. In this case however English Courts would also have come to the same decision because of unreasonableness. Restriction can however be imposed during the term of employment. As for example, if A takes a whole time employment in B's factory the restriction imposed upon joining another employment at the same time is entirely valid. An agreement of service by which a person binds himself during the term of employment from taking any other service is valid. As for example, in Charles v. Mcdonald [(1899) 23 Bom 103], A agreed to become an assistant for 3 years to B who was a doctor practising in Zanzibar. It was agreed that during the term of agreement A was not to have his own practice. After one year A left B's job and began to practise on his own.
It was held that the agreement was valid and A was restrained by injunction from practising. But in case the employee is wrongfully dismissed, the employee becomes free from the restrictive covenant. In this connection one has to examine the legality of cartelization and trade agreements to form monopoly. Sec 27 of the Indian Contract Act does not take away the right of a trader to regulate his business according to his own discretion and choice. In Daulat Ram v. Dharachand [1934 Lah 170] the court held that an agreement for trade combination for the purpose of avoiding competition is not necessarily unlawful. But where the agreement is clearly not for the mutual benefit of the parties but is an attempt to create a monopoly it would be void as against public policy. There are exceptions to this agreement in restraint of trade being void. These are: (i) Sale of goodwill: According to exception to sec 27, a buyer of a good will may impose reasonable restrictions as to time and place on the seller of good will of a business. As for example A buys the right to ply ferries from B with a restriction that B shall not start a ferry service within 10 miles for a period of 5 years. This restriction is reasonable and valid. [See Chandra v. Mallik (1921) 48 Cal 1030]. (ii) Partners' agreements: (a) Under the Partnership Act Partners may agree not to carry on any other business, other than the firm business, while being a partner [Sec. 11(2)(b)]. A retiring partner may agree not to carry on business, similar to that of the firm within specified time period and local limits [Sec. 36(2)(c)]. Partners may, upon the dissolution of the firm, or in anticipation make an agreement not to carry on similar business within given local limits or a specified time period [Sec. 54(d)]. While selling the goodwill of the firm, a partner may agree, not to carry on similar business within a specified local limit and for the specified period [Sec. 55(3)]. (c) Agreement in restraint of Legal Proceedings According to Sec. 28 any agreement by which a party is restricted absolutely from enforcing his rights under or in respect of any contract, by the usual legal proceedings, or which decreases the time limit within which he may thus enforce his rights is void to that extent. Right to legal remedies is a constitutional right and therefore any restriction on it is against public policy. As for example, if A agrees to buy B's plot of land at less than the market value, further agreeing that he shall not go to the court on B's failure to give a better title, the second part of the agreement of not going to the court is void under sec. 28. There are of course some exceptions to this rule. These are: (i) Parties agreement to refer a matter to arbitration and not to have recourse to the courts shall not make the contract invalid. (ii) Similarly a contract to refer to the existing system of arbitration is also valid, if the written agreement between the parties, restrains them from taking recourse to the court.
Reference to M/s. Kerala Electrical and Allied Engineering Co. Ltd v. Canara Bank and Others (AIR 1980 Ker. 151) would not be out of place at this juncture. In this case a clause in a bank guarantee is subjected to judicial scrutiny. The said clause runs as follows: "This guarantee will remain in force for a period of one year from the date hereof and unless a suit or action to enforce claim under the guarantee is filed against us within six months from the date of expiry of (the guarantee) all your rights under the said guarantee shall be forfeited and we shall be relieved and discharged from all liability thereunder" While interpreting the clause in question, the court went on record by saying: "Section 28 makes two kinds of agreements void. What we are concerned in this case is the second of the two kinds, namely an agreement which limits the time within which a party thereto may enforce his rights under or in respect of a contract be the usual legal proceedings in the ordinary tribunals. It is the limiting of the time within the rights are to be enforced that is made void. So it goes without saying that rights to be enforced under the contract should continue to exist even beyond the shorter period agreed for enforcing those rights, to make such an agreement void under the section. If, for example, beyond the shorter period agreed upon the rights under the contract cannot be kept alive, no limiting of the time to enforce the rights under the contract arises and hence the agreement putting a time limit to sue will not be hit by S. 28". (d) Wagering agreements A wagering agreement is one in which there is a promise to pay money or its worth upon the determination or ascertainment of an uncertain future event. According to sec 30 of the Contract Act, all agreements by way of wager are void and no suit shall be brought for recovering anything alleged to be won by any wager, or entrusted to any person to abide the result of any game or other uncertain event in which a wager is made. Hawkins, J., beautifully explained the term wagering in Carlill v. Carbolic Smoke Ball Co. [(1892) 2 Q.B. 484], a wagering contract is one by which two persons, professing to hold opposite views touching the issue of a future uncertain event, mutually agree that, "dependant on the determination of that event, one shall win from the other, and that other shall pay or handover to him, a sum of money or other stake; neither of the contracting parties having any other interest in that contract other than the sum or stake he will so win or loose, their being no other real consideration for the making of such contract by either of the parties. It is essential to a wagering contract that each party may under it either win or loose ..... If either of the parties may win but cannot loose but may loose and cannot win, it is not wagering". Therefore the following are the characteristics of a wagering agreement: (i) It must be a promise to pay money or money's worth. (ii) The promise is conditional on the happening of an uncertain future event. 99
(iii) One party should win and the other should loose. (iv) Both the parties cannot loose or both the parties cannot win. (v) Both the parties have an equal chance in the game. (vi) There is no other consideration. In Gherulal v. Mahadeodas (AIR 1959 SC 781) it was held that a wagering agreement is struck down not on the ground of public policy but because it is void under sec 30 of the Indian Contract Act. The State, in which gaming or gambling is illegal, a wagering agreement is also illegal. As for example wagering is illegal in Bombay. In England wagering is both void and unlawful on ground of public policy. Sometimes it is very difficult to understand the distinction between genuine commercial transaction and a wagering agreement. Suppose A & B enter into an agreement of future sale and purchase of wheat at Rs. 280/- per bag to be delivered
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after three months it is very difficult to understand whether it is a good commercial transaction with an object of delivering the goods or it is a wagering agreement speculating on the price and payment of the difference. In a wagering agreement neither party would intend to perform the contract but pay only the differences [Ram Krishan Das v. Musaddilal (AIR 1942 All 170)]. Option dealings in a stock exchange is not necessarily a wager unless it can be positively proved that both the parties intended not to give and take delivery. Of course recent directions of SEBI prohibit option dealings in securities. Lotteries are both void and illegal because of application of sec 294 A of IPC. Where the Govt. authorizes the holding of a lottery, for developmental purposes, persons conducting the lottery will not be punished, as the agreement is made valid by prescription of law. Similarly prizes for horse racing or an agreement to subscribe or contribute towards any plate, price or sum of money of the value of Rs. 500/- or more shall not be deemed to be unlawful.
8. VOID AGREEMENTS SUB-TOPICS 8.1 Introductory Note 8.2 Grounds of Void agreement 8.3 Uncertain agreement 8.1 INTRODUCTORY NOTE An agreement is void if it is unenforceable by law. A void agreement is different from a void contract, in the sense that void agreement is void ab initio. It is void per se and therefore parties need not agitate over the issues in the court of law. A void contract on the other hand is a contract becoming unenforceable due to various reasons. As for example: (i) By a decree of nullity in the court of law (ii) Parties entitled to avoid opted for avoiding the contract (iii) Due to change of circumstances, the performance of the contract has become impossible. The performance of void agreements may be necessarily be illegal. Only when the performance would involve an illegal act, would it be a punishable offence. A void agreement is merely unenforceable, and not generally punishable. 8.2 GROUNDS OF VOID AGREEMENTS AT A GLANCE In the following cases an agreement is void ab initio: (i) agreement entered into by a minor or a person incapable of entering into it (secs. 11, 12) (ii) an agreement vitiated by mistake of both the parties of an essential fact (sec 20). (iii) An agreement having unlawful object or unlawful consideration (sec. 24) (iv) An agreement without consideration (sec 25)
(v) An agreement in restraint of marriage (sec 26) (vi) An agreement in restraint of trade (sec 27) (vii) An agreement in restraint of legal proceedings (sec 28) (viii) An uncertain agreement (sec 29) (ix) An agreement by way of wager (sec 30) (x) An agreement to do an act impossible in itself (sec 36) Most of these agreements which are void ab initio as indicated have already been explained in the previous topic. Some of the other void agreements are discussed in module II concerning consideration and capacity. Therefore, let us examine the one which is left out, viz., uncertain agreements. 8.3 UNCERTAIN AGREEMENTS An agreement which is uncertain is void. An uncertain agreement means an agreement where any terms of an agreement is not certain or capable of being certain. Some illustrations of an uncertain agreement where some term is not certain or capable of being certain can now be taken. A agrees to sell to B 100 tonnes of oil. There is nothing to show what kind of oil is intended. This agreement is void. But suppose A agrees to sell 100 tonnes of oil with a brand name there is no uncertainty; or suppose A who is a dealer in mustard oil only, agrees to sell 100 tonnes of oil there is no uncertainty here as well. A issues a cheque without specifying any amount. This is not uncertain because the person who receives the cheque may fill in the blank. This is simply empowering the payee to name the amount. Suppose A wants to sell his white horse for Rs. 7000/- or Rs. 8000/- there is nothing to show as to the price he actually wants. Therefore there is uncertainty and the agreement is void.
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9. CONCLUDING REMARKS When an agreement is void or the contract becomes void any party receiving any benefit under such agreement or contract is bound to restore it, to compensate the person from whom he received it. Suppose A pays B Rs. 1000/- in consideration of B promising to marry C, but C is dead at the time of the promise, the agreement is void. So B must pay back Rs 1000/- to A. Or say A gives B Rs. 1000/- for promising not to marry. The agreement is void so B has to return the money to A. According to Sec. 65 of the Indian Contract Act the person who has received advantage under void agreement or void contract has
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the obligation of returning the advantage. This is known as principle of restitution. Sec 65 is not applicable if the parties are wholly incompetent to contract. A minor cannot be asked to restore the benefit Mohori Bibi v. Dharmodas Ghose [(1903) ILR 30 Cal. 539] but in Daviah v. Shivamma (AIR 1959 Mad 188), it was held that the court may on equitable grounds order a minor representing himself to be a major while entering into an agreement, to restore the benefit received. Where the benefit cannot be restored the party must be asked to compensate.
10. BARE TEXT OF THE RELEVANT SECTIONS Sec 13. "Consent" defined - Two or more persons are said to consent when they agree upon the same thing in the same sense. Sec 14. "Free consent" defined - Consent is said to be free when it is not caused by (1) coercion, as defined in Section 15, or (2) undue influence, as defined in Section 16, or (3) fraud, as defined in Section 17, or (4) misrepresentation, as defined in Section 18, or (5) 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. Sec. 15 - "Coercion" defined - "Coercion" is the committing, or threatening to commit, any act forbidden by the Indian Penal Code, or the unlawful detaining, or threatening to detain, any property, to the prejudice of any person whatever, with the intention of causing any person to enter into an agreement. Explanation - It is immaterial whether the Indian Penal Code is or is not in force in the place where the coercion is employed. Sec. 16 "Undue influence" defined - (1) A contract is said to be induced by "undue influence" where the relations subsisting between the parties are such that one of the parties is in a position to dominate the will of the other and uses that position to obtain an unfair advantage over the other. (2) In particular and without prejudice to the generality of the foregoing principle, a person is deemed to be in a position to dominate the will of another (a) where he holds a real or apparent authority over the other or where he stands in a fiduciary relation to the other; or (b) 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. (3) Where a person who is in a position to dominate the will of another enters into a contract with him, and the transaction appears, on the face of it or on the evidence adduced, to be unconscionable, the burden of proving that such contract was not induced by undue influence shall lie upon the person in a position to dominate that will of the other. Nothing in this sub-section shall affect the provisions of Section 111 of the Indian Evidence Act, 1872. Sec. 17 "Fraud" defined - "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 another party thereto or his agent, or to induce him to enter into the contract:(1) the suggestion, as a fact, of that which is not true, by one who does not believe it to be true;
(2) the active concealment of a fact by one having knowledge or belief of the fact; (3) a promise made without any intention of performing it; (4) any other act fitted to deceive; (5) any such act or omission as the law specifically declares to be fraudulent. Explanation - Mere silence as to facts likely to affect willingness of a person to enter into a contract is not fraud, unless the circumstances of the case are such that, regard being had to them, it is the duty of the person keeping silence to speak, or unless his silence is, in itself, equivalent to speech. Sec. 18 "Misrepresentation" defined - "Misrepresentation" means and includes (1) the positive assertion, in a manner not warranted by the information of the 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 any one claiming under him, by misleading another to his prejudice or to the prejudice of any one 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. Sec. 19 Voidability of agreement without free consent - When consent to an agreement is caused by coercion, fraud, or misrepresentation, the agreement is a contract voidable at the option of the party whose consent was so caused. A party to a contract, whose consent was caused by fraud or misrepresentation, may, if he thinks fit, insist that the contract shall be performed, and that he shall be put in the position in which he would have been if the representations made had been true. Exception - If such consent was caused by misrepresentation or by silence, fraudulent within the meaning of Section 17, the contract, nevertheless, is not voidable, if the party whose consent was so caused had the means of discovering the truth with ordinary diligence. Explanation - A fraud or misrepresentation which did not cause the consent to a contract of the party on whom such fraud was practised, or to whom such misrepresentation was made, does not render a contract voidable. Sec. 19A Power to set aside contract induced by undue influence - When consent to an agreement is caused by undue influence, the agreement is a contract voidable at the option of the party whose consent was so caused. Any such contract may be set aside either absolutely or, if the party who was entitled to avoid it has received any benefit thereunder, upon such terms and conditions as to the Court may seem just. Sec.20 Agreement void where both parties are under mistake as to matter of fact - Where both the parties to an agreement are 103
under a mistake as to a matter of fact essential to the agreement, the agreement is void. Explanation - An erroneous opinion as to the value of the thing which forms the subject-matter of the agreement is not to be deemed a mistake as to a matter of fact. Sec.21 Effect of mistake as to law - A contract is not voidable because it was caused by a mistake as to any law in force in India; but a mistake as to a law not in force in India has the same effect as a mistake of fact. Sec.22 Contract caused by mistake of one party as to matter of fact - A contract is not voidable merely because it was caused by one of the parties to it being under a mistake as to a matter of fact. Sec.23 What considerations and objects are lawful and what are not - The consideration or object of an agreement is lawful, unless it is forbidden by law; or is of such a nature that, if permitted, it would defeat the provisions of any law; or
within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein, provided that such limits appear to the Court reasonable, regard being had to the nature of the business. Sec. 28 Agreements in restraint of legal proceedings void 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, or which limits the time within which he may thus enforce his rights, is void to that extent. Saving of contract to refer to arbitration dispute that may arise. Exception 1 - This section shall not render illegal a contract, by which two or more persons agree that any dispute which may arise between them in respect of any subject or class of subjects shall be referred to arbitration, and that only the amount awarded in such arbitration shall be recoverable in respect of the dispute so referred. Saving of contract to refer questions that have already risen.
involves or implies injury to the person or property of another, or the Court regards or it immoral, or opposed to public policy.
Exception 2 - Nor shall this section render illegal any contract in writing, by which two or more persons agree to refer to arbitration any question between them which has already arisen, or affect any provision of any law in force for the time being as to references to arbitration.
In each of these cases, the consideration or object of an agreement is said to be unlawful. Every agreement of which the object or consideration is unlawful is void.
Sec. 29 Agreements void for uncertainty - Agreements, the meaning of which is not certain, or capable of being made certain, are void.
Sec. 24 Agreements void, if considerations and objects unlawful in part - If any part of a single consideration for one or more objects, or any one or any part of any one of several considerations for a single object, is unlawful, the agreement is void.
Sec. 30 Agreements by way of wager void - Agreements by way of wager are void; and no suit shall be brought for recovering anything alleged to be won on any wager, or entrusted to any person to abide the result of any game or other uncertain event on which any wager is made.
Sec. 26 Agreement in restraint of marriage void - Every agreement in restraint of the marriage of any person, other than a minor, is void
Exception in favour of certain prizes for horse-racing - This section shall not be deemed to render unlawful a subscription or contribution, or agreement to subscribe or contribute, made or entered into for or toward any plate, prize or sum of money, of the value or amount of five hundred rupees or upwards, to be awarded to the winner or winners of any horse-race.
is fraudulent; or
Sec.27 Agreement in restraint of trade void - Every agreement by which any one is restrained from exercising a lawful profession, trade or business of any kind, is to that extent void. Saving of agreement not to carry on business of which goodwill is sold. Exception 1 - One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business,
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Section 294A of the Indian Penal Code not affected - Nothing in this section shall be deemed to legalize any transaction connected with horse-racing, to which the provisions of Section 294A of the Indian Penal Code apply.
11.
CASE LAW
Raghunath Prasad V. Sarju Prasad AIR 1924 PC 60 In this case, the defendant and his father were equal owners of a vast joint family property over which they had quarrelled. Consequently the father had instituted criminal proceedings against the son. The defendant in order to defend himself, mortgaged his properties to the plaintiff and borrowed from him about ten thousand rupees on 24% compound interest. In eleven years this rate of interest had magnified the sum covered by the mortgage more than elevenfold. The defendant contended that the lender had by exacting high rate of interest, taken unconscionable advantage of his mental distress and, therefore, there should be presumption of undue influence. While negativing such plea, the court held that the borrower failed to prove that the lender was in a position to dominate his will. The only relation between the parties that was proved was simply that they were lender and borrower. The first requirement of section 16 was, therefore, not fulfilled and, therefore, the borrower was not entitled to any relief. Schroeder Music Publishing Co. v. Macaulay (1974) 1 WLR 1308 In this case there was an agreement between a young song writer and a Music Publishing Co. The arrangement was to remain in force for 5 years and was to be automatically extended for another five years should the royalty from the boy's musical work reached the figure of £5,000. The Company could terminate the agreement at any time by giving a month's notice. The boy had no such right and he wanted to get out of it. The House of Lords ordered his liberation from the bond. The contract was on the terms of Company's standard terms and was, therefore, the result of the company's dictation. Said v. Butt (1920) 1 KB 497 In this case the plaintiff knew that on account of his adverse criticism of some members of a theatre, he would not be allowed to be present at the first performance of a play at the theatre. A
ticket was obtained for him by his friends without disclosing that it was for him. But the defendant, the managing director of the theatre, refused him admission on the night in question. The plaintiff sued him for inducing breach of contract. It was held that there was no contract between him and the theatre. While elaborating the court went on record by observing: "The non-disclosure of the fact that the ticket was bought for the plaintiff prevented the sale of the ticket from constituting a contract, the identity of the plaintiff being in the circumstances a material element in the formation of the contract." Gurumukh v. Amar Singh (1991) 3 SCC 79 In this case the court, held that where two bidders had agreed to supplement one anothers' bids at an auction without any intention to lower the price of the item or to defraud the government, the object of the agreement was lawful and valid. V. Parthasarathy v. Controller of Capital Issues (or the Larsen Toubro Case) AIR 1991 SC 1420 In this case the court held that although a company may purchase another's shares in the open market, if the transaction is done surreptitiously, with a malafide intention and by using a public financial institution in a clandestine manner, the transaction would be void as contrary to public policy by reason of section 23 of Contract Act. Reddiar v. Periara AIR 1991 Ker. 388 In this case an agreement for sale did not state the exact survey numbers or precise limits of the property to be sold. The agreement was thus challenged as void for uncertainty. The court held that as there was only one item of property that could be legally conveyed and this item of property approximated that referred to in the agreement and so both parties were well aware of the property to be conveyed, there was no uncertainty.
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12. PROBLEMS 1. The appellant a jeweller was insured by a company against loss by theft with the exception of jewellery "entrusted to a customer". Mrs. E posing as the wife of a wealthy customer made a few purchases from the appellant to inspire confidence, and then was allowed to take away two pearl necklaces of considerable value 'on approval' to show her supposed husband. She made away with the necklaces and the jeweller demanded compensation from the insurance company. The insurance company refused stating that this was covered by exceptions. Decide. Give reasons. 2. A plaintiff was induced to purchase a lorry by the defendant's representation that it was in an excellent condition. On the first journey after the sale, the dynamo broke and the plaintiff noticed several other serious defects. When the plaintiff informed this to the defendant he offered to pay half the cost of repairs. On the next long journey, the lorry broke down completely and the plaintiff realised that it was in a deplorable condition. He claimed to rescind the contract. Decide with reasons. 3. The Commonwealth Disposal Commission invited tenders for the purchase of a wrecked vessel described as 'an oil tanker on the Jurmaund Reef approximately 100 miles north of Samarai in New Guinea'. The plaintiff Merae's tender was accepted and he thereupon fitted out a salvage expedition at considerable expense. He came to now on this expedition that there was no oil tanker in the locality indicated, nor was there such a Reef called as Jurmaund Reef. The plaintiff brought an action claiming damages. The defendant argued that the agreement was based upon mutual mistake as to the existence of subject matter, therefore, void ab initio as such the defendant was not bound to pay any damages. Decide. Give reasons. 4. 'X' has entrusted cotton yarn for despatch to the 'Associated Transport Corporation Ltd' to the identified consignee in Delhi. The United India Insurance Company has covered these assignments. The goods reached Delhi. But the consignee refused to take delivery of 5 bales of cotton yarn since they were found to be in a damaged condition. The damaged yarn was re-booked through the Delhi office of the carrier on the request of the consignor. They were taken
5.
6.
7.
8.
9.
delivery off by the consignor in a damaged condition. The damage was assessed by the surveyor. The consignor submitted a claim to the insurer. The claim was settled at Rs. 10,89480 and paid by the insurer. The insurer became subrogated to the rights of the consignor. Thereafter, the insurance company filed the suit for recovery of damages from the carriers alleging negligence. The consignment contained printed words 'subject to Bombay jurisdiction alone' and also the following clause: "The goods required to be collected from the depot within six months from the date of arrival, otherwise the goods would be forfeited." Examine the validity of these two clauses. 'X' Company has entered into an agreement with M/s. ABC & Co. a firm dealing with retail sales of certain products. The agreement contains a clause which inter alia places restriction on M/s. ABC & Co. to exclusively deal with the products of X Co only for a minimum period of two years. Decide the validity of the clause. X & Co has entered into an agreement with Y & Co whereby X was to supply a generating set. In the process of entering into such agreement the Manager of X & Co observed that his Company's generating set can work without any mechanical defect for a continuous period of 5000 hours from the moment of installation. In fact the set has no such proven record. Assuming that Y & Co has agreed to purchase, examine under what circumstances, Y & Co may withdraw from the contractual relations. 'X' has entered into an agreement with Y & Co. The object of the agreement is to lobby the government, so that some favourable decisions may be taken in favour of Y & Co. The agreement provides for consultancy charges. Examine the validity of such agreement. X, a student of St. Xaviers College has entered into an agreement with his own professor Y. The agreement is to sell his motorbike for Rs. 25,000/-. However, his father wants to challenge the contract. Advise him. X took employment as clerk-cum-typist in a University and agreed not to serve in that capacity for anyone else in any part of India. Examine the validity of the agreement.
[ Note: Specify your name, ID no. and address while sending answer papers]
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13. SUPPLEMENTARY READINGS 1. Avtar Singh (1985) Law of Contract, Eastern Book Co., Lucknow, pp. 126-158. 2. Anson (1984) Law of Contract, English Language Book Society and Oxford University Press, London, pp. 179-289. 3. P.S. Atiyah (1986) Introduction to Law of Contract, Claendon Press, Oxford, London. 4. Cheshire and Fifoot (1986) Cases and materials on Contract, Butterworth, London, pp. 129-225. 5. Cheshire and Fifoot (1987) Law of Contract, Butterworth, London. 6. A.L. Godhart, Mistake as to identity in the Law of Contract, 57 LQR, 1941, pp 221-235. 7. Joga Rao. S.V. (1991) Cases and materials on contract (NLSIU Publication). 8. Kesava Rao (1990) Contract Inter Praesentes - Mistake in Identity, C.U.L.R. 33. 9. Pollock and Mulla (1986) Indian Contract and Specific Relief Acts, J.L. Kapur (ed), Tripathi, Bombay, pp 126-166. 10. Puri and Ponuswamy (1974) Cases and materials on contract, Eastern Book Co., Lucknow. 11. Trietal, G.H. (1966) Law of contract, Stevensons, London, pp 107-235. 12. Venkatesh Iyer (1987), (Reprint) Law of contract, Asia Law House, Hyderabad, pp. 140-142 and 308-314.
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Master in Business Laws Law of Contracts Course No: I Module No: IV
PUBLIC & GOVERNMENT CONTRACT ENGINEERING CONTRACT & QUASI CONTRACT
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 108
Materials Prepared By: 1.
Prof. V.S. Mallar
2.
Prof. N.L. Mitra
Materials Checked By: 1.
Ms. Sudha Peri
2.
Ms. Archana Kaul
Materials Edited By: 1.
Prof. P.C. Bedwa
© National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore - 560 072.
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Instructions In the Third World Countries the government plays an important role in using contract for generating public goods as well as distribution of the same. Even under capitalism state has a distinct role in economic operations. The famous economist Keynes himself attributed a big role to the state, especially at the time of inflation or stagflation. State has to take at that time a direct role in welfare activities, so that, money can percolate through the economic system, in order to generate public response to the market. These are all done by the government in the name of the state through the medium of contract. So whether it be in a developing economy or a developed economy state makes various types of contracts and manages them. An individual when he enters into a contract, is not accountable in any way for any thing outside the purview of the contract. But that is not so in the case of government and public contracts. As a result, state bureaucracy has to function within the framework of detailed rules and regulations because in the government contracts several issues beyond the contract can be raised. As for example, authority to enter into the contract itself can be challenged, the decision of finalising a specific party can be questioned, or the very methodology of the whole exercise itself can be debated. That makes government and public contracts a special category of study by itself. In this module, the intention is to acquaint you all with the basic framework of government and public contracts. In many cases even the big private enterprises also follow a detailed procedure for big contracts, especially engineering contracts. The main issue at this level is not the question of what is the contract, but relates to how is the contract made? As such many management issues are also concerned. The general rule of contract can explain things within the framework of a contract, because it is confined to the individual parties, who are themselves masters in designing their rights and duties through the instruments of contract. But ‘representative contracts’ be it governmental or not, can be related to many constitutional issues, such as, authority, manner of making the contract, principles of natural justice, so on and so forth. In representative contract therefore, procedure plays a very important role at every stage, and hence it is our intention to bring out in preliminary orders such procedures. A paper on ‘Contract Administration’, by H.B. Mirchandani has been briefly referred to in this module. Many other authors have also been referred to. It is advisable for those of you who want to know more details, and whose job deals with government and public contracts, to refer to the books mentioned in the supplementary readings. I am sure you will be benefitted by this module. N. L. Mitra Course Co-ordinator
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Public & Government Contract, Engineering Contract & Quasi Contracts
TOPICS 1. Public & Government Contract ..........................................................................................
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2. Engineering Contract ............................................................................................................
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3. Quasi Contract ........................................................................................................................
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4. Case Law ..................................................................................................................................
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5. Problems ..................................................................................................................................
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6. Supplementary Readings ......................................................................................................
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1. PUBLIC & GOVERNMENT CONTRACT SUB TOPICS 1.1 Introduction 1.2 Constitutional Framework 1.3. Constitutional Limits and Limitations 1.4. Personal Liability in Government Contract 1.5. Nature of Contractual Relation 1.6. Diverse Types of Contracts 1.7. Selection of Contractor 1.8. Public Law Remedy in Government Contracts 1.9. Statutory Discretion and Government Contracts 1.10. Financial Control 1.1 INTRODUCTION It is true that ‘Contract’ is the device through which people create rights and duties privately in between themselves. In a free market economy, the role of the state is limited to provide facilities for creating and implementing these rights and duties mutually agreed upon. Excepting that, state does not have any other role. But, in case of a ‘Welfare State’, the state has the power of intervention in order to ensure welfare of the people and also to see that no private agreement stands in the way of individual and society’s interst. On the other hand, in a socialist country, the state is a necessary party in all contracts between two or more citizens. Any private agreement can be made unenforceable on the plea of public interest. In a mixed economy, contract as a method of creating private right and duty, is accepted but the state creates a ring around the free contract area. Only parties obtaining licence, quota or permit from the appropriate authority can enter into the area of ‘freedom of contract’. Area of freedom of contract
> Protective line on the logic of public policy & public interest
India is theoretically a socialist state and, as such, state plays an active role in regulating this private legal area in the name of ‘public duty’ and ‘public interest’. Besides, in India the concept of State has been given a liberal interpretation by Article 12 of the Constitution. According to Art.12, the State includes the Government and Parliament of India, and the Government and the Legislature of each of the States and all local or other authorities within the territory of India or under the control of the Government of India. In the International Airport Authority case, (AIR 1979 SC 1628) the Supreme Court has given a very expanding meaning to ‘state’ in order to include all public sector bodies in the concept of local bodies and ‘other authorities’. As such, the area of government contracts has widened. A government company, under such an interpretation, is an instrumentality of the State. Government contracts are treated as public contracts. But all public contracts are not government contracts. Various public bodies enter into contracts which may not be governmental in character. Sometimes, some contracts between private persons may involve huge dimensions, so much so that interest of a large number of people may be concerned, for example, several types of engineering contracts or service contracts. Such huge contracts require detailed procedure both at the formational stage as well as implementation stage, so that interest of all parties are adequately protected. These contracts are also of various types like lump-sum contracts, commissioning contracts, turnkey contracts, labour contracts, etc. Sometimes, in a given situations, we have to construct a contractual relation due to application of principle of equity and justice. This construction of contractual obligation is known as fictional, constructive or quasi contract.
<
Entry through licence, quota, and permit ‘State’ itself is a corporate body and can enter into a contract in order to carry on its functions. There are two types of contracts entered into by a state. Firstly, in order to perform its external obligations and protecting national interest, the state has to enter into various bilateral and multipartite contracts. These contracts 112
are regulated by international bodies in international legal regime. Secondly, in order to discharge sovereign functions of a State, it has to enter into several types of contracts inside the state. These contracts are formally entered into by the Government in the name of the Sovereign (symbolic political sovereign). As for example, according to Article 299 of the Constitution of India, all contracts made in the exercise of the executive power shall be expressed to be made by the President. These contracts are generally known as ‘government contracts’. In a welfare State or a Socialist State, state enters into many types of contracts.
1.2
CONSTITUTIONAL FRAMEWORK
The province of Government contract has become increasingly significant in the modern world. The Government is constantly impelled to deal with the public at large by giving employment, by issuing license, entering into contract or some benefits. Although contract is fundamentally a matter of private law, the government contract partakes the dual character of administrative and contractual powers. The Government contract has become today a matter of public law. The Government has become subject to public law discipline in the contractual arena and
problems of estoppel, principles of natural justice, limitations in terms of fundamental rights and the applicability of the writ jurisdiction of the superior courts have increasingly been considered in the context of giving a good-bye to the earlier purely private law approach. The judicial approach has been to emphasise administrative aspects more than purely contractual aspects. The judicial shift from purely private approach to functionally public law approach thereby implying the applicability of the fundamental principles of administrative law and the constitutional law has been both instructive and interesting.
contracts. Art. 298 in its original form reads thus “The executive power of the union and each of the state shall extend, subject to any law made by the appropriate legislature, to the grant, sale, disposition or mortgage of any property held for the purposes of the union or of such state, as the case may be, and to the purchase or acquisition of property for these purposes respectively and to the making of contracts”. After the amendment of Art.298 by the Constitution (Seventh Amendment Act) 1956, the power of the appropriate Government to enter into the contract is not conditioned by the scheme of distribution of legislative power.
The Government, while exercising diverse commercial activities will have to resort to numerous contracts. Thus, Governments are parties to construction contracts, procurement contracts, repairing contracts, research and development contracts, licensing contracts and service contracts. The cardinal feature of the governmental contracts consists in the public accountability and constitutional responsibility in the negotiation, formation, conclusion, performance and termination. In India, for the purpose of power and capacity of the government to enter into contract and essential preliminaries for the formation of such contract the relevant article is Art.299 of the Constitution of India. Of course, Art 299 confines itself to contract in the exercise of executive power of the appropriate state. If Government enters into the contract in the exercise of statutory power, the relevant statute also becomes the appropriate guide for determining its validity.
The exercise of the contractual power is as important as the existence of such power. A party interested in contracting with the government is deemed to be fully aware of the variety of requirements as to the procedure and form of the contract. These procedural requirements are in the nature of conditions precedent for the constitutionality of a contract, the contravention of which renders the contract invalid. These procedural requirements are required to be distinguished from the terms and the conditions of the contract which regulate the performance of the contract after it is made.
No doubt, Art.299 specifies the triple conditions which the contract made by the Government should fulfill: 1. Such contracts must be expressed to be made by the President/Governor as the case may be. 2. Such contracts are to be executed by such a person in such a manner as the President/Governor may authorise. 3. Such contracts are to be executed on behalf of the President/ Governor as the case may be. Art.299 clearly lays down specific procedural essentials for the exercise of the contractual power by the State. The fundamental purpose and function of Art. 299 appear to be that the Government should not be saddled with the consequences arising from unauthorised contracts, for this would place public funds in jeopardy. At the same time, it is extremely inconvenient and practically impossible to insist that each and every contract must be in the prescribed manner or in a particular form. The judicial approach to Art. 299 has sought to balance the aforesaid two competing interests. The Courts have held that Art. 299 is mandatory and therefore there cannot be estoppel against Government contracts or ratification of such contracts in contravention of Art. 299. If such claims are entertained, it would result in repeal of a paramount provision in the constitution which is intended for protection of the public interest. It must be borne in mind that the power to enter into contract is an exercise of executive power. Art.298 makes it abundantly clear that the executive power extends to the making of
The formal requirements embodied in Art. 299 of the Constitution require some clarification: 1. The contract must be in writing: There are a number of interpretations in this area of government contract as to whether the written document should be formal or informal. If a formal contract deed or contract culminates from the consolidated correspondence and is not expressed through a formal deed it would suffice. The preponderance of the judicial decisions has been in favour of the proposition that it should be valid and binding contract between the parties despite the fact that it is not formally made and has been entered through correspondence. The word ‘execute’ in Art.299(1) should not necessarily mean the execution of a formal document of contract. It simply conveys the meaning that it should be in writing. [K.P. Choudhury v. State of MP AIR 1967 SC 203; Union of India v. N.K. Pvt. Ltd. AIR 1972 SC 915]. 2. The contract ‘expressed to be made’ by the President/ Governor as the case may be: The aforesaid constitutional requirements insist that the contract be expressed as having been made in the name of the President/Governor. Hence no valid document can be executed in the name of the Central Government or State Government and such contracts will not be valid and binding. It was held by the Kerala High Court in K.N. Vidyadharan v. State of Kerala [AIR 1980 Ker 212] that a contract made by the ‘Government of Kerala’ is not a contract made on behalf of the Governor and therefore there is no valid contract in the contemplation of the constitution. 3. The contracts must be entered into in such a manner as the President/Governor may direct: No specific law, rule, resolution or otherwise has been made to prescribe the manner in which contract be executed. However, all the 113
requirements which are prescribed by the constitution cannot be dispensed with or waived by any law made by the Parliament or the State legislature or by the consent of the parties to the contract. But, a supplemental law is not however forbidden. A Parliamentary law or a law made by the State legislature may provide for some more formal requirements in addition to those already enumerated in Art.299 sub clause (1) of the Constitution. In Karamshi v. State of Bombay, [AIR 1964 SC 1714], a contract between the Minister of Public Works Department (PWD) and the appellant firm was repudiated by the Government of Bombay on the solitary defense that the contract was not expressed in the name of the Governor who constitutionally represents the State. The reliefs sought by the appellant were specific performance of the contract or in the alternative damages for the breach of the contract. The Supreme Court dismissed the appeal on the singular preliminary ground of the failure to comply with the mandatory requirements of Art. 299(1). The Courts have more often than not adopted a pragmatic attitude in this area realising fully well that the insistence of too rigid postures and observance of all the conditionalities embodied in Art. 299 would be highly impracticable and greatly inconvenient from the administrative point of view. Hence the judicial approach to Art. 299 has sought to reconcile and harmonize two conflicting requirements: 1. to safeguard the interest of the government from unauthorised contracts. 2. to protect the bonafide contracting parties who enter into the contracts with the governments without complying with all or some of the formalities mentioned in Art. 299. A strict and rigid compliance would result in inequitable consequences as far as private parties are concerned. Hence the courts have softened the rigours of the formalities prescribed in Art. 299 by judicial interpretation taking into account fact situations. This equitable protective umbrella has been applied by the Supreme Court in respect of government contracts in the following cases. In the State of West Bengal v. B.K. Mandal, [AIR 1972 SC 77], the contract did not comply with the formalities found in Art. 299 but the contractor was ordered to be restored back any advantage received by the government applying Section 65 of the Indian Contract Act 1872. Likewise, where the contract for the supply of goods have been found to be void for noncompliance of Art. 299 but goods had already been delivered to the government by the contractor under such void contract the statutory obligation under Section 70 of the Indian Contract Act was applied with full vigor. It is also suggested that the contravention of the Art. 299 would nullify the contract. Consequently, therefore the acceptance of the application of the doctrine of estoppel or recognition of ratification of such contract have been refused by the Supreme Court. Before 1968, the judicial view was expressed that although informal contracts could not impose liability, government by ratifying such contracts could accept 114
responsibility. But Mulam Chand v. MP [AIR 1968 SC 1218], the Supreme Court adopted the rigid procedure and posture. No doubt the judicial view vacillated between liberal and rigid interpretation of Art. 299 depending upon the peculiar facts and circumstances of the cases. 1.3 CONSTITUTIONAL LIMITS AND LIMITATIONS Earlier the judicial tendency was to grant large amount of discretion to the government, to choose the party with whom it would enter into contractual relations, on the premise that the government enjoyed the same freedom as the private party in the matters of entering into contract. The Court shrugged its shoulders when asked to interfere with the governmental discretion in the matter of awarding contracts. This purely private law approach of the Supreme Court could be seen in acute form in an early case in C.K.Achuten v. State of Kerala, [AIR 1959 SC 490]. The petitioner in this case had contracts for the supply of milk at the government hospital over a considerable period of time. In 1957, the petitioner along with others submitted tenders and the same was scrutinised and the tender of the petitioner was accepted on 20th January 1958. After sometime, the petitioner was informed that the policy of government in the supply of milk to Government medical institutions was to be given to the co-operative milk supply union. The government invoked clause 20 of the conditions of the tender which empowered it to cancel a contract after giving a month’s notice. There upon the contract of the petitioner was cancelled. The bone of contention in this case was not the rejection of tender but a contract which was duly entered into. Hence a writ petition was filed before the Kerala High Court challenging the cancellation of contract as unconstitutional but the High Court dismissed the writ petition on the ground that it was a case of breach of contract if any, by the Kerala government, the appropriate forum was ordinary civil court of competent jurisdiction and the petitioner was advised to file a civil suit and not to proceed under Art. 226. A letter’s patent appeal was also dismissed. It is interesting to note that the petitioner instead of approaching the Supreme Court through special leave petition invoked the jurisdiction of the Supreme Court under Art. 32 raising the contention that he was denied equality before law by subjecting him to hostile discrimination as regards third respondent. He invoked the constitutional guarantees under Articles. 14, 16(1), 19(1) (g) and 31. With regard to Art. 14, the Supreme Court opined that there was no substance in the allegation of discrimination because the choice of the person to fulfil a particular contract must be left to the government which like any other private individual could prefer any contractor over another. Hence, claim for the protection of guarantee under Art.14 was not well founded. It was alleged by the petitioner that he was entitled to equal opportunity of employment under Art.16 of the constitution. The Supreme Court distinguished the contract for supply of goods from a contract of employment and pointed out Art.16 (1) has reference to employment in service rather than as contractors. There is no master and servant relationship between
the petitioner and the first respondent. Hence the second contention with regard to attraction of Art.16 in the instant case was rightly repelled by the Supreme Court. The court further held that the rejection of a tender or for that matter even the breach of contract does not tantamount to deprivation of the right of the petitioner to practise any profession or to carry on any occupation, trade, or business contained in Art.19(1)(g) of the Constitution. It also refused to invoke Art.31 to prevent the cancellation of the contract in the exercise of powers conferred by the terms of the contract per se. After all, a contractual right is not a property within the meaning of Art.31. The rationale behind the holding of the court seems to rest on the assumption, that the parties to the contract must accept the burdens of the contract along with its benefits. A mere breach of the contract cannot be remedied by the courts under the supervisory or visitorial jurisdiction. Hence in the Milk Supply case the Supreme Court refused to issue a writ of Mandamus because the contract merely produces private right and not public right. The ratio in Milk Supply Case was affirmed in Punnan Thomas v. Kerala, [AIR 1969 Ker. 81], where the question for consideration was whether any contractor could be blacklisted from submitting any tender or taking any government work for ten years. The challenge of the contractor was negatived by the Kerala High Court on the ground that no one had a fundamental right to insist that the government should enter into a contract with a particular person. The dissenting judgement of Justice Mathew, which became a forerunner of future judicial policy, struck down the government decisions as invalid for failure to observe principles of natural justice. The action of black listing not only involves economic loss but also a loss of reputation and any democratic government should not lay down arbitrary and capricious standards in the matter of choice of person with whom alone the government would deal. The aforesaid judicial decisions distinctly and clearly conceded extenuated powers to the Government in the matter of choice of persons as the other party to the contract. The analogy between Government and a private trader was over-emphasised. Governmental contractual power was not subject to fair and non-discriminatory norms. In the province of the Government Contracts, nowadays, Art.14 is invoked frequently. Wrongful and arbitratory rejection of tenders, arbitrary cancellation of tenders, tenders awarded by showing undue preference to others, unfair and wilful blacklisting of the contractors disabling them from entering into a contract with government in future coupled with concomitant result of considerable loss to the Exchequer are the usual allegations raised under Art. 14. Originally, the court took the view that the formation of the contract is a commercial function and not governmental function and the question of discrimination does not arise. The government like a private party can enter into contract with any individual at its sweet will and pleasure and the challenge under Arts. 14, 19 and 31 does not arise, all that an aggrieved party could do was to ask
the court to award damages or seek specific performance of the contract. The affected person cannot complain of constitutional contravention in the field of contract where there is no vested rights in any person. The compulsion to the effect that the government should enter into any contract with any particular individual has been negatived by the Supreme Court in Milk Supply case. However, a ray of hope was seen in Eurasian Equipment case, [AIR 1975, SC. 266] in which broad and all pervasive contractual power was sought to be subjected to a salutary restriction viz., government is bound to give a fair hearing to a person who was being blacklisted from entering into a contractual relation with it. Failure to do so would attract Art.14. The Supreme Court, rejecting the private law approach held that the public contracts are subject to Art.14. In the instant case the order of blacklisting contractor was served for the alleged reason that the contractor had infringed some of the provisions of Foreign Exchange Regulation Act, 1947 and the pendency of consequential proceedings against him. The Supreme Court, rejecting the private law approach, held that the public contracts are subject to Art.14. The government has to follow equality before law and cannot choose to exclude any person in a discriminatory manner. The State need not enter into contract with any one, but if it does, it has to be in accordance with fair procedure. Hence the Supreme Court struck down the blacklisting order for failure to issue the prior notice. The above proposition was reiterated by the Supreme Court in Vilangandan v. Executive Engineer, [AIR 1979 Supreme Court 1628], where blacklisting of a contractor was done without observance of principles of natural justice which would prevent the concerned person from advantage of a lawful relationship with government for gain. Hence blacklisting under such circumstances did raise problems under Art.14. But the application of Art.14 was invoked only at the threshold of a deal to protect the legitimate expectation of the citizen. It was unfortunately not extended to the stage of termination of contract by the government. A writ petition is always tenable to flay discrimination at the threshold when the contract is awarded as it inevitably involves the question of infraction of Art.14. The government must act fairly and impartially, granting equal opportunity to one and all. In Radha Krishna Agarwal v. Bihar, [AIR, 1977 SC 1496], certain forest lands were leased out for a specified period to collect and exploit certain seeds, on payment of a royalty. The cancellation of the contract for breach of certain conditions thereof was sought to be questioned by the appellants through a writ petition. The main plank of argument of the petitioners was that the obligation imposed by Art.14 could not be avoided by the State in the contractual field. The Supreme Court, rejecting the writ petition, said that Art.14 would be applicable at the very threshold or at the time of entering into a contract because at this stage, the State exercised executive power, but once a contract is created, the relations between parties would be 115
determined by the terms of contract and Art.14 does not hold the sway under such circumstances. This ruling of the Supreme Court kept away the application of Art.14 for the enforcement of performance of the contract or its cancellation. However, judicial attitude has undergone a sea change with the epoch making decision of the Supreme Court in R.D. Shetty v I.A.A.I. [AIR 1979 SC 1628] where the governments were compelled to follow certain standards and norms which are rational, relevant and reasonable in the matter of invitation of tenders. In the instant case, the Supreme Court was highly critical of the International Airport Authority of India, an agency or instrumentality of the Government of India, for entering into a contract for carrying on cafeteria at the airport with a person, who admittedly did not fulfil the conditions contained in the notification inviting tenders. The principle of reasonableness and non-arbitrariness of governmental action was heralded by the Supreme Court as the touchstone of Art.14. The public law limitations in terms of Arts.14 and 19 could enter, where the terms of the contract vest arbitrary and unreasonable power in the state. Therefore, State is bound to give equal opportunities to all those potential candidates who could offer themselves as contracting parties. The Supreme Court reiterated the same principle in Kasturilal v. J&K, [AIR 1980 SC 1992] speaking through Justice Bagawathi J. and held that there are two limitations imposed by law on the discretion of the government to deal with the public whether by way of entering into contract, or by way of giving jobs or permitting any other category of largess: (1) the terms and conditions on which largess might be granted; and (2) parties might be recipients or beneficiaries of such largess. The court is duty bound under the Constitution to assure and ensure that the terms and conditions are not detrimental to the public interest and choice of the party is not arbitrary and unreasonable by denying equal opportunities for all those who were potential competitors for government contracts. The Supreme Court entered with vehemence into the reasonableness and non-arbitrariness of terms of a valid contract which determines the rights and obligations of parties inter se in Central Inland Transport Corporation Ltd. v. Brojanth, [AIR 1986 SC 1571], wherein a rule constituting a part of the contract of employment between the corporation and its permanent employees came under scrutiny. The Supreme Court emphasized that it will not enforce and will strike down an unfair and unreasonable clause in a contract entered into between the parties because Art.14 is now considered as fountain head of audi alterem partem. The perplexing problems of contractual powers and its exercise in the context of constitutional limitations came in for further formulation and elaborate elucidation in Kumari Shri Lekha Vidhyarthi v. State of U.P and others [AIR 1991 SC 537]. The immediate problem for consideration in the instant case was the validity of an omnibus circular which embodied the decision of the State Government to terminate the engagement of all the Government counsels engaged through the State of U.P. at the district level, however so designated and it equally applied to all the Government 116
counsels irrespective of their tenure. In view of the formidable effect of this Circular, the Additional Advocate General of the State of U.P. strenuously contended on behalf of the State of U.P. that the relationship of the appointees to the offices of the Government counsel in the district, is purely contractual on the terms of the contract and is in essence an engagement of a counsel by a private party who can be changed anytime at the sweet will and pleasure of the litigant, without there being a corresponding right in the counsel to insist on continuance of the engagement. Further, it was contended that the appointment of a District counsel is only professional engagement terminable at will on either side and not appointment to a post under the government and hence, logically, there is a power vested with the government to terminate the appointment at any time without assigning any cause. This supra-distinction between ‘professional engagement’ and ‘appointment to a post under the government’ was deliberately made with a view to get out of the constitutional limitations to which a power-holder is subject to. The acceptance of the aforesaid attractive argument of the Additional Advocate General would, in effect and substance, involve unwarrantable assumption that the appointment may be terminated even during currency of the contract even without the existence of any cogent and convincing cause. This construction would result in conferring arbitrary power of termination to the government. The Supreme Court went in depth into the facts of the case and after thorough and threadbare analysis reached the following conclusion: “Applicability of Art.14 to the executive action of the State being settled and for the same reason its applicability at the threshold to the making of a contract in exercise of the executive power being beyond dispute, can it be said that the State can thereafter cast off its personality and exercise unbridled power unfettered by the requirements of Art.14 in the sphere of contractual arrangements and claim to be governed therein only the private law principles applicable to private individual whose rights flow only from the terms of the contract without anything more? We have no hesitation in saying that the personality requiring regulation of its conduct in all spheres by requirements of Art.14 does not undergo such a radical change after making of a contract merely because some contractual rights accrue to the other party in addition. It is not as if the requirements of Art.14 and contractual obligations are alien concepts, which cannot co-exist”. The aforesaid statement clearly and categorically brings out the judicial philosophy underlying the mandate of Art.14 is to be attending not only at the threshold of entering into the contract but also after the valid contract is entered into between a legal entity and any agency or instrumentality of Government. This is in view of the fact that an additional contractual obligation cannot divest the claimant of the guarantee under Art.14 of non arbitrariness at the hands of the State in any of its actions. The Supreme Court therefore clearly and categorically pointed out that once Art.14 is applicable, the existence of contractual obligation cannot be an excuse for non-performance of constitutional obligation.
Sterling Computers Ltd. v. M.N. Publishers [1993(1) SCALE 36], repeated and reiterated judicial dicta perceived in Kumari Shrilekha Vidhyarthi’s case and expressed the limits and limitations of the powers of the Government and the authority of the courts to interfere and intervene in the exercise of the executive power. The State takes into account objective considerations of the interest of the State and the public, and the Court cannot substitute its own decision for the decision of the authority entering into contract, for the court is not an appellate authority. However, Art.14 eschews arbitrariness and if the contract clearly violates Art.14, the claim of the State for some latitude or liberty in contractual matters cannot be upheld on the plea that it tantamounts to an encroachment of the exclusive right of the executive to decide one way or another. A carspectus of catena of cases clearly demonstrate the judicial policy that openness, impartiality and fairness are required to be observed not only while entering into contract but also in the terms and stipulations of the performance of contracts as well as its breach. 1.4 PERSONAL LIABILITY IN GOVERNMENT CONTRACT Article 299 (2) exempts the President and the Governors of the States from the personal liability in respect of the government contracts made by the union of India or the appropriate State. The personal immunity conferred on the President or the Governor as the case may be does not confer any immunity in the case of appropriate governments in respect of any consequential proceedings against them as mentioned in Art. 300 of the Constitution. In fact, the Bombay High Court in P.V. Rao v. Kushal Das [AIR 1949 Bom 277] held that Governor and the state government are two different legal entities. Hence immunity granted to the Governor cannot be extended to the state government. Hence the Governor cannot be held personally or vicariously liable. Merely because all executive actions have to be taken in the name of the Governors does not necessarily fasten them with personal liability. As far as the personal liability of the contracting officers signing on behalf of the state government is concerned Art. 299(2) provides for exemption from personal liability in respect of such contracts. In Chathurbhuj v. Moreswar [AIR 1954 SC 236] the Supreme Court was indirectly concerned with application of Section 230 (3) of the Indian Contract Act 1872 in respect of a government contract which was not in proper form. Hence difficulty arose as to whether the principal could be sued. The question was whether Section 230(3) of Indian Contract Act is applicable under such circumstances. The constitutionality of the government contracts nor the attention of the court was invited to the exemption of the personal liability embodied in Art. 299(2). The government was also not impeded in this case which arose out of an election dispute between two citizens. Therefore, the observation of the Supreme Court in Chathurbhuj v. Moreswar indirectly suggesting the invocation of Section 230(3) of the Indian Contract Act can be considered as not laying down the law correctly. A statutory provision
like Sec.233 of the Indian Contract Act cannot go contrary to Art. 299(2) of the Indian Constitution. Hence a statute cannot fasten a liability contravening the exemption accorded by Art. 299(2). If the contract is void and therefore legally unenforceable against the government, Section 230(3) cannot be given effect to. In State of U.P v. Murali Lal [AIR 1971 SC 2210], an attempt was also made to apply personal liability on the strength of Section 235 of the Indian Contract Act. The Supreme Court rightly rejected the contention and held that Section 235 would be applicable only if a valid contract is in existence. A void contract is incapable of ratification because whatever is applicable to Section 230 will also with equal strength be applied to Sec 235. Hence, from the aforesaid case the conclusion emerges that the contracting officer will not be liable personally in respect of a contract entered into on behalf of the government whether or not requirements of Art. 299 are complied with. 1.5
THE NATURE OF CONTRACTUAL RELATION
When government enters into the contract with governments of other countries for various purposes, such contracts are made in the exercise of sovereign power of State. Such contracts need not be necessarily made only for the pursuance of commercial activities, but also for the purpose of promotion of general welfare, and protection of international peace. These contracts are known as treaties or pacts which may be bi-lateral or multi-lateral and such are governed by the principles of international law. There are also contracts made by the government in the exercise of statutory powers. The government in India can carry on any business or trade or acquire any property or enter into any contract by making a law or without making a law. The power to contract is expressly vested in Art. 298 of the Constitution. Article 298 of the Constitution categorically makes it clear that it is an exercise of an executive power. However, the Constitution of India commands that under special circumstances a law is required for the purpose of certain types of exercise of executive power. Even without constitutional commands, the legislature may enact a law to enable the government to carry on avowed functions and consequently regulate such function and any exercise of such function must be in accordance with law. Any contract entered into in accordance with such law is known as the contract made under statutory power. For example, some of the State legislatures in India, have enacted laws for sale or option of the right to collect forest produce. The contract for aforesaid purposes made under the statute or the prescribed rules are contracts made in the exercise of statutory powers. Contract in order to be valid must satisfy each and every provision in the statute. However, Parliament has so far not made any law to regulate the contract of the Union of India. Once contracts are made under a statute, any infringement of statutory conditions can compel the government to act in accordance with law at the instance of the aggrieved party who might approach the court for the discharge of statutory duty by way of writ of mandamus. The last type of 117
contracts are those which are made in exercise of executive power of the State. Most of the contracts of the government of India fall under this category. It must be clearly understood that Arts. 298 and 299 refer to only government contracts namely contract made by union of India or States which are the units of Indian Federation. A statutory authority, local authority or any agency or instrumentality of the government could be a ‘State’ for the purposes of the enforcement of fundamental right under Art. 12, but they are not subject to the procedural limitation imposed by Art. 299. The contractual relationship between the government and other legal entities including individuals, comprehends a variety of dealings. For the sake of clarity they can be conveniently classified under the following heads: 1. Where the government acts as a supplier, manufacturer, producer of commodities and services. The persons are buyers or users and consumers. These include water, electricity, telephone, carriage of passengers and goods by railways, posts and telegraphs. Supplies and disposal of commodities and services are controlled by appropriate statutes. However, the supply of such services and commodities are given effect to mostly through contracts express and implied made between the consumers and the government. 2. The governmental contracts may include contracts made by them for the disposal of surplus goods and unserviceable stores. Such contracts are generally made through the process of auction. The sale of natural produce from the forest comes under the same category. The right to collect the produce from the forest as well as the right to catch fishes are sold through process of auction. Some of the States have made appropriate statutes and naturally contracts entered by them do fall in the province of statutory contracts. 3. The third category of contracts refers to cases where the government itself is a consumer of goods and services and therefore the biggest buyer. The following contracts come under this category. a. Procurement contracts : The modern government purchases many things ranging from ordinary stationery to supersonic jet. The contracts made for the aforesaid purpose can be grouped under this head. b. Construction contracts : These types of contract include new construction, addition and alteration to the existing property, replacement or remodelling of bridges, buildings, roads etc. Although there are Public Works Departments (PWD) at the government levels they neither have the capacity nor sufficient expertise for such massive construction and hence they award contracts to the experts in the field for which detailed procedure is followed. c. Repairing contract : They are entered into for the purposes of repairing, reconditioning, maintaining buildings, plants, machinery, bridges and roads etc. 118
d.
e.
f.
Development and Research contracts : Such types of contracts are for the purpose of conducting studies and research in the field of natural and applied sciences, social sciences etc., which may have bearing on the development of the State concerned. Licensing contracts : These are contracts meant for securing the performance of various services, running liquor shops, fair price shops etc. The inability of the government to carry on commercial activities by itself necessitates the issue of license to the persons concerned. All the ingredients of a contract could be found in the license. The governments in order to raise resources for the developmental activities are constrained to issue securities and bonds. Although these loans are governed by the respective statutes, these bonds inevitably constitute the contractual relations between the State and the citizens advancing the money. Service Contracts : It is highly doubtful whether a contract of service with government, can under ordinary circumstances be considered as a contract between the person so employed and the government and further whether such service contracts can be declared void for non-compliance under the provisions of Art. 299. This is because of the fact that once a person is appointed to government service, the government servant acquires a status, and his rights and obligations are no longer determined by the contract but by the statutory rules framed by the government or law made by the appropriate legislature and relevant constitutional principles. No formal document is executed between the government and the servant and issuance of the letter of appointment by the government and acceptance by the servant is the focal point of the commencement of the government service and the view has developed that such contracts are outside the scope of Art. 299.
1.6 DIVERSE TYPES OF CONTRACT There are different varieties of government contracts. The nature of supplies or services would determine what type of contract is required in a given situation. The difficulties are heightened because there is no statute or set of rules defining or regulating the diverse types of contracts. In commercial practice the following types of contract are in vogue. (1) Single Transaction or Fixed Price Contract Most of the government contracts fall under this category. It is known as Fixed Quantity Contract or Lump-sum Contract. Under this type of contract, the quantity of the materials to be supplied and the price and the time are fixed. Generally, the contractor is not entitled to raise additional expenses for any reason whatsoever. But variation in the price of the goods by the contractor may be permitted if there is ‘escalation’ clause. The remarkable feature of this type of contract is the inherent incentive to the contractor to perform the contract as early as
possible. It promotes efficiency. But the assessment of the price must be realised; otherwise under assessment or over assessment of the price might affect the contracting parties. (2) Rate Contract In a contract for supply of services for a sufficiently long yet specified period of time this type of contract is usually resorted to. In this category of contract an offer to supply goods at a fixed rate by a party is accepted by the other. The acceptance is not legal acceptance in the eye of the law. The offer is a standing offer and an order is placed in response to that standing offer, such order constitutes a fresh contract leading to and resulting in a binding obligation between the parties. (3) Running Contract Under this contract the contractor is required to supply an approximate quantity of goods at certain fixed intervals. The price is fixed and it remains so throughout the pendency of contract subject to price variation clause in which case increase in the price is allowable. The purchaser agrees to purchase a fixed minimum and the contract contains a clause permitting to buy an additional quantity of the goods upto a fixed percentage. During the currency of contract the condition forming part of the contract would empower the contractor to increase or decrease quantity of goods to be purchased under the terms of the contract. (4) Cost plus Percentage of Cost Under this type of contract, contractor gets actual cost incurred in the performance of the contract and the percentage of actual total cost as profit or fixed amount as determined on some rational basis. The actual cost would include the amount spent by the contractor on raw materials, taxes, duties, labour charges, depreciation and other establishment charges. If the contract is for the supply of goods for a long period, actual cost will rise with the increase in the inputs of different instalments, as the same goods are liable to be priced in different way. To obviate this difficulty the contract could provide for periodic revision of the prices. There will be stipulation in these types of contracts for the production of books of accounts for the inspection, periodic submission of certificates with regard to prevailing prices of raw materials etc. There is no incentive to the contractor to perform contract in time. (5) Cost plus Fixed Fee Contract This is an innovative version of the above type of contract. The actual cost incurred by the contractor is reimbursed whether it be incurred for supply of the goods, or rendering of services along with a fixed amount as fee. The profit of the contractor in this case is not linked with the cost. It is a sum which is mutually agreed and irrespective of the cost incurred he gets the fee. In repair or maintenance work, this type of contract is often pressed into service. Time is the only incentive for the contractor. The earlier the performance the quicker he gets money.
1.7 SELECTION OF CONTRACTOR The two processes generally employed for the initiation of government contracts are 1. Competitive tendering 2. Negotiative or non-competitive tendering The process of auction may also be resorted to. The choice of a particular process in a given situation depends on diverse considerations. The 'competitive tendering' is the usual method of entering into contract. Through the medium of competition, the supply of goods and services is possible at the most economical price. There is openness, impartiality and fairness in the selection of contractor. But, sometimes in view of constant competition prices are cut down and parties may try to avoid contractual obligation at the slightest pretext and on flimsy grounds. The quality may consequently suffer. But there are innumerable instances where the contracts have not been awarded to the last tenderer. There is not much rigid reliance on the rule of acceptance of the last tenderer. The acceptance of the slightest higher tender in genuine cases may result in increased cost. If there are reasons for doing so, the court would be shy to interfere. The competitive tendering is of two types : a. Open competitive tendering All invitation to tenderers are advertised, and everyone who considers himself as competent can submit his/her offer. Invitation to tenderers are issued to limited tenderers who are on the approved list. Those who are not on the approved list cannot submit tenders. b. Non competitive tendering The other method of entering into contract is known as ‘noncompetitive tendering’ by process of negotiation. If a particular brand of commodity or a product of the particular manufacture is required this type of method is resorted to so as to ensure that the price is fair and is not excessive. This is suitable for the procurement of stores. In India, the sole manufacturers are required to submit quotations. They are examined by the designated officials who are empowered to visit the place of manufacture to inspect the books of accounts and to gather such information as they deem fit. Afterwards, taking overall factors into consideration a tentative price is fixed. Then stage is set for negotiation and a compromise price is arrived at. The government has added in all these types of contract a concise condition as to “post costing rights” which empowers the government the right to refix prices under the negotiated contract after the contract have been completed. The said condition has become a part of the standard contract. When the government has to sell certain goods, or the right to collect the forest produce, catching of fishes in government fisheries, tolls, excise and licence, the contract is entered into through the process of auction. An auction sale may be either 'open competitive' or 'non competitive' depending on the mode of conducting the auction. In an auction sale, where a 119
government is not a party to the contract, a valid and binding contract comes into existence vide S.64(2) Sale of Goods Act, 1930. This provision may be applicable in an auction sale in which the government is the auctioneer or in an auction which is conducted on behalf of the appropriate governments. Even if after the hammer falls both the offer and acceptance are oral and such oral agreement are beyond the purview of Art. 299 of Constitution of India. Hence a critical and crucial question which falls for consideration is as to when can a binding contract be said to have concluded with the government through the processes of auction. This matter was considered by the Supreme Court in K.P. Choudhury v. State of Madhya Pradesh & Others, [AIR 1967 SC 203], where the appellant, a forest contractor agreed to bid for certain contracts for auction of diverse contract in that division in pursuance of a notification issued by the divisional forest officer. Every bidder was required to deposit earnest money as a condition of auction. The appellant gave bids for two contracts and his bid being the highest, the hammer fell in his favour. The amount of contract being more than what divisional forest officer could accept, the matter was referred to the Chief Conservator of Forest. Before the Chief Conservator could accept, dispute arose between the bidder and the government. When the matter finally came on appeal, the Supreme Court held that there was no contract between the government and the appellant before he bid at the auction nor was there any contract between them after the auction was over as required under Art. 299 because Art. 299 in effect rules out all implied contracts. In view of the above holding, an auction is held on or behalf of government. A contract entered into through auction comes into existence not at the fall of the hammer but when it is signed by the competent authority. Hence until it is approved by such competent authority no valid or binding contract comes into existence. This is a definite departure from the rule applicable to contract made through auction between private individuals. [State of Assam v. K.P. Singh, AIR 1953 SC 309]. It is also mentioned that if statute provides for oral contract, a valid contract comes into existence on the fall of the hammer. If however a contract is not made in pursuance of statute, it must satisfy the provisions embodied in Art. 299. This is on the assumption that Art. 299 will apply only in respect of contracts entered into in the exercise of executive powers and not those contracts made in the exercise of statutory powers. 1.8 PUBLIC LAW REMEDY IN GOVERNMENT CONTRACTS The contractors are inclined to invoke writ jurisdiction to enforce contractual obligation against the government. The writ of Mandamus can be issued by the superior courts only if the following conditions are cumulatively complied with: (1) the petitioner must have a legal right to the performance of the legal duty, (2) the legal duty must be of public nature (3) the right must be subsisting on the date of the writ petition, and (4) petitioner must have demanded the performance of the duty and the authority must have refused to do so. 120
The Supreme Court in an appeal, refused to concede a writ petition under Art.226 by holding that it is not maintainable to enforce a liability arising out of the breach of the contract. A contractual obligation cannot be enforced through a writ as the violation of the contractual obligation is not a breach of duty imposed by law. Any person affected by the exercise of a constitutional or statutory power by the government alone can seek redress by way of writ. The remedy lies some where else. The problem of enforceability of contractual obligation through the writ petition came in before the Calcutta High Court even before the commencement of the Constitution in P.K. Banerjee v. L.J. Simonds [AIR 1947 Cal.315]. In this case, the contract of the petitioner was cancelled on some valid grounds. The subject matter of the contract was the supply of iron scrap. Auction of the said iron scrap was advertised in a news paper subsequently, whereupon the contractor filed an application for an order directing the government to forbear from advertising for the sale of iron scrap. The attractive argument on behalf of the contractor was that by entering into a contract, a statutory duty had been created under S.31 of the Sale of Goods Act, 1930. And the refusal of the government to deliver the goods of the appellant as per the statutory duty amounted to breach of statutory duty imposed by Sec.31 of Sale of Goods Act, 1930. The Court repelled the contention and said that the contractual obligation cannot be enforced through a machinery created by Sec.45 of the Specific Relief Act. The identical argument was repeated with vehemence before the Calcutta High Court after the commencement of the constitution in C.M.W.M. Co. v. H.M.Jagtiani, [AIR 1952 Cal. 315]. It was contended in the instant case that the writ jurisdiction of the High Court under Art. 226 of the constitution is very wide. The writ could be issued to “any person” and “for any other purpose”. Hence writ of mandamus could be issued to enforce the obligation arising out of the contract. The High Court held that the duty imposed by the terms of the contract could not be considered as a duty of a public nature and hence the remedy was refused. If there had been a constitutional or statutory duty and there had been a failure to discharge aforesaid duties, writ of mandamus would be issued. In Venkata Subbayya v. Government of A.P. [AIR 1965 A.P. 425], the State Text Book Committee selected Hindi Text Book of the petitioner for the use of students. The Director of Public Instruction communicated that the petitioners books have been ordered to be prescribed during the year 1964-65 subject to the fulfilment of twin conditions: (a) the deposit of specified sum of money in the Government treasury; (b) execution of the agreement by the petitioner in favour of the Government. After some time D.P.I. informed the petitioner that the earlier communication is to be kept in abeyance. Afterwards, a third communication informed that the order prescribing the text books was cancelled. The subject matter of judicial scrutiny was the third communication. It was argued on behalf of the petitioners that they had sufficient interest emanating to file a writ as they have accrued a specific right by the first communication from the respondent. The court came to the
conclusion categorically that the concluded contract had not come into being. ‘ An interest is something inferior to a right in fact, it is merely a chance. It is inchoate right or incipient interest which cannot be the foundation for the exercise of writ jurisdiction under Art.226. The legal proposition that a writ of mandamus will neither lie to enforce the contractual obligation nor breach of contract is subject to some exceptions. While making a contract or at the time of breach thereof, if there is violation of the fundamental rights of the contractor or violation of the statutory provision under the pre-existing contract a writ of mandamus could lie. Moreover rights and liabilities may owe its genesis to the contract but may not be purely contractual but partly contractual coupled with statutory flavour, a writ of mandamus might lie. A breach of contract could take place in any one of the three ways: (a) where a contract is entered into in the exercise of the statutory powers under certain enactments and/ or the rules made there under and there is a reasonable allegation with regard to breach of the aforesaid statutory conditions on the part of the government; (b) where there is a genuine grievance that there has been a breach of promise or an assurance made by the government in pursuance of which the other party has acted to his detriment, but the agreement is short of Art.299 of the Constitution of India; and (c) where the contract entered into by the government and the affected party is non-statutory in character and purely contractual; the rights and the obligations are fully governed by the terms and conditions of the contract and the breach of the contract by the state is the subject matter of the challenge. In cases coming under the purview of the third category, no writ is maintainable to prevent a breach of contract. The remedies are the ordinary remedies either by way of suit for damages or for an injunction to restrain the breach of contract. In respect of cases covered by the second category the obligation arising against the State out of its representation amounting to a promise may be enforced ex-contractu by a person who acts upon its promise. This is out of equity, the courts have issued a writ of mandamus to compel the government to fulfil the promise or assurance on the ground of equity. [Union of India v. Anglo Afghan Agencies, AIR 1968 Sc. 718]. As far as the cases covered under the first category are concerned, the problems may arise for the alleged violation of the fundamental rights or statutory rights. In both the cases the origin of the right is in a contract. In Rashbihari Panda v. State of Orissa [AIR 1961 SC 108], the State of Orissa created its monopoly in the trade, government with a view to implement a monopoly scheme contemplated under the Act, entered into with agreement for the sale of kendu leaves after inviting tenders from the traders. One of the terms of the tender notice permitted renewal of the appointment for one year on mutually agreed terms and conditions between the parties. In 1968, the
government agreed to review the leases on fulfilment of the terms. Under the scheme, the government offered these leases to those who have worked satisfactorily in any previous year and made no default in the matter of payment. The writ petitions were filed challenging the legality of the fresh offers made by the government on the ground that while inviting tenders the government offered these leases only to certain old contractors which in effect and substance shut out existing business men and new entrants in the field. It was therefore ex facie discriminatory and unreasonable. Hence the Supreme Court refused to uphold the validity of the scheme and adjudged the same in the light of Art.14 and 19(1)(g) of the Constitution. Similarly the Allahabad High Court struck down an auction as ultra vires Art.14 and 19(1)(g) for the property of the State cannot be used in such a manner so as to enrich a particular category of persons to the detriment of the other citizens. [Rajendra Singh v. State of U.P. AIR 1973 All. 37] In State of Assam v. Thulsi Singh [(1964) 1 SCJ. 42], a rule framed under Northern India Ferries Act, 1878 provided that the sale shall be through auction generally to the highest bidder, and provided that there can be a deviation from the rule, if the competent authority gives sufficient reasons to be recorded in writing. Acting under the aforesaid rule, the Executive Engineer was reported to have rejected the highest bid of the appellant and accepted the next bid. The respondent challenged the order of the Executive Engineer rejecting his bid. The question for consideration before the Supreme Court on appeal was whether the settlement of the ferry rights by the Engineer was in accordance with the Act and the rules made thereunder. The court held in this particular case it was merely enforcing a statutory position and not an obligation arising out of contract. Sometimes, the courts have issued a writ of mandamus to provide succor to the harassed contractors. In Shaifulla v. State of U.P. [AIR 1961 All. 485], the government proceeded to recover the contractual dues as arrears of land revenue, which was an exclusive remedy available to the government, in the exercise of sovereign power and not as a contracting party. In this case, admittedly there was no enforcement of any statutory provision; but the court directed the government not to resort to special provisions of revenue recoveries for recovering damages for the breach of contracts, but merely to pursue the ordinary remedies available to the contractors. 1.9 STATUTORY DISCRETION AND GOVERNMENT CONTRACTS The executive power of the government to make a contract is not uncontrolled and unlimited. A contract can be varied or even abrogated by the legislature acting within its plenary power. It is a fundamental principle of law that a public authority which is empowered by a statute with a discretionary power meant to be exercised for the promotion of the public welfare by entering into a contract in general terms, cannot fetter itself in the exercise of such discretion. This is called the 'principle of non-fettering' of statutory discretion by a contract. The rationale for the aforesaid principle stems from the fact that the power of the 121
legislature to make the law is plenary and such power cannot be fettered. The pertinent question is whether the government could incur this ability by virtue of a contract which is statutory discretion came in for consideration before the courts more than once. In B.K. Das v. State of Assam, [AIR 1956 Assam 23], where the appellant firm was appointed as a distributor of certain controlled commodities including salt, subject to certain terms and conditions contained in the letter of appointment. One of the pre-conditions for the appointment was that of keeping in stock a specified quantity fixed by the government for such controlled commodity. The agreement could not be executed in the formal form. The government, in the exercise of the statutory power decontrolled the salt. Consequently the price of the salt came down, and as a result the firm incurred a huge loss which they tried to recover from the government. The contentions before the High Court was that the distributor was required to have a specified quantity of stock of salt till the date of decontrol, and the decontrolling of commodity resulted in the reduction of price and accumulation of loss. Rejecting the contention the court held that agreement between two parties could not control the statutory power of the government to remove control over controlled commodity. It was done by the governmen in different capacity. The power to control or decontrol vested in the statute could be exercised at any time by the government not withstanding any thing said in the contract to the contrary. This principle has been reiterated by the A.P. High Court in Secretary to Government, P.W. & T Department, A.P. v. Adoni Ginning Factory [AIR 1959 A.P. 538]. In this case the government entered into agreements with consumers in the State for supply of energy in bulk at specified rates for 10 years. There was no provision in the agreement to enhance the rate during the currency of the agreement. The government in exercise of the powers vested in it by virtue of Sec.3 of Madras Temporary Powers Act, 1949 issued two orders enhancing the rate contracted between the parties and imposing fuel surcharge. Being aggrieved by this action of the government, a consumer who is the party to the agreement also objected to the unilateral enhancement of the rate and challenged the legal validity of action. But the Division Bench of the Andhra Pradesh High Court held that enhancement of rate was done by the government not in the exercise of executive powers but in the exercise of statutory powers. The court further added that if the action of the government had caused any detriment to contracting party, the government will not be saddled with costs and consequences. However, where the Electricity Board was given a special statutory power to fix the tariffs by agreement with the consumers by virtue of special circumstances, the Supreme Court in Indian Aluminium Co. v. K.S.E. Board, [AIR 1975 SC.
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1967], held that the Board could not override the terms made in such agreement making use of the power to prescribe uniform tariffs specified in another section of the Act. The judicial scrutiny on contractual powers has expanded considerably in view of inevitable fact that the government contracts are standard forms of contract and are therefore onesided. In the normal commercial contracts the citizens have hardly any discretion to settle the terms of the contract. If any citizen would like to carry on commercial activities he will have no option but to agree to the terms of the contract to be entered into with the government. 1.10 FINANCIAL REGULATIONS The Constitution of India provides for the government accounts of the States and the Centre to be kept in three parts, viz., (a) Consolidated Fund (b) Public Accounts Fund (c) Contingency Fund Expenditures from Consolidated Fund are stipulated in Art. 112(3). The expenditure relating to all contracts of supplies and services are not a charge on the consolidated fund. These are to be included in various estimates of the claims of respective Ministries. Once the demands of grants are made and presented to the House, these are admitted to voting. Due to enormous increase in the governmental activities, effective direct parliamentary control has become physically impossible. Many of such activities are presently regulated by number of Standing or Adhoc Committees. Some of such committees relating to finance are Estimate Committee, Committee on Public Undertakings & Public Accounts Committee. Finance Ministry regulates the periodical needs. The Comptroller and Auditor General is responsible for examining all financial transactions in the country. The audit conducted by him ensures: (a) that all expenditures are incurred according to the provisions of the Constitution, laws and financial rules and regulations; (b) that proper sanctions and authorities exist; (c) that the expenditure is within the prescribed limit; (d) that supported documents and vouchers are kept; and (e) that the expenditure has been properly accounted for. Again, Public Accounts Committee ensures that the amount has been spent on the items for which it was granted. The Committee has to satisfy itself that the money shown in the accounts as having been disbursed was legally available for and applicable to, the service or purpose to which they have been applied or charged. As such all government and public contracts are subjected to all forms of Parliamentary Control. These are to be scrutinised by the Public Accounts Committee and externally audited by the Comptroller and Auditor General.
2. ENGINEERING CONTRACTS SUB TOPICS 2.1 Introduction 2.2 Types 2.3 Stages of Engineering Contracts 2.4 Tender Procedure 2.5 Management of Engineering Contracts 2.6 Special Contractual Features 2.1 INTRODUCTION Engineering contracts are given a special focus of study on account of the importance of such types of contracts both in the public as well as in the private sector. Most of the engineering contracts either directly involve public interest or indirectly touch the public interest. From the point of view of size, money involved and the need for huge labour inputs, all engineering contracts attract public notice in several ways. Everyday when we open newspapers we find several notices, informations and reports about these types of contracts. There are variety of engineering contracts, namely civil engineering contracts, mechanical, electrical and other types of installation contracts and service and maintenance contracts. An engineering contract can be defined as one where the promisor (builder contractor, installer, architect) promises to construct building (civil engineering) or install (mechanical / electrical/ telecommunication/electronics) a bridge, workshop or machine against consideration, at the site of the promisee. Alfred Hudson, King’s Counsel defined an engineering contract as one “under which .... a person .... called variously the builder or contractor undertakes for reward to carry out for another person, variously referred to as the building owner or employer, works of a building or civil engineering character. In the typical case the work will be carried out upon the land of the employer or building owner ....”. Following the example of the definition any mechanical/electrical/telecommunication contract can also be defined. 2.2 TYPES OF ENGINEERING CONTRACT Engineering contracts may have different types in formulating the contracts. Common types are: (i) Item Rate Contract (measured contract) (ii) Schedule Contracts (percentage rate contract) (iii) Lump-sum Contract (iv) Cost Plus Contract (v) Cost Plus Fixed Fee Contract (vi) Petty Labour Contracts (vii) Turn-key Contracts (viii) Sub Contract (a) back-to-back sub contract (b) other sub contract
Some of these types of contracts are explained in specific terms in the chapter on government contracts in this module. You have to take into account that explanation as well. (i) Item Rate contract: This is one of the most common civil contracts in India. In this system a schedule of items, quantities and rates form the conditionalities in the tender form, keeping rate column blank. The entire project work is broken into minutest constituent items which are described in detail keeping no doubt in work specification. The list is made in a schedule enclosed in the ‘tender documents’. The tenderer has to only specify the ‘rate’ and then the total item-cost based on the rate. Since the quantities in each item is accurately measured at the end of the performance of the contract to make the final bill notwithstanding the measurement given in the schedule, it is also known as measured contract. This type of ‘tender documents’ can only be prepared by professional architect who can calculate itemwise detail specification. If there is error in the specification the result can be disastrous. An error in the load capacity calculation may lead to irrepairable consequences. (ii) Schedule contracts or percentage rate contract : This is a type of item rate contract with a difference that in the schedule an ideal rate per item and the cost calculated on that are specified. The tenderer has to quote a certain percentage either above or below the scheduled rate. Generally speaking, Public Works Committee of the Central and the State government specifies item-wise ideal rate within a local limit. These CPWD/PWD rates are quoted item-wise in the tender document. The tenderer has the information about the ideal rate as calculated by CPWD/ PWD so that he can quote his rate percent in view of his own calculation. The rate percent may be specified item-wise or on the overall calculation. Item-wise percentage quotation (either above and below) requires itemwise calculation, whereas overall rate percent is easier to calculate on the overall ideal cost mentioned. (iii) Lump-sum contract : In Lump-sum contract the whole work is expressed in one single figure of cost. In this system, the parties require to know the drawings of work including crosssection drawings and all other general drawings of, minor changes required. A ‘schedule of deviation’ is also agreed upon. In a lump-sum contract, parties are not engaged in controversies on each step of the construction or installation which arise in ‘item-rate contracts’. Lump-sum contracts are suitable in stereotyped building works. (iv) Cost Plus contracts : These contracts generally have two components: (a) the cost of the work done, and (b) profits stipulated in the contract. Whereas part (a) is based upon actuals, part (b) may either be expressed in fixed amounts or as percentage of the cost. Percentage of profits may be either fixed or may be stipulated in a sliding scale [rate of profit is ‘variable’ depending on the cost of project]. This type of contract is generally preferred by the contractors, because in any case on account of increasing cost structure the contractor’s 123
interest is not hampered. But, it is very difficult for the employers to regulate this type of contract because ‘higher the cost involved, greater is the profit for the contractor’. As such, there is no auto regulation by the contractors to keep the cost at a minimum. (v) Cost plus fixed fee contract: This mode of contract is already explained above. These are contracts where the profits remain fixed regardless of any increase or decrease in the cost. (vi) Petty Labour contracts: In case of minor construction or maintenance works, the employer carries on the work under his own supervision with the help of labour contracts. In such contracts, the labour contractors who are also called ‘Sardars’ supply the labour, but the labour contractor is required to receive a pre-determined portion of work either daily, weekly or fortnightly. He is paid on the basis of actual measurement of the work done on the basis of pre-determined rates. He is personally responsible for paying the labourers. Although the employer does not have any contract with the labourers on which the employer-employee relationship depends, but for purpose of many statutes, like Minimum Wages Act, Payment of Wages Act etc, he is deemed to be the principal employer bound to fulfil statutory requirements. (vii) Turn-key contracts: Turn-key contracts are basically those where the contractor is himself required to design the project and execute the same. In all other forms of contract, the design is the job of an architect, or consulting engineer, or a designer, or of the in-house engineer. In turn-key contracts, the employer does not prepare the design of the project in detail. It is left to the contractor, either wholly or in bulk. As for example, in case of a building contract, the employer prepares the site-plan and an outline of the building, but leaves the detailed planning, architecturing, and the execution to the contractor. Therefore, in these contracts, the contractor is not only required to construct the work, but he is also accountable as a ‘project expert’, an ‘architect’ and a ‘designer’ as well. Turn-key contracts are generally suitable for high value jobs and can be done by highly professional and competent firms having multidisciplinary membership from various sections of engineering. (viii) Sub contract: A sub contract is one where the contractor enters into a further contract with another person known as a sub-contractor for some part of the work undertaken or sometimes even for the whole work. In the contract of agency, the sub-contractors are called as sub-agents. Generally speaking, an agreement of contract, authorises the contractor to do a specific job. He may do it either by himself or by appointing sub contractors. Unless specifically prevented in all engineering contracts sub contracting is an accepted phenomena. As for example, in the construction work there are several specialized works to be done,which are done through sub contractors, like plumbing, mosaic cutting wood work, painting etc. Sub-contracts are generally of the following two categories, viz : (a) Back to back: These are those sub contracts in which the prime contractor passes on the burden of execution of a specific issue of the contract to the sub-contractor almost on the same 124
terms and conditions as exist between him and his employer. As for example, in a building contract the job relating to plumbing on the basis of item rate contract may be delegated to a plumber almost on the same terms and conditions. Since the terms and conditions are the same, this type of sub-contracting is known as back to back. (b) Other Sub contracts: There may be various other types of sub contracts, on the basis of different conditions, for example, item rate, lump sum, schedule plus or cost plus. In case of huge construction or installation works the sub-contracting may even be on turn-key basis. 2.3 STAGES OF ENGINEERING CONTRACT Engineering contracts specially those in vogue in various government departments as well as large private concerns have the following distinct parts: 1) tender notice; 2) conditionalities in tender; 3) general and special specifications; 4) schedules for the purpose of billing; 5) payment schedule; 6) tender drawings; and 7) memorandum of agreement. 1) Tender notice Tender notice is a simple notice published in newspapers or sent individually to prospective tenderers. The notice may be local, regional, national or global based upon the size, importance and technology involved. The notice contains the work descriptions and call for collection of tender form. Tender documents are sold from a definite centre. Sometimes tender notice includes along with the nature of the work some information about the details of the work, time for completion, and approximate value of the work. The tender notice is the invitation to make an offer. But tender notice does not contain details of the works to be completed and the rates and offered amounts. The tender documents are obtainable by paying a fee and contain all those details. 2) Conditionalities in tender The tender documents contain three types of conditionalities namely: (i) Standard form conditionalities: Generally government works as well as works of big private institutions have a standard form contract with some uniform conditionalities either expressed in some regulation or guidelines. The tender documents may only refer to those rules, regulations or guidelines without specifying those in the document itself. In Jawaharlal Burman v. Union of India [AIR 1962 SC 378] it was held that the reference to such rules and regulations in the tender documents is enough for binding those conditionalities against the contractor even though in reality a copy of such a rule and regulation is not available.
(ii) General conditionalities: Apart from standardised ones which may include force majeure clause, escaclation clause, security clause and arbitration clause. (iii) Special conditions: These may be work specific location specific and contract specific. Some of these conditions are drawings, materials to be made available, special provisions for payment, sale contracts, third party indemnity, and liquidated damages. Some of these conditions require a brief explanation. (a) Material issue clause In some cases the contractor is supplied with some materials on certain terms. The contractor is required to account for the material according to the guideline issued, as for example, in the cement issue clause it may be stipulated as to how much cement to be issued to the contractor at what time and from which site. The terms and conditions of issue of such materials are stipulated in this clause. (b) Force majeure clause Force majeure clause protects the contractor from certain acts of God and acts of human being. This force majeure clause sometimes are specially designed for locational needs. As for example, an earthquake Richeter scale 2 may be a force majeure in Calcutta but may not be so in Garwal hills. Sometimes this clause also includes protection against strike and lockout. (c) Escalation clause In engineering or supply contract there may be an automatic adjustment provision in the contractual consideration based upon the market price fluctuations. (d) Bank guarantee clause Construction contract requires long time for performance. As such the employer often requires some kind of assurances for the timely performance of the contract, financial stability and security on the advance paid by the employer. This is often done through bank guarantee. in which the banker certifies the financial standing of the contractor. But such a bank guarantee does not make the bank bound as a surety. In order to make a specific guarantee a contract of guarantee is required to be entered into by the creditor with the surety, according to which the surety specifically undertakes to compensate the creditor in case of failure of principal debtor. Sometimes for obtaining bank guarantee of this nature some marginal money is required to be deposited and kept in the bank. (e) Recovery clause Sometime the contract includes recovery clause empowering the employer to withhold any amount of money on account of failure of the contractor to perform certain warranties (warranties are conditions but not essential for the purpose of contract, the breach for which shall make the employer entitled to claim compensation). (f) Arbitration clause In all inter-country agreements based on the issue of global tender arbitration clause is to be compulsorily included in the
contract. But a local regional contract may not have the clause. This is always advisible for the contracting parties to keep an arbitration clause in order to create an alternative forum for adjudication of disputes. If both the parties agree, they may have one arbitrator named in the clause to whom all matters of disputes between the parties are to be referred for decision. Alternatively each party may retain the right of appointing a separate arbitrator. In which case the arbitrator in their first meeting shall appoint an umpire. 3) General and special specification In engineering contracts there may be several general and special specifications. These are based upon drawings of the superstructure like framework, shuttering, centering etc. Sometimes special specifications are given for the purpose of load bearing capacity and terminal requirements. 4) Schedule of billing This clause includes the schedule containing finally negotiated and accepted rates of tenderer, and the modalities of periodically billing sometimes based upon the progress of the work or on the basis of time or both. 5) Schedule of payment The schedule of payment indicates payment to be made at various stages on the basis of schedule or bill of quantities submitted. 6) Tender drawings Tender drawings form the basis of contractors pricing. Engineering contracts often cannot be communicated in language. These are generally done through drawings. So the employer expresses his demands to the tenderer through the specification of drawings. Since the contractual rates and calculations are based upon these drawings a strict observation of the drawings is always necessary. 7) Memorandum of agreement The memorandum of agreement is the summary of the agreement reached between the employer and contractor which is required to be signed by both the parties on acceptance of the tender. 2.4 TENDER PROCEDURE An engineering contract can be entered into either through direct negotiation between the parties or through tender. Tender is infact a bidding process. The difference between tender and an auction is that, an auction is an oral bidding in the hearing of everybody whereas tender is a confidential bidding in writing without having any knowledge about the other bidders bidding. The tender notice as was already stated is an invitation to offer as well as information for an offer. A tender is an offer by the tenderer and the communication of acceptance of tender through the memorandum agreement or otherwise is the acceptance. Tendering is made in four stages as follows :
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(i) (ii) (iii) (iv) (i)
Preparation of tender documents; Receiving tenders; Processing and comparing the tenders; and Selection and communication of acceptance. The preparations of tender papers is a very important task. Based upon the types & nature of the tender, tender documents are prepared as e.g., in item rate tender or schedule contracts, detailed issues are laid down along with plans, standard form drawings of the work standard schedules are prepared; besides the standard form contract special conditions are drafted in the tender document. Tender may be open or limited. Where it is capable of being responded to by any one it is open, where there are prequalifications laid down and previous enlistment is necessary the tender is said to be limited. In most of the government contracts a previous enlistment is made on the basis of capacity of investment, work experience and technical competency. The enlisted contractors have various grades and they are capable of submitting tender within the capacity of listed grade of contractors specified by the govt. order. Once the documents are prepared the second stage of the work starts. (ii) In the second stage a notice of tender is published in daily newspapers as well through direct communication. Govt. contracts require these notices to be published under Public Notification Act, as such the tender notice is to be published in at least two local dailies of which one must be in the local language and the other in English. After the notice is published tender documents are sold from a notified address within the specified time period. The tenderers based upon the type of tender submit their offer enclosed in a sealed cover within the specified time and date. A receipt of receiving the tender may also be given. Immediately after the close of the tender, the tendering officer shall open the tender letters in front of the tenderers present at the time. The tender documents are checked, verified and signed by the tendering officer. Sometimes prospective tenderers may be required to visit the sight in order to effectively workout the tender offers. With the opening of the tender the second stage is complete. (iii) At the third stage, details of the tender documents submitted by the tenderers are checked and comparative tables prepared. If it is turn-key project comparative tables are prepared for each separate work required to be completed. Sometimes a meeting is called in which a negotiation is attempted by asking the tenderers their last turn. Such meeting may be general or individual. This is known as best bargain effort. The tenderer may withdraw his tender at any time before the tender is accepted. At the completion of the third step a complete comparative table is made based on which the final decision is arrived at. (iv) At the fourth stage the tendering officer takes a decision which is commonly known as acceptance of tender. He makes a decision on the most comparative advantage which 126
may be based on cost of the project, time of completion, quality of the work, reliability of the firm etc. Generally speaking, in govt. contract, best bargain is the lowest tender but it is not always necessary that the lowest tender has to be accepted. The deciding officer has to take an objective view of the comparative advantage. Once the decision is taken the contract paper is signed by the parties and the work order given. 2.5 MANAGEMENT OF ENGINEERING CONTRACT Once the contract is formulated, it is necessary that there is complete internal and external control mechanism at various stages. The following stages require a very careful considerations : 1. arranging bank guarantee and drawal of advances; 2. receiving mobilisation and other grant advance; 3. site makeover and initial development of the site; 4. planning of the work in different phases; 5. monitoring turn over in different phases; 6. work assessment and quality monitoring; 7. change in the constitution of the firm or company of the contractors (this is one of the most critical and litigative situation which requires a very careful monitoring); and 8. engaging sub contractors. Besides the internal control, there has to be on job controls, in order to have a balanced progress. The management has to identify the serious crisis points and locate insilnent failures. Of course payment of dues is the most controversial and litigative situation. In Hadley v. Baxendale it was decided that in a situation where the contractor has performed a part of the contract and he is unable to proceed further, he is entitled to the proportionate payment for the job he has already accomplished. This is known as quantum meruit. In the engineering contract, there are interactions of several line and vertical laws as for example, in order to construct a factory, one has to be careful about not only the contract law but also the Factories Act. A contractor is of course subjected to many other laws like Minimum Wages Act, Payment of Wages Act, Guarantee and Indemnity etc. Stages of Management: Given below are the various stages in the management of engineering contracts. (a) Work Plan The task of preparation of a work plan for a contract has to commence immediately after the award of the contract. Depending upon the nature and scope of the contract, it is first necessary to establish a task group to prepare the work plan. This group is entrusted with the collection of all available data relating to the work, the terrain, the environment, and all the internal or external factors which may affect all the three. The process of data collection and preparation of work plan is interactive and continuous and may also continue throughout
the execution of the contract. For large sized works, setting up a small team to update the data and point out glaring discrepancies from the initial data and its impact on the work plan is well worth the effort and the expense involved. The work plan has to be comprehensive and yet concise. A typical plan for a large civil engineering work may contain the following information (suitably abbreviated): (a) Description and scope of work (b) Mobilisation - phases (c) Construction survey and detailed construction programme
(c) Topic wise files - dealing with different stages or topics, such as, pre-tender, negotiations, agreement, mobilisation, execution, price and cost estimates, bills - variation equipment - materials - manpower - schedules - record of meetings held with client or the officer designated in the contract. Every contract manager tends to adopt his or her own system the key test being how quickly the required and correct data and details can be produced for taking timely decisions at every significant stage of the contract.
(d) Preparatory works for installation of the plant complex
(c) Claims
(e) Basis for plant selection and design (f) Individual plants - description in brief
As per L.J. Duncan Wallace, contractor's claims arise out of two principle basis:-
(g) Deployment of plant
1) Damages for breach of contract by employer (client)
(h) Production process of plant complex
These are sub-divided into:
(i) Sequence/methodology of work
(i) Breaches affecting the performance of the contract, which nevertheless proceeds to completion;
(k) Quality assurance (m) Construction schedule, PERT net work.
(ii) Breaches resulting in termination or recision of the contract before completion;
(n) Drawings/plates
(ii) Breaches of employer's payment obligations.
(o) Requirement of funds
(2) Additional Payment due under one or the other of contract provision, sub-divided into:-
(l) Safety programme
This work plan becomes the basis for the mobilisation and implementation of the contract.
(i) Sums due to variations (referred to as 'Deviations' in India).
(b) Records
(ii) Sums due to measurement in unit-price contract.
The execution of a contract is a one-off activity, which varies with each work depending upon its scope, location, environment in which it is to be executed, and the personalities involved. The term environment in this context includes the client's organisation, distribution of functional responsibilities within the organisation, working methods and procedure, and the culture of the organisation, in particular, its decision making process, and pace at which these decision are implemented in practice.
Mr. G.A.N. Rajan in his book - Law of Engineering Contracts Construction disputes and Remedies - analyses the relevant provisions of a claim for damages as arising when:
Over the years, efficient record keeping techniques have been evolved and implemented in large organisation. Good contract administration depends upon data. For data to be useful, it must be accessible and to be accessible, it must be recorded whether on paper or on a computer. For this purpose, it is preferable to derive check lists for critical aspects/issues and decide type of records to be maintained. Useful records may be maintained as under: (a) A complete and up to date copy of the contract along with all changes (finalised and in process) such as amendments, variations, interpretations, or decisions given in terms of the contract. (b) Contract files - either a continuous file - containing the correspondence in chronological sequence - with each page numbered and in parts - each containing 100 pages.
(ii) sums due to miscellaneous provisions in contract under changed physical conditions, variation in prices or other compensatory clauses in the contract.
a) A contract must have been broken by the other party. b) The other party should have suffered a loss or damage on this account. (if not, only nominal loss may be granted). c) The losses and damages must have occurred in the usual course of events from such a breach. d) The parties knew at the time of the signing of the contract, that in such a kind of breach, they would have to pay losses and damages to the other party, who has suffered by the said breach. e) No loss or damage is to be paid for any remote or indirect consequences. f)
The party claiming losses and damages should have taken steps to minimise it in the given circumstances.
g) In case of termination or recision of contract by employer, the contractor has to prove that this was unjustified. Let us now refer to the categories given above and briefly illustrate the possible basis of preparing the claim: 127
Breach 1.
Breach occurs, but work proceeds to completion
2.
Breach occurs before the commencement and work cannot be commenced
3.
Breach occurs during the work and the contract is terminated
Likely causes - Delay in handing over of site or change in site or site conditions - Delay in fixing orientation or change in orientation - Late supply of design, drawing of essential - Delay in clearances - Delay by other contractors - Unreasonable rejection of work - Defects or shortage of employer's supply materials - Suspension of work for causes not attributable to contractor - Excessive quantity variations - Delay in payment - Non-availability of site - Non-payment of advance - Failure of employer to obtain sanction to start work, or necessary funds - stoppage of work due to causes not attributable to contractor - unjustified termination of contract - continuing suspension or force majeure
2.6 SPECIAL CONTRACTUAL FEATURES Engineering contracts are of several types, such as (i) civil construction contract; (ii) supply contract; (iii) erection contract; (iv) mechanical/instrumentation contract like contract for testing and commissioning a plant or machinery; (v) maintenance contract, etc. 128
Possible Scope of claim - Increased costs arising out of the cause incl. losses or damages claimed by subcontractor/subsupplier (if any) - Idling of labour/ equipment
- Loss of profit which the contractor would have earned from the contract
- Fair and reasonable value of work executed plus loss suffered on account of termination/ recession
These contracts have several special features. Some of these features are discussed below: (a) Time is of essence to the contract : In engineering contracts time of performance plays a very important role. Generally speaking the stipulation is provided in the ‘tender papers’. According to Sec.55 of the Contract Act if time is of essence to the contract and the executing party does not fulfil his part of the contract within the stipulated time, the balance of the work not performed becomes voidable at the option of the other party. In case, promisee accepts the
performance after the stipulated time, he is said to have waived his condition and is not entitled to any other compensation. But if the time is not essential according to the intention of the parties to the contract, the promisee is entitled to some compensation but cannot repudiate the contract in case the contract is not executed in full within the stipulated time. The standard form contract in government departments, like Railway, CPWD, MES etc. time is mentioned in the respective rules as essence of contract with a proviso that authority may extend the time in appropriate cases. In Hind Construction Contractors v. State of Maharashtra [AIR 1979 SC 720] the contract was for the construction of an aquduct. The work was to commence on 5.7.55 and completed on 4.7.56. Terms and conditions, inter alia, included that (i) time shall be deemed to be of the essence of the contract (ii) In case of failure to commence or complete the work in time the contractor shall have to pay compensation per diem. (iii) in case of compensation payable by the contractors amounting to the full amount of security deposit, or in case of abandonment of the work by the contractor, the Executive Engineering shall be entitled to rescind the contract. (iv) in pursuance of an application by the contractor the time for performance could be extended at the discretion of the Executive Engineer. The contractor failed to complete the work within 4.7.56. The Executive Engineer in a letter dated 27.8.56 rescinded the contract w.e.f. 16.8.56 when the per diem compensation for delay accumulated and exceeded the security deposit. In this case, Court held that all the stipulations read together, and regard being had to the provision for penalty course per deim and the extension clause, the time was not intended to be of the essence of the contract. The Court further held that there was a case for extension due to onset of monsoon, absence of proper road at the site and other reasons as pleaded. A notice should have been given fixing a stipulated time for completion of the work failing which the contract could be rescinded. In the absence of the notice, the action was arbitrary and illegal. In English law unless 'the time as an essense of contract is clearly stipulated by the parties in the contract, time is rarely held as essence in a building and engineering contract. One may compare the position of the above Supreme Court decision with another Supreme Court decision in State of Maharastra v. Digambar Balwant Kulkarni [AIR 1979 SC 1339]. (b) Banker’s status report is not guarantee : A banker’s certificate of status report about a contractor is not to be treated as a bank guarantee. According to Sec. 12 of the Contract Act a contract of guarantee is one in which a party,
called the surety, undertakes to perform the promise of or discharge the liability of the principal debtor to the promisee. A bank guarantee is obtained against either a margin money deposit kept with the bank or against an overdraft facility with a limit. Sometimes bank also asks for counter-guarantee. On the other hand, a status report is one in which bank certifies the financial standing of the contractor with the bank on a particular date. It contains no guarantee. (c) Fair practice in acceptance :A contract is a method of establishing private relationship through offer and acceptance. An acceptor is free to accept any proposal he has received against his offer notice. He is not accountable generally to any one, far less the proposer, to explain why he has accepted the particular proposal, but in a representative status where an official takes the decision of acceptance he is accountable to explain why he has accepted a proposal to the institution or person whose representative he is. It is therefore, understandable that a public official having the responsibility of accepting a proposal is accountable to the public to justify his stand on certain objective criteria in order to show that his acceptance is for the best bargain. This is quite understandable but in govt. contract the public official accepting the proposal is required to have a fair play while accepting the proposal and he is bound to the proposer to explain absence of arbitrariness and favouritism. In several writ applications, courts have taken a position that there has to be a fair practice on objective criteria in accepting a proposal. Therefore govt departments, statutory undertakings, and even big industrial houses lay down stringent rules and procedures to ensure that there is a fair practice. In case of deviations specially in the situations of not accepting the lowest tender the bonafide of the decision has to be established according to the procedure established by law. d)
Rules of Interpretations: Odger’s construction of deeds and statutes provided rules of construction of contracts, specially engineering contracts. Supreme Court in Delhi Development Authority v. Durga Chand recognised Odger's rules of constructions listed below : Rule 1 : Meaning of a document or of a particular part of it is to be sought from the document itself. Rule 2 : Intention of the parties shall be understood from the document itself, unless otherwise clear. Rule 3 : Words must be given literal meaning. Rule 4 : Literal meaning depends on the circumstances of the parties. Rule 5 : The contract has to be construed as a whole. Rule 6 : Technical terms will have technical meaning.
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3 QUASI CONTRACT SUB TOPICS 3.1 Theoretical Foundation 3.2 Indian Instances 3.3 Concluding Remark 3.1 THEORETICALFOUNDATION Quasi contract or contract in fiction is an equitable concept arising out of the application of principle of equity in the realm of interpersonal relations. Chapter V of the Indian Contract Act relates to such type of interpersonal relations. The Chapter heading indicates the character of this type of relation. The heading of chapter V is ‘of certain relations resembling those created by contract’. It therefore suggests that there may be some situations when the law can construct a contract from the similarity of the position of the parties with that of contractual relations. This idea of fictional contract is a product of common law jurisprudence in England. According to Anson (p.617) “circumstances must occur under any system of law in which it becomes necessary to hold one person to be accountable to another, without any agreement on the part of the former to be so accountable, on the ground that otherwise he would be retaining money or some other benefit which has come into his hands to which the law regards the other person as better entitled or on the ground that without such accountability the other would unjustly suffer loss. The law of quasi contract exists to provide remedies in circumstances of this kind”. Anson of course, did not think the term quasi contract to a happy one though he is clear about the existence of such a situation where justice demands creation of accountability by one to the other. According to him distinctive marks of quasi contracts are: (i) Such a right is always a right to money mostly a liquidated sum though may not always be so. (ii) It does not arise out of contract between parties, but is imposed by law. (iii) This right is unlike tort, right against only a specific person. Anson has also examined the two views about quasi contracts. The traditional view is that it rests upon a hypothetical contract which is implied by the law. According to this view quasi contract has to be a branch of Law of contract and hence subject to some limitations. On the other hand modern view is that the liability in quasi contract is not connected with contract at all. Obligations are imposed by the law in the situation when one person unjustly enriched himself at the cost of another. It cannot be taken into the realm of tort because the remedy is not in rem. Historically, the situation has arisen out of the action of Account. The action was used against bailees, receivers and guardian in soakages, as they were called upon to account for money or other goods committed to their charge. The writ also came into use where money had been paid under a mistake or upon an executory consideration which had wholly failed or also where it had been extorted by fraud or duress. In 1602, in Slade’s Case [4 COREP 91] the full court of exchequer chamber held 130
that an indebitatus assumpsit could be brought in circumstances in which the debt was really the proper action as for example there can be a quantum meruit to be awarded against the person who had not performed his contract. Lord Mansfield is said to be the real founder of the modern law of quasi contract. In his judgement in Moses v. Macferlan [(1760)2 Burr 1005], Mansfield explained the judicial basis of such an action. Moses received from Jacob four promissory notes of 30s each. He endorsed these to Macferlan who, by a written agreement, contracted that he would not hold Moses liable on the endorsement. Subsequently Macferlan sued Moses on the notes in a Court of Conscience. The Court refused to recognise the agreement and Moses was forced to pay. Later, Moses brought an action against Macferlan in the King’s bench for the money. Lord Mansfield allowed the prayer holding “this kind of equitable action to recover back money, which ought not in justice to be kept, is very beneficial, and therefore much encouraged. It lies only for money which, ex acquo et bono, the defendant ought to refund: It does not lie for money paid by the plaintiff, which is claimed of him as payable in point of honour and honesty, although it could not have been recovered from him by any course of law; as in payment of a debt barred by the Statute of limitations, or contracted during his infancy, or to the extent of principal and legal interest upon an usurious contract, or, for money fairly lost at play : because in all these cases, the defendant may retain it with a safe conscience, though by positive law he was barred from recovering. But it lies for money paid by mistake; or upon a consideration which happens to fail; or for money got through imposition (express or implied); or extortion; or oppression; or an undue advantage taken of the plaintiff situation, contrary to laws made for the protection of persons under those circumstances. In one word, the gist of this kind of action is, that the defendant, upon the circumstances of the case, is obliged by the rules of natural justice and equity to refund the money”. This opinion of Lord Mensfield gave rise to the modern theory of fiction of law which was finally confirmed by Lord Haldane in Sinclare V. Brougham [(1914)AC 398] when he said “so far as proceedings, in personam are concerned, the Common law of England really recognises (unlike the Roman Law) only actions of two classes, those founded on contract and those founded on tort. When it speaks of actions arising quasi ex contractu it refers merely to a class of action in theory based on contract which is imputed to the defendant by a fiction of law”. The next principle that is presented is known as ‘restitution’. Any unjust enrichment at the cost of another is required to be restituted. According to Anson, the principle “includes the tortious action of conversion and also a proprietory remedy by which an owner can follow his property into the hands of any person into which it may come”. In equity, the principle of restitution includes both a personal action similar to, but not identical with, the action for money had and received (Re Diplock [(1948)Ch 465] and also the proprietory remedy of ‘tracing’.
3.2 INDIAN INSTANCES The instances of quasi contract in Indian law are based upon common law principles to a great extent. These are: (1) Supply of necessaries : According to Section 68 of the Contract Act (the Act) if a person is incapable of entering into a contract or any one whom he is legally bound to support, is supplied by another person with necessaries suited to his condition in life, the person who has furnished such supplies is entitled to be reimbursed from the property of such incapable person. This provision is explained by two illustrations: (a) A supplies B, a lunatic, with necessaries suitable to his condition in life. A is entitled to be reimbursed from B’s property. (b) A supplies the wife and children of B, a lunatic, with necessaries suitable to their condition in life. A is entitled to be reimbursed from B’s property. The essense of this provision is protecting the interests of the voluntarily supplier on the ground of equity without making any personal liability as happens in the case of contract. Essential ingredients are : (i) incapacity of the beneficiary to enter into a formal contract for the supply; (ii) the supply must form necessary to the conditions of the life of the beneficiary; (iii) the supplier to be reimbursed from the estate of the beneficiary. This is known as a equitable compensation in the case of the agreement being void on the ground of the incapacity of the party. In England, this principle is applied in a very wide context. This type of quasi contractual remedy is available when the consideration totally fails or where the agreement is void due to any reason. As for example, supply has been made by the contractor in an agreement found subsequently void. A supplier shall receive the money. (2) Payment by an interested person : According to Section 69 of the Act a person who is interested in the payment of money which another is bound by law to pay, and who therefore, pays it, is entitled to be reimbursed by the other. As for example, B holds land in Bihar, on a lease granted by A, the zamindar. The revenue payable by A to the government being in arrear, his land is advertised for sale by the government. Under the revenue law, the consequence of such sale will be the annulment of B's lease. B, to prevent the sale and consequent annulment of his own lease, pays to the government a sum due from A. A is bound to make good to B the amount so paid. The conditions of liability under this section may arise on the fulfilment of following conditions : (i) The plaintiff is not under legal compulsion to pay but he has only interest in the payment. Under the statutory provision court authorities are bound to pay compensation to the injured workman employed by
its contractors. Under workman compensation Act the contractor is liable to pay the compensation due. In Port Trust Madras v. Bombay Co., [AIR 1967 Mad 318] the Port authority was statutorily held liable to pay injured workman and had to pay him the compensation. So, when the Port Trust asked the contractor to reimburse the said amount, the Court held that it could not recover from the defendant, the contractor, whose negligence has caused the injury because the Port authority was statutorily liable to pay the compensation. (ii) The defendant is lawfully bound to make payment. As for example, in Govindram v. State of Gondal [AIR 1950 PC 99] the buyer of the property from Maharaja of Gondal had to pay the arrears of municipal taxes in order to save the society from being sold, it was held that he is entitled to the money. (iii) Plaintiff must have paid the amount. The plaintiff must have made the payments to another person. He himself must not be the creditor or the claimant. He must be a third party who has interests in the payment of money. In Secretary of State for India v.Fernandes [(1907) 30 Mad 375], the government was a tenant of a land and premises from a landlord who defaulted paying land revenue to the government. The government realised the amount from the rent payable to the owner. It was held that the government cannot realise the amount from the land lord. (3) Liability to pay for non gratuitous acts : According to Section 70 of the Act, where a person lawfully does anything for another, or delivers anything to him, not intending to do so gratuitously, and such other person enjoys the benefit thereof, the latter is bound to make compensation to the former in respect of or to restore, the thing so done or delivered. As for example, A tradesman, leaves goods at B’s house by mistake. B treats the goods as his own. B is bound to pay A for them. According to justice Gajendragadkar, there are conditions to be satisfied for application of this provision. These conditions are: (i) the person should lawfully do something for another person or delivers something to him; (ii) he must not intend to act gratuitously; The recipient of the goods or service must himself be benefitted. [See State of West Bengal v. B.K. Mandal & Sons' AIR 1962 SC 779 for details]. (iii) the basic philosophy of this section is based upon ‘compensating an innocent supplier’ for his act of subsistence. It must be remembered at the same time that the receiver of the benefit is not bound to accept the service or the goods. He has every right to either reject the goods supplied or services rendered or enjoy its benefits. Section 70 is applicable only when a person enjoys the benefits. By accepting the enjoyment of the goods or services, he has tacitly undertaken the obligation 131
of paying for the same. Therefore, it comes within the purview of implied contracts. In Secretary of State v. G.T. Sareen & Co. [ILR 11 Lah 37], it was held that “a person without an enforceable contract in his favour supplying goods to government department is entitled to a money equivalent of the goods delivered assessed at the market rate prevailing on the date on which the supplies were made". So a Contractor who has under oral instruction done something, he is entitled to the money u/S 70 even though he fails to prove the oral contract. The services that are rendered, or the goods that are supplied must be lawfully done. It must be remembered that Section 70 is based upon a principle of equity for compensating an innocent supplier, therefore one who comes to the equity must come with clean hands. A person who has kept some goods of another and is not legally competent to do so cannot demand compensation. As such a finder of goods cannot ask for compensation for the goods kept in the house of another person who used the same. (4) Finder of goods: According to Section 71 of the contract Act, a person who finds goods belonging to another and takes them into his custody, is subject to the same responsibility as the bailee. A finder of goods therefore becomes a bailee in case of need. He is therefore responsible for the restoration of the property to the owner. A finder has a better title on those gods against everyone excepting the true owner of these goods. (5) Mistake or Coercion: According to Section 72 a person to whom money had been paid or anything delivered, by mistake or under coercion, must repay or return it. As for example, A & B jointly owe rupees 100/- to C, A alone gives the amount to C,
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and B not knowing this fact pays rupees 100/- over again to C, C is bound to repay the amount to B. Money paid under mistake of law is also recoverable under this section as decided by the Privy Council in Sri Sri Shiva Prasad Singh v. Maharaja Srishchandra Nandi [(1949)76 I.A.44 (P.C)]. In English Common law money paid under mistake of law is not recoverable. Money paid under coercion is subject to the option of the person on whom the coercion has been perpetrated. If he elects to avoid the contract, the money thus paid is refundable. Of course the word ‘coercion’ has a wider import in Section 72. Money received in any condition of duress including under the pressure of circumstances makes Section 72 applicable. 3.3 CONCLUDING REMARK Quasi Contracts are instances of the application of equity principles in certain factual situations in order to construct a contractual obligation. Therefore, one who comes for equity must come with clean hands. If no factual situation the person who seeks equity shall be justified in one type of argument like ‘no one can be enriched without a cause’. He has also to substantiate the bona fide innocence, intention or justification of self actions. In this sense, a quasi contract is different from a tortious action. In quasi contract, a bipartite situation of benefit flow and obligation process is required to be established as if the benefit flows out of a constructive contract. As such, such an obligation cannot originate from a violation of right in rem. In such a case, the compensation question shall be related to tort. By and large, Indian instances of quasi-contract are based upon the same English common law principles.
4. CASE LAW 1) Charles Rickards Ltd v. Oppenheim [(1950) 1 All E.R. 420 C.A.] By a contract made between the plaintiffs and the defendant, the plaintiffs agreed to supply a motor car chassis to the defendant and to have a body built on to it within seven months, time being the essence of the contrct. The plaintiffs gave the work of building the body to sub-contractors and authorised them to accept instructions in regard to the work direct from the defendant. The sub-contractors failed to complete the work within the time stipulated. The defendant waived the original condition in regard to time but some months later, he gave a notice requesting delivery within a stated time. The car was not delivered within the time stipulated by the notice and the defendant cancelled the contract. The plaintiffs brought an action against him, claiming the price of the body work and he counterclaimed for chassis or its value. The court held that as there was an initial stipulation making time the essence of the contract, the defendant after waiving that initial stipulation was entitled to give a reasonableness notice making time the essence of the matter, whether the contract was for the sale of goods or for work and labour. The reasonableness of the notice had to be judged at the time at which it was given, and it could not be held to be bad because, after it was given, there were unanticipated difficulties in making delivery. The court further held that on the facts of the case, the notice was reasonable, and it was good notice to the plaintiffs even though it was given by the defendant only to the sub-contracts. Waiver of the notice could be inferred only from conduct which showed an intention to affect the legal relations of the parties and therefore, the defendant’s failure to reply to a letter from the plaintiffs in which they assumed that he would take delivery of the car at a later date, did not amount to a waiver of the notice, and the defendant was entitled to rescind the contract and to receive the chassis or be repaid its value. 2) Fateh Chand (Appellant) v. Balkishan Dass, (Respondent) [AIR 1963 SC 1405] In this case, the leasehold rights in the land together with building were sold to Balkishan Das (plaintiff). The plaintiff contracted to sell his rights in the land and the building to Fetch Chand (Defendant). The plaintiff received money and delivered possession of the building and the land in his occupation to the defendant, but the sale of the property was not completed before the expiry of the period stipulated in the agreement. Alleging that the agreement was rescinded because the defendant had committed default in performing the agreement, the plaintiff brought an action claiming a decree for possession of the land and building and a decree for compensation for use and occupation of the building. The trial judge held that the plaintiff had failed to put the defendant in possession of the land agreed to be sold and therefore could not retain the money received by him under the
agreement.He accordingly directed that on the plaintiff depositing Rs. 25,000/- less 1400/-(being the amount of mesne profits prior to the date of the suit) the defendant do put the plaintiff in possession of the land and the building, and awarded to the plaintiff future mesne profits at the rate of Rs.140/- per mensum from the date of the suit until delivery of possession. In appeal, the High Court modified the decree passed by the trial court and declared that the plaintiff was entitled to retain out of Rs.25,000/- paid by the defendant under the sale agreement, a sum of Rs.11,250/- being compensation for loss suffered by him and directed that the plaintiff to get from the defendant compensation for use and occupation. The defendant filed an appeal to the Supreme Court. The Supreme Court held that in the absence of any proof of damage arising from the breach of the contract, the amount of Rs.1000/- (earnest money) which has been forfeited and the advantage that the plaintiff must have derived from the possession of the remaining sum of Rs.24,000/- during all this period would be sufficient compensation for him. The plaintiff has separately claimed mesne profits for being kept out of possession for which he has got a decree and therefore the fact that the plaintiff was out of possession cannot be taken into account in determining damages. The Court set aside the decree passed by the High Court awarding Rs.11,250/- as damages to the plaintiff. The Supreme Court modified the decree and ordered that the plaintiff is entitled to retain out of Rs.25,000/only Rs.1000/- received by him as earnest money, and that he is entitled to compensation at the rate of Rs.140/- per mensum and interest on that sum at the rate of six percent as it accrues due month after month till the date of delivery of possession subject to the restriction prescribed by O20R12(1) of the CPC. 3) Gambhirmull Mahabir Prasad (Plaintiff) v. The Indian Bank Ltd and another [AIR 1963 Cal 163] Defendants 1 & 2 had their branch office at Rangoon. The plaintiff instructed the defendant Bank in Calcutta (defendant No.1) to arrange for the immediate re-shipment of the goods, lying in Rangoon to Calcutta and if re-shipment was not possible to arrange for insurance and storage of the goods. The Defendant No.2 offered to re-ship the goods on receipt of a deposit of Rs.400/- and certain documents. This letter was handed over by the plaintiff to the Defendant Bank (Defendant No.1) for further action. Thereupon the defendant bank wrote to defendant No.2 to arrange for re-shipment through its agent at Rangoon. Defendant No.2 agreed to reship the goods through its Rangoon Agents upon the deposit being made. The defendant bank paid to the defendant No.2 the said sum and accordingly the defendant No.2 communicated to its Rangoon Agent instructions for re-shipment. The plaintiff filed a suit against the defendant bank alleging that the defendant bank committed breaches of its agreement and of its duties as an agent of the plaintiff and conducted the business undertaken by it negligently and without skill and diligence. 133
The court held that it is essential to a cause of action that the act complained of should be the real or effective cause of the injury or loss sustained. The law disregards such subtleties and niceties, as to causes and possibilities, and it acts upon the intelligible ground that where there has been misconduct or negligence in the agent, all losses and damages occuring afterwards to which the property would not be exposed but for such misconduct or negligence, are fairly attributable to it, as a sufficiently proximate cause, although not necessarily the immediate or nearest cause of the loss or damage. The doctrine, too, may be vindicated upon the broader ground of public policy, that no wrongdoer ought to be allowed to apportion or qualify his own wrong; and that, as a loss has actually happened, whilst his wrongful act was in operation and force, which is fairly attributable to his wrongful act he ought not to be permitted to set up, as a defence, that there was a more immediate cause of the loss, acting upon the subject matter at the same time, or a bare possibility of loss, if his wrongful act had not been done. The measure of damages in an action by a Principal against his agent for negligence or any other breach of duty by the agent in course of the agency is the loss actually sustained by the Principal, provided that it was the nature and probable consequence of the breach or such loss as in the particular circumstances the agent might reasonably have expected to result from such negligence or breach of duty. 4) Jawahar Lal Barman v. Union of India [AIR 1962 SC 378] The principal point which this appeal by special leave raises for our decision related to the construction of Ss. 32 and 33 of the Arbitration Act, 1940 (hereafter called the Act). The respondent, Union of India, filed a petition in the Court of the First Class Sub-Judge at Delhi against appellant M/s. J. Burman and Co., through its proprietor Jawahar Lal Burman under Ss. 33 and 28 of the Act. The respondent alleged that a concluded contract had been entered into between the parties on August 31, 1949, for supply of 1701/2 Cwt. of coconut oil by the appellant to the respondent. The respondent had advertised in the Indian Trade Journal for the said supply and the appellant had submitted its tender No.SM-I/104524. This tender was accepted by the respondent which concluded a contract between the parties. The respondent’s case was that the said contract was governed by general conditions of contract Form W.S.B. 133. These conditions included an arbitration agreement. Disputes arose between the parties regarding the said contract, and so in pursuance of the arbitration agreement they were referred to the two arbitrators appointed by the parties. After the arbitration proceedings had gone on for a considerable time before the arbitrators, the appellant objected to their jurisdiction to deal with the disputes on the ground that there was no concluded contract between the parties. This plea made it necessary for the respondent to move the court for decision of the question about the existence and validity of the arbitration agreement. It was on these allegations that respondent in its petition claimed that it may be held that there was a concluded contract between the parties containing a valid agreement. The petition having been made under S.28 along with S.3 the respondent prayed 134
that suitable extension of time be granted to the arbitrators for making the award. The appellant pleaded in defence that no concluded contract had been made between the parties and that there was no jurisdiction in the Court to grant extension under S.28. The quetion as to whether there was a concluded contract between the parties or not requires careful consideration. We have noticed that in response to the advertisement published by the respondent in the Indian Trade Journal the appellant submitted its tender. It is common ground that the tender thus submitted was subject to the conditions of contract governing the Department of Supply Contracts which were set out in the Government Publication Form W.S.B.133, Clauses 4(a) and (b) of these conditions are relevant. They deal with the security deposit. Clause 4(a) provides that on acceptance of the tender the contractor shall at the option of the Secretary, Department of Supply and within the period specified by him, deposit with him a security deposit therein specified. Clause 4(b) provides that “if the contractor is called upon by the purchaser to deposit security and the contractor fails to provide the security within the period, such failure will constitute a breach of the contractor and the Secretary, Department of Supply, shall be entitled to make other arrangements at the risk and acceptance of the contractor”. It is thus obvious that the tender offered by the appellant submitted to these terms and that on these terms security deposit is a condition subsequent and not a condition precedent is not disputed; but Mr.Din Dayal contends that this position has been substantially varied by the Form in which the appellant’s tender was accepted by the respondent. His argument is that the material words used in the acceptance letter changed the pre-existing position and made the security deposit a condition precedent to the acceptance itself. If this contention is right it would necessarily mean that there was no concluded contract. Thus the decision of this point depends upon the construction of the letter of acceptance issued by the respondent to the appellant after receiving its tender. In this letter written on August 31, 1949, the respondent stated as follows : “Dear Sirs, Ref : Your Tender No & Date Nil. Your offer is hereby accepted for a quantity of 1704 Cwts & 2 qrs. of Coconut oil conforming to specification No.IM.1370(d) at Rs.89/6- (Rupees eighty-nine and annas six only) per Cwt. packed in non returnable sound, strong 45 gallon drums delivery ex-godown at Calcutta by 30-9-49 or earlier possible subject to your depositing 10 per cent as security. The security money which comes to Rs.15,230/- should please be deposited immediately into a Government Treasury in favour of the Deputy Accountant General, I & S., Akbar Road, New Delhi and the Treasury Receipt forwarded to this office. This security money will be refunded to you after the completion of the contract.
The contract is concluded by this acceptance and a formal acceptance of Tender will follow immediately on receipt of Treasury Receipt Kindly acknowledge receipt Yours etc. etc.” The whole argument is founded on the use of the clause “subject to your depositing 10 percent as security”. Prima facie this clause may justify the argument that it is intended to make the security deposit a condition precedent; but in construing the true effect of this clause we must look at the whole of the letter bearing in mind the fact that it has been written not by a lawyer or in consultation with a lawyer but by a Government officer in the ordinary course of the discharge of his duties. The first sentence in the first paragraph clearly shows that the offer was accepted for the quantity therein specified amount is deposited immediately into the Government Treasury. This paragraph is more consistent with Cl.4(a) of the general conditions. It reads as if having accepted the tender the appellant is reminded that it has to deposit the amount under the relevant condition, and the letter ends with the categorical statement that the contract is concluded by this acceptance. Mr. Din Dayal is right when he contends that S.7 of the Contract Act requires that the acceptance of the offer must be absolute and unqualified, it cannot be conditional; but reading the letter as a whole we do not think that the Courts below have erred in coming to the conclusion that this letter amounts to an absolute and unqualified acceptance of the tender or offer made by the appellant. While dealing with this question it may be pertinent to recall that the general conditions of the contract prescribed by Form W.S.B 133 are made a part of the tender, and the contract itself was intended to be executed expeditiously. The tender shows that the appellant represented that the earliest date by which delivery could be effected would be within twenty days from the date of the receipt of the order and it also said that full quantity of coconut oil required was held by it. Therefore, to begin with the tender treated the security deposit as a subsequent condition, the contract was for the immediate supply of goods and the acceptance purports to be in accordance with the relevant government rules and uses the expression that the contract was concluded by the said acceptance. Therefore, in our opinion, reading the letter as a whole it would not be possible to accept the appellant’s argument that the letter was intended to make a substantial variation in the contract by making the deposit of security a condition precedent instead of a condition subsequent. In the result the appeal fails and is dismissed with costs. Appeal dismissed. 5) Union of India and Others v. Messrs. Bhim Sen Walaiti Ram [(1963) 3 SCC 146]. An auction was held for the sale of licence of country liquor shop in Bela Road, Delhi for the year 1949-50, on March 23, 1949. The respondent offered the biggest bid of Rs.4,01,000/for the shop. Under the Excise Rules, the bidder was required to deposit one sixth of the price within seven days of the auction but the deposit was not made by the respondent. In these
circumstances, the Chief Commissioner did not confirm the bid of the respondent and resale of the Excise Shop was rendered. On May, 3, 1949, the shop was again auctioned when Messr. Daulat Ram Amar Singh offered the highest bid of Rs.2,20,000/ - which was confirmed by the Chief Commissioner on July 7, 1949. Holding the respondent liable for the loss of Rs.1,81,000/ - being the difference between the bid of the respondent and of Messrs, Daulat Ram Amar Singh the Collector of Delhi started proceedings for the recoveryof Rs.1,81,000/- Thereupon the respondent filed a suit in the Court of the Senior Subordinate Judge, Delhi, praying a permanent injunction restraining the appellant from taking any proceedings to recover the suit amount. The trial Judge decreed the suit holding that the sale was subject to confirmation by the Chief Commissioner under Clause 33 of the conditions of auction and since the auction in favour of the respondent was not accepted by him there was no concluded contract between the parties. The decree of the Trial Court was upheld by the lower appellate court. In the second appeal, Falshaw J of the Circuit Bench of the Punjab High Court at Delhi, took the view that Clause 33 was not in consonance with the statutory rules and the contract came into existence when the bidding was closed in favour of the respondent on March 23, 1949. The respondent therefore was held liable to make good the loss which the Government sustained in resorting to the resale of the excise shop. In the Letters Patent Appeal, the decision of the single Judge was reversed and that of the Trial Court. The appellant contended that the respondent was under a legal obligation to pay onesixth of the price within seven days of the auction under Clause 21 of Rule 5.34 of the Excise Rules and it was due to his default that a re-sale of the excise shop had to be ordered; and under Clause 22 of Rule 5.34,the respondent was liable for the deficiency in price and all expenses of resale which was caused by his default. This appeal is brought by certificate from the judgment of the Division Bench of the Punjab High Court. 2. An auction was held for the sale of license of country liquor shop in Bela Road for the year 1949-50" ExD-23 Clauses 31 and 33 of the conditions were to the following effect ; “31. The Chief Commissioner is under no obligation to grant license until he is assured of financial status of the bidder. At the conclusion of the auction an enquiry will be made into the financial position of any bidder not known to the excise staff and any such bidder shall if necessary be called upon to furnish security for the observance of the terms of his licence as required by sub-section (2) of Section 34 of the Punjab Excise Act 1 of 1949, as extended to Delhi Province. 33. All final bids will be made subject to the confirmation by the Chief Commissioner who may reject any bid without assigning any reasons. If no bid is accepted for any shop, the Chief Commissioner reserves the right to dispose it off by tender or otherwise as he thinks fit...” 3. The respondent offered the highest bid of Rs.4,01000/- for the shop, Under the Excise Rules the bidder had to deposit one135
sixth of the purchase price within seven days of the auction but the deposit was not made by the respondent. In these circumstances the Chief Commissioner did not confirm the bid of the respondent and resale of the excise shop was ordered. On May, 3, 1949, the shop was again auctioned when Messers Daulat Ram Amar Singh offered the highest bid Rs.2,20,000/which was confirmed by the Chief Commissioner, on July 7, 1949. Holding the respondent liable for the loss of Rs.1,81,000-. On July, 22, 1949, the respondent filed a suit in the Court of Senior subordinate Judge, Delhi, praying for permanent injunction restraining the appellants from taking any proceedings to recover the amount. The trial judge decreed the suit holding that the sale was subject to confirmation by the Chief Commissioner under Clause 33 and since the auction in favour of the respondent was not accepted by him, there was no binding obligation between the parties. The decree of the Trial Court was upheld by the lower appellant court. In second appeal Falshaw J took the view that Clause 33 was not in consonance with the statutory rules and the contract came into existence when the bidding was closed in favour of the respondent on March 23, 1949. The respondent was therefore held liable to make good the loss which the Government sustained in resorting to the resale of the excise shop. The respondent preferred an appeal under Letters Patent. The Division Bench allowed the appeal reversing the decision of the Single Judge and restored that of the Trial Court. Clause 21 of Rule 5.34 states: “A person to whom a shop has been sold shall pay one-sixth of the annual fee within seven days of the auction (any deposits already made shall be credited to future payments) by the 7th of the month in which he begins his business under his license and by the 7th of every subsequent month the licensee shall pay one twelfth of the annual fee till the whole fee is paid. But he may at any time pay the whole amount due if he wishes. If the total amount due is less than Ra.100 it shall be payable in one sum unless the Collector on special reasons, allows payment to be made in instalments. If any person whose bid has been accepted by the officer presiding at the auction fails to make the deposit of one-sixth of the annual fee, or if he refuses to accept the license, the Collector may resell the license, either by public auction or by private contract, and any deficiency in price and all expenses of such resale or attempted resale shall be recoverable from the defaulting bidder in the manner laid down in Section 60 of the Punjab Excise Act I, of 1914, as applied to the Delhi Province”. Rule 22 states: “When a license has been cancelled, the Collector may resell it by public auction or by private contract and any deficiency in price and all expenses of such resale or attempted resale shall be recoverable from the defaulting licensee in the manner laid down in Section 60 of the Excise Act as applied to the Delhi Province”. 4. On behalf of the appellants it was contended by Dr. Syid Muhammad that the respondent was under a legal obligation to 136
pay one sixth of the annual fee within seven days of the auction under Clause 21 of Rule 5.34 and it was due to his default that a resale of the excise shop was ordered. Under Clause 22 of Rule 5.34 the respondent was liable for the deficiency in price and all expenses of such resale which was caused by his default. We are unable to accept this argument. The first portion of Clause 21 requires the “Person to whom the shop has been sold” to deposit one-sixth of the total annual fee within seven days. But the sale is deemed to have been made in favour of the highest bidder only on the completion of the formalities before the conclusion of the sale. Clause 16 of Rule 5.34 states that “all sales are open to revision by the Chief Commissioner”. Under Clause 18, the Collector has to make a report to the Chief Commissioner where in his direction he is accepting a lower bid. Clause 33 of the Conditions, Ex D-28, states that “all final bids will be made subject to the confirmation by the Chief Commissioner who may reject any bid without assigning any reasons”. It is, therefore, clear that the contract of sale was not complete till the bid was confirmed by the Chief Commissioner and till such confirmation the person whose bid has been provisionally accepted is entitled to withdraw his bid. When the bid is so withdrawn before the confirmation of the Chief Commissioner the bidder will not be liable for damages on account of any breach of contract or for the shortfall on the resale. An acceptance of an offer may be either absolute or conditional. If the acceptnace is conditional the offer can be withdrawn at any moment until absolute acceptance has taken place. This view is borne out by the decision of the Court of Appeal in Hussey v. Hornepayne [1878(8)CHD670 at 676]. In that case V offered land to P and P accepted `subject to the title being approved by my solicitors. `V later refused to go with the contract and the Court of Appeal held that the acceptance was conditional and there was no binding contract and that V could withdraw at any time until P’s solicitors had approved the title. Jossel M.R., observed at p.626 of the report as follows: ‘The offer made to the plaintiff of the estate at the price was a simple offer containing no reference whatever to title. The alleged acceptance was an acceptance of the offer, so far as price was concerned, 'subject to the title being approved by our solicitors’. There was no acceptance of that additional term, and the only question which we are called upon to decide is, whether that additional term so expressed amounts in law to an additional terms or whether it amounts, as was very fairly admitted by the counsel for the respondents, to nothing at all, that is, whether it merely expresses what the law would otherwise our solicitors’ appears to me to be plainly an additional term. The law does not give a right to the purchaser to say that the title shall be approved by any one, either by his solicitor or his convening counsel, or any one else. All that he is entitled to require is what is called a marketable title, or, as it is sometimes called a good title. Therefore, when he puts in subject to the title being approved by our solicitors’, he must be taken to mean what he says, that is, to make a condition that solicitors of his own selection shall approve of the title”.
It was submitted on behalf of the appellant that the phrase “Person to whom a shop has been sold” in Clause 21 of Rule 5.34 means a “person whose bid has been provisionally accepted”. It is not possible to accept this argument. As we have already shown the first part of Clause 21 deals with a completed sale and the second part deals with a situation where the auction is conducted by an officer lower in rank than the Collector. In the latter case the rule make it clear that if any person whose bid has been accepted by the officer presiding at the auction fails to make the deposit of one-sixth of the annual fee, or if refuses to accept the license, the Collector may resell the license, either by public auction or by private contract and an deficiency in price and all expenses if such resale shall be recoverable from the defaulting bidder. In the present case the first part of Clause 21 applies it is not disputed that the Chief Commissioner has disapproved the bid offered by the Clause 33 of Ex.D-23 the auction sale in favour of the respondent would have been a completed transaction and he would have been liable for any shortfall on the resale. As the essential prerequisites of a completed sale are missing in this case there is no liability imposed on the respondent for payment of the deficiency in the price.
6) M/s. Timber Kashmir Pvt. Ltd v. The Conservator of Forests, Jammu [AIR 1977 SC 151]
5. For these reasons we hold that the judgment of the Punjab High Court is correct and this appeal must be dismissed with costs.
“5.13. The power to sanction or cancel the terms of instruments, leases, agreements is delegated in the following cases :
Sr. No. 1 9.
The Jammu and Kashmir Government had filed three applications under Sec.20 of the Jammu and Kashmir Arbitration Act, 2002, to refer disputes arising out of three agreements between it and the appellant Company to arbitration under the arbitration clauses of agreements between the parties. The applications had been dismissed by the learned Single Judge on the ground that the arbitration clause was, in each case, a part of an agreement which was not duly executed in accordance with the provisions of Section 122(1) of the Constitution of Jammu and Kashmir which correspond to those of Article 299 (1) of the Constitution of India. The Division Bench had allowed the appeals of the Conservator of Forests, Jammu Circle, after holding that the provisions of Section 122 (1) of the Constitution of Jammu and Kashmir could not be said to have been infringed if contracts were signed by the Conservator of Forests in compliance with an order of the Government. The main stay of the case of the appellant company was an instruction or rule contained in “the book of Financial Powers” which reads as follows:
Nature of Power
To Whom Delegated
Extent
2
3
4
To sell forest produce and to enter into contract for the same
Chief Conservator of Forests.
Upto Rs.7,000/- in value in each case provided the highest tender is accepted.
Conservators of Forests.
Upto Rs.3,000/- in each case provided the highest tender is accepted.
Divisional Forest Officer
Upto Rs.1,000/- in each case provided the highest tender is accepted”.
This rule existed prior to coming into force of the Constitution of Jammu and Kashmir. It may also be pointed out that this rule deals with the powers to “sanction or cancel” leases, agreements, and other instruments which was delegated to the officers mentioned there with limitations on their powers specified there. But, the Constitutional provision, relied upon on behalf of the appellant, relates to the manner of the execution of the formal document containing the contract after its sanction. It is true that the contract could not be executed with out the sanction. Nevertheless, if the sanction could be either expressly
or impliedly given by or on behalf of the Government, as we think it could, and if some acts of the Government could fasten some obligations upon the Government the lessee could also be estopped from questioning the terms of the grant of the sanction even where there is no written contract executed to bind the lessee. In this case, we have agreements from which the appellant company has derived benefits. And, these are contracts validly executed on behalf of the Government of Jammu and Kashmir by the Conservator of Forests. It is true that, if the appellant 137
could take up the legal plea that the contracts were not duly executed, in accordance with Section 122(1) of the Constitution of Jammu and Kashmir, it could urge that they did not have any effect at all as contracts whatever other legal consequences its acts or conduct may have had. But this does not mean that, if a party obtains benefits on the understanding that it would abide by certain conditions, as the appellant company had done, it could not be compelled to observe those condition to refer disputes to arbitration. The threee leases, containing the arbitration clauses which the appellant wants to avoid, were executed on 27th February, 1963 and 28th February, 1963 and 19th March, 1963, after the notification mentioned above. The leases were duly signed by Conservators of Forests, who were expressly authorised, without any limits imposed on the valuation of the leases, to sign and execute them on behalf of the Government. The delegation of power made prior to the Jammu and Kashmir Constitution related to grants of sanction and their cancellation. It did not expressly refer to powers to execute leases which is a separate matter. The notification of 1957, however, is specifically related to the execution of formal documents including leases. Hence, it will cover the three leases before us even if the former rules relating to the limits of the authority of Forest Officers to give or cancel certain sanctions could be said to be in existence at all after the enactment of the new Constitution of Jammu and Kashmir and the notification of 23rd February, 1957, cited above. The Jammu and Kashmir Government had tried to remove the doubts it entertained about the validity of past leases executed by the Conservator of Forests. It, therefore, passed two orders: one of 14th April, 1965, and the other of 29th April, 1971. The order of 14th April, 1965, ran as follows : “In suppression of previous orders regarding signing of lease agreement it is ordered that the Conservator of Forests will sign agreements relating to all cases of Forests leases and appropriation of forest products and Chief Conservator of Forests will act as the arbitrator as provided under Cl.44 of the agreement.
By order of the Government of Jammu and Kashmir. Sd/- Bharat Bhusan Secretary to Govt. Forest Department”. The order of 29th April, 1971, runs as follows : “Government Order No.FST-31 dated 14-4-65 shall be deemed to have taken effect from 29-1-63 and all actions taken by the Conservators of Forests in executing the lease agreements by virtue of the said order are hereby regularised. By order of the Government of Jammu and Kashmir. Sd/- R.C. Bhargava, Secretary to Government, Agricultural Department”. 7. The learned Chief Justice had observed that these orders, purporting to ratify the leases which were valid, did not have any legal effect whatsoever and were unnecessary. If there had been any question to be decided as to whether the Government had sanctioned the leases, its actions, apart from the execution of leases, could be considered. But, once there has been a valid execution of leases by duly authorised officers, the documents would be the best evidence of sanction also. That was one of the objects of prescribing a formal mode of execution of instruments on behalf of the Government apart from the need to protect its interests against mala fide and other unauthorised acts of its servants or agents. The only question which needed decision here was whether formal execution of the leases by duly authorised officers had been proved. We are of opinion that the Conservator of Forests was, for the reasons given by us. duly authorised to execute the leases. Accordingly we affirm the orders of the Division Bench so that matters in dispute between the parties could be validly referred to Arbitration under the appropriate clauses of the agreements These appeals are, therefore dismissed with costs.
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5. PROBLEMS 1.
Moti & Sohan Lal were bus owners who ran bus service and carried passengers for hire on different routes in the State of Uttar Pradesh. After the Constitution came into existence some of the persons were denied the permit to operate their buses on certain routes by the State transport authorities. This was done in pursuance of the policy of the State Govt. to run buses of their own on some of these routes.
Does the exercise of the executive power of the Union and the States under Art. 298 of the Constitution to carry on any trade or business activity to enter into contracts require any legislative sanction? Give reasons. 2. A tender was not accepted within a stipulated time. At the request of the govt. the tenderer agreed to keep it open upto 19.12.88. However on 30.12.88 he withdrew his tender offer. The govt. after giving him an opportunity of being heard, blacklisted the tenderer. a) Can a contractor be blacklisted for committing a breach of contract? b) Can a tenderer be blacklisted if he is not informed previously that such a penalty can be imposed if he withdrew the offer? c) Can govt. insert a new condition of blacklisting not previously known to the tenderer with retrospective effect in the invitation to tender? 3. A contractor had entered into a contract with the Union of India for supply of certain goods. A dispute arose between the parties and the same was referred to arbitration. Before the arbitrator, the contractor claimed a sum of Rs. 2,35,000 from the Union of the India on account of breach of the contract by it. The Union of India filed a counter claim against the contractor for a sum of Rs. 2,28,000 on account of loss suffered by it as general damages. When the matter was pending before the arbitrator, the Union of India asked the contractor to pay the said sum failing which, he was threatened that it will be recovered from his pending bills without any further reference to him. This action was proposed to be taken pursuant to clause 12 of the conditions of contract. The contractor approached the court under Sec. 41(b) of the arbitration Act, 1940. a) Discuss the issue involved in the case. b) Prepare a brief for the contractor. 4. Mr. Murthy’s firm is registered with Mr. Sohan. Under this registration, the annual requirement of Mr. Murthy has been assessed at 15,000 quintals. As such Mr. Murthy can quote only for this registered quantity. Regional Office of Mr. Sohan at Chandigarh invited tenders for the purchase and removal of damaged food grains declared fit for cattle/ poultry feed etc. Mr. Murthy submitted his tenders through Sri. Niranjan Lal in the prescribed form. The tender submitted by Mr. Murthy, was not signed by all the partners
of his firm. Tenders were submitted and opened on June 29, '93. However the tender of Mr. Murthy was accepted and an acceptance telegram was issued by Sohan on July 22, '93 which was received by Mr. Murthy on July 24, '93. The telegram dated July 22, '93 placed an order for stock of about 6200 M.Ts of damaged paddy for purchase. Mr. Murthy did not furnish the security deposit sum. Explain: a) Whether the contract between the parties is valid and binding on Mr. Murthy? If so, to what effect. b) Whether Mr. Murthy could quote only for the registered quantity of 1500 metric tonnes? What is the effect of capacity assured for registration on the contract entered into between the parties? c) Whether the contract could be executed by an authorised person on behalf of Mr. Murthy? If not, why? 5. The Govt. of U.P. had grown a large quantity of bhabar grass suitable for manufacturing paper. The Conservator of Forest was authorised on behalf of the govt to sell the grass and enter into contracts with regard to it on behalf of the govt. The Conservator of Forests invited tenders for a leased sale of the said grass. It was stated in the invitation to tender that the exact terms of the contract will be subject to settlement, but approximate terms can be ascertained before submission of tenders. Devi Prasad submitted a tender which did not reach in time. However the Conservator of Forest invited Devi Prasad to submit a fresh tender in which he offered to pay a royalty of rupees one lakh per year and agreed to take the lease for a period of ten years. He also agreed to deposit any amount by way of security as may be mutually agreed upon. Thereafter, a number of letters were exchanged between the parties negotiating the various terms and agreeing on many of them. Subsequently Devi Prasad without any valid reason refused to execute the leased sale and proceeded against the govt. for the recovery of security money which was forfeited. a) Is Devi Prasad entitled to recover the security money because it was a condition of the contract that a formal deed would be executed later on embodying the contract? b) Did Devi Prasad have an option not to go on with it as the contract was not complete until such deed was executed? 6. Chief Director of purchases, Food Department. Govt. of India invited tenders for selling the American cigarettes lying with the department. Rallia Ram submitted his tender offering to purchase the entire stock for Rs. 39 lakhs. Some correspondence took place between the govt and Rallia Ram and finally the tender of Rallia Ram was accepted by the govt. Rallia Ram took delivery of about 30 thousand packets of cigarettes and paid for the same. On inspection he found 139
that these cigarettes were mildewed and were unfit for use. The govt of India appointed a Board of Survey who after inspection reported that the cigarettes of the value of Rs. 6.5 lakhs wholly unfit for use and for the remaining cigarettes the Board recommended a reduction of price at a certain rate. Rallia Ram refused to accept the goods on the revised terms. The Govt cancelled the contract and offered to take back such cigarettes as were in the original packing. Afterwards a dispute arose as to the loss suffered on the cigarettes not in the original packing and interest. Matter was referred to arbitration. Arbitrator gave award in favour of Rallia Ram. Govt of India files an appeal on the ground that the award is liable to be set aside as there was no valid arbitration agreement in confirmity with Sec. 175(3) of the Govt. of India Act, 1935 which authorised the umpire to make his award. Decide. 7.
There was an advertisement for the sale of govt property. Mr. Joshi submitted his tender for the same. The govt. issued the acceptance to Mr. Joshi by a telegram. The telegram stated as follows:
“..... your tender for purchase of Government Gram sanctioned as follows(.) ....” FOOD SUP. Not to be telegraphed Sd/- R.L. Soni, for Director of Food & Civil Supplies M.P.
Index 5.1.74 Is there a valid and binding contract between the parties? Explain with reasons. 8. B agreed to erect a house for the plaintiff according to a plan by certain date. The defendants were B’s sureties. After partly completing, B ceased work, and the plaintiff, after giving notice to the sureties, entered and completed and sued the sureties for damages. Discuss with reasons if plaintiff is entitled to any relief. 9. The plaintiff agreed to build a house for the defendant using a special type of pipe. A different sort of pipe in fact was used, and the defendant refused to pay the final instalment of Rs. 50000/-. To replace the pipe would involve virtual demolition of the house and the substitute pipe was just as efficacious. Under this situation what is the liability of defendant towards the petitioner? 10. The plaintiff agreed to erect certain buildings on the defendant’s land for £ 1000. He failed to complete the contract. The defendant there upon completed the building himself using materials left at the site by the plaintiff. The plaintiff brought an action to recover the value of the work done and also claimed in respect of the building material used. Explain the liability of the defendant.
[Note: Specify your name, ID No. and address white sending answer papers]
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6. SUPPLEMENTARY READINGS 1.
Avtar Singh, Law of Contracts, (1985), Eastern Book Co. Lucknow.
2.
Anson, Law of Contract, (1984), English Language Book Society & Oxford University Press, London.
3.
Agarwal Y.K., Government Contracts Law and Procedure, (1984), Eastern Book Corporation, Delhi.
4.
Friedman, Law in Changing Society, (1984), University Book House, Delhi.
5.
Iyer, Venkatesh, Law of Contract, (1987), Asia Law House, Hyderabad.
6.
Jain M.P. & Jain S.N., Principles of Administrative Law, (1986), N.M. Tripathi Pvt. Ltd., Bombay, pp.808-889.
7.
Rao, S.V.J., Contract Law, (General Principles) Cases and Materials, (1991), NLSIU, Bangalore.
8.
Laxmi Narain and Murthy, B.S., Public Enterprises and Fundamental Rights, (1984), N.M. Tripathi Pvt. Ltd., Bombay.
9.
Puri, K.K., Australian Government Contracts Law and Practice, (1978), CCH Australia Limited, North Ryde, N.S.W.
10.
Puri and Ponnuswamy, Cases and Materials on Contract, (1974), Eastern Book Co., Lucknow.
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Master in Business Laws Law of Contracts Course No: I Module No: V
DISCHARGE OF CONTRACT
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 142
Materials Prepared By: Prof. S. Jagapathy, B.Com., (Hons), B.L., Advocate.
Materials Checked By: Ms. Sudha Peri, M.A., LL.M. Ms. Archana Kaul, B.Sc., LL.M.
Materials Edited By: Prof. N. L. Mitra, M.Com., LL.M., Ph.D. Prof. P.C. Bedwa, LL.M., Ph.D.
© National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore - 560 072.
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Instructions According to H.L.A. Hart law is a rule and in a legal system there are structures of various types of rules. To him the rule of governance i.e., rule of power management of the State craft is known as secondary rule of recognition whereas people are bound by primary rule of conduct which make the society possible. This primary rule of conduct is known as primary rule of evidence. There can be at least two types of primary rules of obedience. Firstly, involuntary and autonomous primary rule and secondly, voluntary and individual specific primary rule of conduct. Constitutional lawyers call the first as realm of public law of regulation and second as private law of conduct. Contract falls under the second category. Here two individuals entering into a specific contract among themselves create and determine mutual rights and obligations. Suppose A takes loan from B, A is obligated to pay it back. This principle of obligation discharge which neutralizes the contractual rights and obligations is covered in this module. The neutral position of the parties in the pre contract situation is shaped into a relational obligation which is again neutralized by certain action or inaction of the parties, thus discharging the contract. We have discussed various types and forms of contractual relations in the previous module. In this module we shall discuss about various ways of discharging the contract and ending the contractual relationship. If A takes loan from B, the easiest way is of course payment of the loan amount by A. But suppose B cannot be found despite all reasonable enquiry how long should A be bound to pay. The contract may itself provide a time period. The law of a country also provides a time period under the rule of limitations, at the expiry of which time the contract is discharged. If the government prohibits the payment A need not pay and he is discharged. So these are several of the ways through which the contractual obligations may be neutralized. You have to first determine as to what is the type of the contract which you are examining, who are the involved parties, what are their mutual rights and obligations either for demanding discharge or performing the role to discharge the contractual obligations. Then only you can observe various ground rules for discharging the contract. It is better for you to make a detailed marginal notes as you read the module and then prepare a check list of information given stating the ground rule of discharge. The relevant sections of the Indian Contract Act have to be analyzed in all cases. N. L. MITRA Course Co-ordinator.
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Discharge of Contract TOPICS 1. Discharge of Contract at a Glance ............................................................
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2. Discharge by Performance ........................................................................
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3. Discharge by Agreement ............................................................................
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4. Impossibility of Performance .....................................................................
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5. Bare Text of the Relevant Sections ............................................................
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6. Case Law ...................................................................................................
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7. Problems ....................................................................................................
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8. Supplementary Readings ..........................................................................
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1. DISCHARGE OF CONTRACT AT A GLANCE SUB TOPICS 1.1 Introduction 1.2 A Flow Chart 1.3 Types of Contracts 1.1 INTRODUCTION As contract has been formed by the creation or sometimes transfer of enforceable rights and obligations arising out of agreement between or among parties, the legal relationship can be brought to an end only by the Discharge of the Contract. Discharge of contract terminates the vinculum juris or legal tie that became the binding element between the parties. Discharge of Contract may take place in various ways as follows, by 1. Performance 2. Attempted Performance or Tender 3. Impossibility of Performance 4. Agreement 5. Breach of Contract 6. Operation of Law 7. Lapse of time When contract is discharged fully, the original rights and obligations get extinguished. However, different consequences follow the different modes of discharge of contract. There is cessation of legal ties in the more natural ways of discharge. There is nothing more to it between the parties. But when discharge takes place in certain other ways, the original rights and obligations no doubt terminate, but other rights and obligations arise between the parties out of the very process of discharge. The law has to follow the logical consequences of the new rights and obligations that have arisen even though the original contract is at the end. Let us illustrate this by antithetical examples : When contract is discharged by Performance which is what the parties originally intended, the mutual rights and obligations are extinguished as they have been fulfilled. But, when contract is discharged by Breach of Contract, or in other words when it is broken by the promisor by non-performance, the original mutual rights and obligations inside the contract are no doubt ended but the law takes its course by foisting between promisee and promisor, remedial rights and obligations of claiming damages or specific performance, as the case may be. The juridical basis of the last-mentioned situation is not limited to contract. It rests on the fundamental legal principle that as legal rights and obligations have to be enforced, their violation should lead to some suitable remedial rights and obligations. The general principle is expressed in the legal maxim, “Ubi jus ibi remedium” - “where there is a legal right, there is a remedy” : so far as law of contract is concerned, the breach of 146
contractual obligations will lead to the remedial rights to damages or specific performance, as the case may be. Taking an overview of the various ways in which discharge of contract may take place: Performance is the logical fulfilment of contractual obligations. It is doing what the parties intended to do when they entered into the contract and what they are bound to do under S.37 of the Contract Act. Performance is actual performance when the contractual obligations are fully and properly carried out. The contract is discharged. Attempted Performance or Tender will also discharge the contract. It is the legitimate attempt on the part of the promisor to perform his obligations under the contract at the proper time and place and unconditionally. But if the promisee unjustifiably either does not allow or accept the performance, the law treats the attempted performance or valid tender as equivalent to actual performance and deems the contract as discharged. This is the effect of S.38. Any rights accruing to promisor against the promisee inside the contract are not prejudiced by the discharge of his own obligations. The word “tender” came to be synonymous with “attempted performance” because of its English law association with the actual payment of the money in contract of debt by debtor to creditor. When dealing with Performance, various aspects connected with performance arise. Who are the persons obliged to perform contracts? Primarily they are the promisors. S.37 is the crucial enforcing section in the Contract Act. However, under S.40, where suitable, there can be vicarious performance by agents or other competent persons. Promises also normally bind the legal representatives, [see S.37]. They may have to perform such promises in case of death of promisor. Sometimes there may be joint promisors (Ss.42 to 44). Whether there can be assignment or transfer of contractual obligation has to be considered. Who are the persons entitled to claim performance? Prima facie, promisees or their legal representatives in suitable cases. A stranger to the contract cannot enforce performance except in exceptional cases considered in the Module on “Consideration”. There may be joint promisees under S.45. There can be assignment or transfer of contractual rights subject to certain conditions and the assignees can claim performance from promisors. Issues on time and place of performance are provided from S.46 to S.50. When we are on sequence of mutual performance, we turn aside and consider in this Module, the performance of Reciprocal Promises treated from S.51 to S.58. The important question as to when time of performance is deemed of the essence has to be considered. It is dealt in S.55 of the Act. This question has also special reference to commercial contracts with its crop of case law. What is the effect of failure to perform on time when time is of the essence? S.55 also treats of this. The law of appropriation of payments found in Sections 59 to 61
adjoins this area because it is a mixed question of time and place of performance. From the point of view of performance contracts can be classified generally in to absolute contracts including conditional contracts and what are truly contingent contracts dependant on a contingency, for example, a contract of insurance. The rules relating to performance of contingent contracts are contained in Sections 32 to 36 and the topic is considered adjoining performance. Discharge of Contract may take place by Agreement or Consent including Waiver. As it is agreement which binds the parties they can loosen themselves from it by another agreement which may be express or implied or between them and a fresh party or parties. This mode of discharge of contract vests on the legal principle ‘Eodem modo quo quid constitutor eodem modo destruitur’, - a thing may be destroyed in the same manner in which it is constituted. Discharge by agreement are covered in Indian law by Ss.62 and 63 of the Contract Act. S.62 deals with Novation or the substitution of a new agreement in the place of the old, S.62 also covers Rescission in which parties may agree to cancel all or some of the terms in the contract. S.62 also covers Alteration in which parties may agree to alter all or some of the terms in the contract. S.63 deals with Remission in which the promisee accepts a lesser fulfilment of the promise giving up the balance or extends the time or accepts a lesser satisfaction or wholly dispenses with the performance called Waiver such that the parties’ rights are abandoned. The difference between the English and Indian law is intricate, in this regard. Discharge of contract may take place by Impossibility of performance. Impossibility of performance may be - (a) impossibility apparent on the very face of the contract, intrinsic or absolute impossibility, as for example, an agreement to discover a treasure by magic, which certainly must be taken to be known to the parties themselves, so that the agreement is void ab initio. The contract may be said to be still born. Or, when making the agreement the parties may have been ignorant of its impossibility, as in the case of mutual mistake of fact as to the very existence of the subject matter when on discovery of the impossibility, the contract becomes void. On other hand, in practice, the more material kind of impossibility is that which arises subsequent to the formation of the contract which is called Supervening Impossibility or subsequent impossibility. S.56 of the contract covers both kinds of impossibility. Supervening impossibility as a ground of discharge was evolved by the English law on the basis of different sets of judicial theories. The old rule of English law was that impossibility of performance is no excuse as laid down in Paradine v. Jane [(1647) Aleyn 26]. called the “do or die” theory. But the rigor of such a view was modified by one line of judicial decisions that courts may read into a contract an implied provision even in the absence of an express one that the parties themselves contemplated that under the circumstances that have arisen rendering the performance of the contract impossible the contract would stand discharged. This theory is known as the “doctrine of implied term”. Another line of judicial decisions
in English cases developed the view that the doctrine of implied term is really a positive rule of law which requires the court to import into the contract, irrespective of the intention of the parties, in the circumstances that have arisen a term that there is such an impossibility that the contract justifiably is discharged. This theory is known as that of a positive rule of law of supervening impossibility. The English courts applied the principle of frustration as the result of either theory to various classes or categories of cases (reviewed in detail in the Module) including frustration in commercial contracts. These classes of cases are also recognised in Indian law. However, there are limitations to the doctrine of frustration of which the most important one is that frustration should be selfinduced. The Indian law of supervening impossibility is grounded in S.56 of the Act. It is closer to the second English theory of doctrine of positive rule of law. The Supreme Court of India held in the leading case of Satyabrata Ghose v. Mugneeram Bangur & Co. [AIR 1954 SC 44] that S.56 lays down a positive rule of law of supervening impossibility and it is the function and duty of the court to come to a conclusion whether in the changed circumstances on any of the recognizable grounds a contract has been discharged by supervening impossibility. What are the consequences of discharge by supervening impossibility or frustration? The older position in English law in Chandler v. Webster [(1904) 1 KB 493] was that any loss must lie where it fell was overruled by the House of Lords in Fibrose Spolka Akejsna v. Fairbairn Lawson Coombe Barbour Ltd [(1943) AC 32], by holding that as far as may be restitution had to be made as between the parties to a frustrated contract. The English law was consolidated by the Law Reform (Frustrated Contracts) Act of 1943. It is interesting to note that the position reached in English law by the above statute is already secured in the Indian law by S.65 of the Act with respect to the consequences of frustration. Discharge of contract by Breach will be treated in the next module in detail as it has many ramifications. It remains to briefly refer to discharge of contract by operation of law and by lapse of time. It is not necessary to treat them in any greater detail in this Module. A contract may be discharged independent of the intention or wishes of the parties by operation of law. This happens in the following situations: (a) Death: Death of party in a contract involving personal skill or ability. It is only in other contracts the rights and liabilities can devolve on the legal representatives. (b) Merger: Merger takes place when rights accruing to a party under a contract get absorbed into certain other rights accruing to the same party under the same or some other contract. For example, T holds property under a contract of lease. Later, he enters into a contract with the lessor to buy the same property and buys it and becomes its owner. Another good example is when the acceptor of a bill of exchange becomes its holder by a subsequent endorsement eventually. 147
(c) Insolvency: In Insolvency, when an order of discharge has been obtained from the court, the insolvent is discharged from all debts and contracts subject to certain exceptional debts. In insolvency, the estate of the insolvent vests in the insolvency authorities who also exercise all his rights ex-contractu, arising from contract.
against persons who were parties thereto before such alteration unless they have consented to the alteration. The Act exempts in specific sections certain material alterations necessary for the operation of instruments. For example, the crossing of cheques. A contract may get discharged by lapse of time. The law of limitation which in India is codified in the Limitation Act, 1963, lays down that a contract should be performed within a specified period, failing which, if no action is taken by the promisee within the period of limitation, the remedy at law is deprived. This, in effect amounts to discharge of the contract. The period of limitation for simple contracts, in India, is three years. S.5 of that Act provides for extension of time in proper cases.
(d) Unauthorised Alteration in Contract Deed: Where a party to a deed or contract in writing makes any alteration in it without the consent of the other party, and the alteration is in a material part of the contract which depends on the character of the instrument, and it changes in a significant way the rights and liabilities of the parties, the other party can avoid the contract. According to S.87 of the Negotiable Instruments Act, a material alteration of a negotiable instrument renders the same void 1.2 A FLOW CHART
Discharge of Contract Types of Contract Contingent Contract (S.31)
Reciprocal Contract (S.51)
Positive Contingency (S.32)
Negative Contingency (Ss.33-34)
Alternate Contract (S.58)
Rule of Discharge By performance
Who (Ss.37 38,39)
Where (S.49)
Single promisor (Ss.40,41)
By non performance
When (Ss.46-48, 55)
How (Ss.50 -54,57,58)
Joint promisor (Ss.42,45)
Novation
Rescission
cannot be performed (Supervening impossibility) Destruction of subject matter
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Appropriation of payment (Ss.59-61) By consent (Ss.62-65)
Death
Alternate
Revocation of Rescission
Breach of Contracts (Ss. 73-75)
War
Change of circumstances
Constructive Breach
Actual Breach
1.3 TYPES AND NATURE OF CONTRACTS AND PERFORMANCE The rule of discharge of contract is dependant upon the nature and type of contract because these rules are to address both general and specific situations and may be both substantive and procedural. Substantive general principles as well as procedural in case details regarding discharge of a contract are based upon the following enquires: 1. What is the nature of the contract? 2. What are the conditionalities of the contract which determine the performance of the contract by the promisor? 3. When is performance needed or not needed? 4. On what factors time and place of performance are determined? 5. What regulates inter-personal relation between the promisor and promisee, as well as between the joint promisor and joint promisee? 6. In case of several contractual relation between the same parties what should be the general or particular principle in appropriation of advances and payments? Therefore, the immediate necessity is to understand the nature and time between the parties in order to appreciate rules of discharge. Contingent Contract From the point of view of performance, a general classification of contracts could be made as (a) absolute contracts and (b) Contingent contracts. An absolute contract is one in which the promisor binds himself to performance without any condition external to the contract. There may be a condition which is internal to the contract itself, as for example, when the performance of one party is conditional on the readiness or willingness to perform of the other party. For instance, S agrees to deliver hundred bags of rice to B and B agrees to pay the price afterwards. Here the performance of B is conditional upon the performance of A. Nevertheless it is an absolute contract. But a contingent contract, as defined in S.31, is a contract to do or not to do something, if some event, collateral to such contract does or does not happen. Here, the condition for performance is collateral to the contract. For example, N promises to pay the value of the car of M if it is destroyed by fire. The contingency on which performance is dependent is collateral and external to the contract. Such a contingency may be an event in the external world or even an act entirely within the will of the promisor but not the mere will of the promisor. Thus, if A promises to B that he will pay to him Rs.1,000 if A leaves Madras for Calcutta, it is a contingent contract as going to Calcutta is an act within the will of A. But if A promises to B that he will pay Rs.1,000 if he so chose, it is not a contingent contract because the contingency is the mere will of the promisor. In fact there is no contract at all. Thus in Roberts v. Smith [(1859) 4 H & N 315], there was a promise that for a certain service the promisor will pay whatever he himself thinks right or reasonable. Held, there was no promise.
Contracts of insurance, contracts of indemnity and contracts of guarantee are all contingent contracts because the condition is collateral to the contract. A wagering agreement is contingent but unlawful. In Ranchhodas v. Nathmal Hirachand & Co [(1949) 51 Bom. LR 491], there was a contract for a sale of American parachute cloth by S to B. The goods were to be delivered when they arrived. S failed to give delivery. B sued for breach. S pleaded that the contract was a contingent one and as the goods had not arrived there was no obligation to give delivery. But, held the contract was not a contingent one and the obligation was absolute. Contingent contracts may be classified as follows : (a) Contingent on future event happening. S.32 (b) Contingent on future event not happening. S.33 (c) Contingent on future event happening within a fixed time. S.35 (d) Contingent on future event not happening within a fixed time. S.35 (e) Contingent on the future conduct of a living person. S.34 (f) Contingent on impossible events. S.36 (a) Contingent on future event happening: According to S.32, a contingent contract to do anything if an uncertain future event happens cannot be enforced by law unless and until that event has happened. If the event becomes impossible, such contract becomes void. Illustration: U agrees with N to pay her a sum of money when she marries X. The sum becomes payable on N marrying X. The agreement becomes void if X happens to die without marrying N. It should be noticed that the collateral condition is a positive condition precedent to the enforcement. Thus in Anjali Das v. Bidyut Sarkar [(1992)1 Cal LT 166], a sale was subject to approval by a co-operative society in accordance with its bylaws. On the happening of the approval, held specific performance of the contract can be demanded. If the event does not happen in the way contemplated by the contract, the contract cannot be enforced. In V.P. Desa v. Union of India, [AIR 1958 MP 297], a car was insured against loss in transit. The car was damaged without being put in course of transit. Held, the insurer was not liable. (b) Contingent on future event not happening: According to S.33, a contingent contract to do or not to do anything if an uncertain future event does not happen can be enforced when the happening of that event becomes impossible, and not before. Illustration: M agrees to pay O a sum of money if a certain ship does not return. The ship is sunk. The contract can be enforced. It may be noticed that there is a negative condition subsequent to which the contract becomes enforceable. 149
(c) Contingent on future event happening within a fixed time : According to S.35, a contingent contract to do or not to do anything if a specified uncertain event happens within a fixed time, becomes void if, within such fixed time such event has not happened, or if, before the fixed time such event becomes impossible. Illustration: M promises to O a sum of money if a certain ship returns within the year. The contract is enforceable if the ship returns within the year. If, within the year, the ship is sunk without returning, the agreement becomes void. (d) Contingent on future event not happening within a fixed time. According to S.35, a contingent contract to do or not to do anything, if a specified uncertain event does not happen within a fixed time may be enforced by law when the fixed time is over and such event has not happened or before such fixed time it becomes certain that such event will not happen. Illustration: M promises to O to pay a sum of money if a certain ship does not return within a year. The contract may be enforced if the ship does not return within the year or is sunk within the year. (e) Contingent on the future conduct of a living person: According to S.34, if the future event on which a contract is contingent is the way in which a person will act at an unspecified time, such event shall be considered impossible when such person does anything which renders it impossible that he should so act within any definite time, or otherwise than under further contingencies. In Frost v. Knight [1872 LR 7 Exch 111], D promised to marry P on the death of his father. D married X while the father was still alive. Held, P can sue D for breach of contract. (f) Contingent on impossible events:
are required to simultaneously perform their promise, no promisor need perform his promise unless other party is willing to perform his promise. As for example, A agrees to supply B against payment be made on delivery, A is not bound to deliver the goods unless B is ready and willing to pay for the goods when delivered (S.51). Where in case of reciprocal promise one party prevents the other from performing his promise, the contract becomes voidable at the option of the party who is so prevented. He is also entitled to compensation from the other party for any loss which he may sustain in consequence of the non performance of the contract. As for example, A and B contract that B shall execute certain work for A for Rs.1000/- B is ready and willing to execute the work, but A does not allow to get the possession of the land on which the work is to be done. B may now rescind the contract and recover compensation from A for any loss which he has sustained (S.53). Similarly, where in a reciprocal promise one party cannot perform his promise until the other performs his part or where the second party cannot claim the performance from the first party unless he performs his part, and the second party fails to perform it, the second cannot claim performance of the reciprocal promise from the first party and must make compensation for any loss which the first party may sustain due to non performance. As for example, A hires B’s ship to take in and convey, from Calcutta to Mauritious, a cargo to be provided by B, B receiving a certain freight for this conveyance. A does not provide cargo for the ship. A cannot claim the performance of B’s promise, A must make compensation to B for the loss which B sustains for the non performance of the contract. Similarly suppose A contracts B to deliver to him, at a specified price, certain merchandise on board a ship which cannot arrive for a month, and B engages to pay for the merchandise within a week from the date of contract. B does not pay within a week. A’s promise to deliver need not be performed and B must make compensation (S.54).
Illustration 2: A and B agreed that A will pay a sum of money to B if a certain ship returns to port. Unknown to both the parties at the time, the ship is already sunk. The agreement is void.
In a set of reciprocal promises, if one part is legal and other illegal, the part which is legal is contract and the part which is illegal is void. As for example, A and B agree that A sell B a house for Rs.10,000/-, but, that if B uses it as a gambling house, he shall pay a Rs.50,000/- for it. The first set of reciprocal promise that is the selling the house for 10,000 is lawful and the contract is valid but the second set is for unlawful object making the agreement void (S.57). But in such cases those set of reciprocal promises legal or illegal must be clearly identifiable and divisible. If the whole set of reciprocal promises has any unlawful element which is not separable the total agreement fails.
Reciprocal Promise:
Alternate Promise :
A promise for a promise forming the contract is a reciprocal promise (see S.8). Such a reciprocal promise may expressly provide the order of performance. In some cases the nature of the contract may indicate the order of performance. As for example, A and B contract that A shall build the house of B at a fixed price and at each stage of billing on the basis of constructions work done, B shall pay 80% of the bill. Here, in this contract, A shall first construct the building and B has to pay later (S.52). Where in reciprocal promises both the parties
An alternate promise is one where parties have alternate options either for alternate promise or for alternate consideration or may be both. In such a case if one alternative is legal and the other is illegal, the legal part is only enforceable. As for example, A and B agree that A shall pay Rs.10,000/- to B for delivering smuggled opium or failing, rice produced in his farm. Here the agreement for delivery of rice is a valid contract but not the opium. Here also the alternative must be clear, identified and divisible, otherwise the whole agreement fails.
According to S.36, Contingent agreements to do or not to do anything, if an impossible event happens, are void, whether the impossibility is known or not to the parties to the agreement at the time when it is made. Illustration 1: A and B agreed that A will pay Rs.1,000 to B if he brings back to life a dead person C. The agreement is void.
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2. DISCHARGE BY PERFORMANCE SUB TOPICS 2.1 Introduction 2.2 Persons obliged to perform 2.3 Who can demand performance 2.4 Time and place of performance 2.5 Appropriation of payment 2.6 Tender of performance 2.1 INTRODUCTION Contract may be discharged by Performance. S.37 of the Contract Act imbibes in itself the entire sanction behind the law of contract by laying down: “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 any other law.” Thus it is clear that the obligation of performance rests on promisors except in certain extenuating circumstances, on performance, the contract would stand discharged. S.37 itself allows the promisor in the alternative to actual performance to offer to perform which is called “tender of performance”. Provided such offer to performance fulfils the conditions laid down in S.38 to constitute a valid tender, it is for the promisee to accept the performance. Failing which, the promisor is not responsible for non-performance, the contract having been discharged by attempted performance or tender, nor does he thereby lose his rights under the contract. Tender will be considered at its proper place. About Performance itself various aspects arise as follows : Questions arise by whom is a contract to be performed and who can demand the performance of a contract, time and place of performance and whether time is of the essence. 2.2 PERSONS OBLIGED TO PERFORM 1. Promisors, agents and legal representatives: Prima facie, performance should be by the promisor (S.37), and the obligation binds the legal representatives unless a contrary intention appears (S.37). S.40 requires that if parties intended that the promise should be performed by the promisor himself, it should be performed only by the promisor himself. For example, A promises to paint a picture for B. Obviously A himself must paint it. According to S.40, in other cases the promisor or his representative may employ a competent person to perform it. This is called vicarious performance. S.41 goes a step further and lays down that where a promisee accepts performance from a third peron, he cannot afterwards enforce it against the promisor. According to S.37, unless a contrary intention appears from the contract, promises build the representatives of the promisor in case of death of the promisor before performance. A contract
involving the use of personal skill or which is founded on personal considerations is ended at the death of the promisor following the rule of law ‘actio personalis moritur cum persona’, a personal action dies with the promisor. If the contract is otherwise, the legal representative of the deceased promisor is bound to perform it, unless a contrary intention appears. For example, A promised to paint a picture for B. Obviously, if A dies, his legal representative cannot be compelled to do so. But if A had borrowed Rs.1000/- from B, and A dies, B can recover the amount from the legal representative of A from his estate. Here again, the liability of a legal representative under a contract is limited to the value of the property inherited from the deceased [New India Motors (P) Ltd v. Smt. S.P. Duggal (1982) Comp Cas 352)]. 2. Joint Promisors: Sometimes there may be joint promisors. The Indian law laid down in Sections 42 to 44 is at variance with the English law. In English law, joint promise and joint and several promise are two diferent things with respect to liability and devolution of liability. But in Indian law, joint promise is also joint and several promise. According to S.42, unless contrarily intended, joint promisors must jointly fulfil the promise. However, according to S.43, unless contrarily intended, the promisee may compel any one or more of several joint promisors to perform the whole of the promise. For example, D1, D2 and D3 jointly promise to repay a debt of Rs.3000 to C. Though they are bound to repay jointly, C may compel all or any of them to repay the entire amount. According to S.42, after the death of a joint promisor, unless contrarily intended, his representative along with the survivors, and after the death of the last survivor, the representatives of all jointly must fulfil the promise. S.43 gives the performing joint promisor the right to claim equal contribution from the others. And where one of them defaults, the others must bear the deficiency in equal proportion. Illustration: D1, D2 and D3 have jointly promised to repay a debt of Rs.3000 to C, C compels D3 to pay the whole. D1 is insolvent but his assets are sufficient to pay half of his debts. D3 may receive Rs.500 from D1’s estate and Rs.1250 from D2. According to S.44, the release of any joint promisor or promisors by the promisee does not discharge the others from the liability nor does it free such joint promisor or promisors from liability for contribution. 3. Assignment of Contractual Liability: Assignment of contractual right by the promisee to another person has been fully discussed at its proper place. Here, we are concerned with the question whether there can be an assignment of contractual liability by the promisor to another person. Assignment means transfer. Both in English and Indian law, there cannot be an assignment of a contractual liability by a promisor to another person without the consent of the promisee. 151
In the leading English case of Robson & Sharpe v. Drummond [(1831) 109 ER 1156], D agreed to take from S, coach builders, carriages on hire for five years, S being bound to look to their excellent conditon. After three years, S assigned his business to R. D refused to be bound further by the contract. Held, S cannot compel D to have the work done by R, D had entered into the contract by virtue of personal confidence in S. If, however, there is a transfer of a contractual liability by the promisor to another person with the consent of the promisee, there is really a Novation or a new contract shifting the liability to another with the consent of the promisee. Venkatarama Iyer J. of the Supreme Court explained this in Khardah Co. Ltd v. Raymon & Co. Ltd [(1963) 3 SCR 183] thus: “As a rule obligations under a contract cannot be assigned except with the consent of the promisee, and when such consent is given, it is really a novation resulting in a substitution of liabilities”. Novation is discussed later. According to S.40, where it is not the intention of the parties that the promise should be performed by the promisor himself, the promisor or his representative may employ a competent person to perform it. Such vicarious performance is not assignment. In such a case, the liability of the promisor subsists and he is responsible for the performance by his agent. In practice, this may be true of many contracts. This was recognised by Lord Greene MR in Davis v. Collins [(1945) 1 AER 247], when he said, “In many contracts all that is stipulated for is that the work shall be done and the actual hand to do it need not be that of the contracting party himself ; the other party will be bound to accept performance carried out by somebody else. The contracting party of course, is the only party who remains liable”. It may also be mentioned that there is nothng to prevent the parties to a contract themselves from making the liability under it assignable if they so wish. Thus in Tolhurst v. Associated Portland Cement [(1903) A.C. 414], the House of Lords construed a contract as one between the parties named in it and their respective assigns. Here, the assignment of liability arises inside the contract itself and must be so distinguished from the general position that the liability under a contract cannot be assigned. 2.3 PERSONS ENTITLED TO CLAIM PERFORMANCE 1. Promisee and legal Representatives : Primarily it is the promisee who can demand performance under a contract. This is so whether the promise is for the benefit of the promisee or any other person. For example, A promises B to pay Rs.1000 to C. It is only B who can enforce the promise of A. In case of the death of the promisee, his legal representative can enforce the promise in suitable cases. It is a general rule of law of Contract that a stranger to a contract cannot enforce the contract. This is known as the doctrine of privity of contract. This rule and the exceptional cases in which a person not a party to the contract namely not the promisee 152
may enforce a contract have already been discussed in the module on Consideration. 2. Joint Promisees : According to S.45 of the Contract Act when a promise is made to more than one person jointly, unless a contrary intention appears from the contract, the right to claim performance rests with them during their joint lives and on the death of any of them, with the representatives of such deceased person jointly with the survivors, and after the death of the last survivor with all the representatives jointly. Thus the devolution of joint rights in contract is on the same principle as the devolution of joint liabilities. The partners of a firm, the members of a Hindu joint family, co-owners and mortgagees are all joint promisees with respect to any debt in their favour. 3. Assignees of Contractual Rights: Whether a contractual liability can be assigned, and if so, what are the qualifications has been discussed earlier. Here, we shall consider the assignment of contractual rights by promisees. In English law, a contractual right is regarded as chose-in-action as distinct from a chose in possession. It means it is a species of movable property being non-corporeal over which lawful possession can be exercised only by legal action and not physical possession like a thing. A chose-in-action has been defined by Channel. J. in Trokintan v. Magee [(1902) 2 K.B 427] thus “A chose-in-action is a known legal expression used to describe all personal rights of property which can only be claimed or enforced by action, and not by taking physical possession”. Originally, in English common law, rights under a contract as chose-in-action could not be transferred at all by assignment but only by novation. If A owes £ 100 to B and B owes £ 100 to C, it may be agreed between all the three that A shall pay C instead of B. Only certain special contractual rights, or benefits, or rights of action on contract, could be transferred by the customs and usages of the Law Merchant, as for example, negotiable instruments. Equity permitted the assignment of chose-in-action including contract rights. If the right was equitable, such as a share in a trust, the procedure was direct and easy in a court of equity. But if the chose was legal such as a contract right, the court of equity required the assignor to lend his name to the action of the assignee before it could enforce it. This position continued down to the passing of the Judicature Acts in the latter nineteenth century which unified common law and equity courts. Equity as stated above, allowed the assignment of contractual rights. No particular form was necessary. It need not even be in writing. If the intention to assign a contractual right which lends itself to such assignment is clear, it is valid in equity called an equitable assignment. Thus in Brandt’s Sons and Co. v. Dunlop Rubber Co. [(1905) A.C. 454.], A agreed with B who funded him that the prices of all goods sold by A should be paid to B. A sold some goods to X to whom B gave notice to pay the price to him, B. and not to A. But X ignored it and
paid to A. Held, there was an equitable assignment of the price in favour of B, and X was liable to B not withstanding his payment of the price to A. All rights ex-contractu except where personal confidence or personal qualifications of one party was of the essence of the contract could be assigned. Thus in Kemp v. Baerselman [(1906) 2 K.B. 604], B undertook to supply K with all the eggs he shall require for manufacturing for one year. K undertook not to buy eggs elsewhere so long as B is ready to supply them. Held, K cannot assign his right to be supplied with eggs to X. Secondly, because of the rules in English law against maintenance and champerty, a mere right to sue, for damages for breach of contract, cannot be assigned. Assignment of contractual right, was however, subject to certain features affecting the rights of the assignee, as follows : (a) As between assignor and assignee consideration was necessary for an agreement to assign a chose-in-action, but if it is transferred without consideration as a gift and the transaction completed, the question of consideration does not arise. In modern practice, the doubtful position whether this would extend also to the assignment of a legal chosein-action provided it is completed, has been resolved in favour of the better view that consideration is not necessary between assignor and assignee whether the chose-in-action assigned is equitable or legal. The view is adopted by Alkinson J. in Holt v. Heather Field Trust [(1942) 2 KB1], and supported by the court of appeal in Re Mc Andle (1951) 1 AER 905. (b) The assignment will not bind the promisor until he has received notice, not necessarily in writing although binding assignor and assignee from the time made. (c) The assignee takes subject to equities between the promisor and the assignor. In other words, the assignor cannot give a better title than what he has. As seen above, the Judicature Acts in the latter nineteenth century allowed statutory exception to the Common law rule that a chose-in-action is not assignable. The Law of Property Act, 1925, in S.136 re-enacted the statutory exceptions allowing assignment of legal chose-in-action. The statute is supplementary and does not supplant the existing law in equity. Under the Act, the assignment must be (a) absolute and not by way of charge, (b) must be in writing signed by assignor, (c) express written notice must be given to the promisor, and (d) the assignee takes subject to equities. The Law of Property Act, 1925 substitutes the term ‘thing in action’ for the term ‘chose-in-action’. Assignment of contractual rights may also take place under the special laws of insurance, marine insurance and companies etc. Assignment of contractual rights may also take place by operation of law in intestate and testamentary succession, bankruptcy, and in property. The assignee of a contractual right is in a position to claim performance from the promisor.
In Indian law, an ‘actionable claim’ is defined in S.3 of the Transfer of Property Act as, “ a claim to any debt, other than a debt secured by mortgage or hypothecation or pledge, or a claim to any beneficial interest in movable property not in the possession, either actual or constructive of the claimant, which the civil courts recognise as affording grounds for relief, whether such debt or beneficial interest be existent, accruing, conditional or contingent.” An actionable claim in Indian law is therefore similar in many respects to a chose-in-action of English law. It includes most contractual rights which are capable of being transferred. It was held in Jaffar Mehar Ali v. Budge Budge Jute Mills Co. [34 Cal 289] that the right to claim the benefit of the contract or the right on certain conditions for delivery of goods in a contract is an actionable claim being a conditional or contingent beneficial interest in movable property. An actionable claim can be assigned and transferred in Indian law under S.130 of the Transfer of Property Act. It must be made by an instrument in writing executed and signed by the transferor or duly authorised agent. The assignment must be absolute and not by way of charge and it should be of the entire right. If debt, it should be of the whole debt. No registration is necessary. The transfer may be made with or without consideration. On such assignment, all the rights and remedies of the transferor vest in the transferee whether any notice of such transfer is given or not. However, notice to the promisor has an important bearing on the transferee’s right because so long as proper notice is not served the debtor is not directly liable to the transferee and any payment or performance by him to the transferor or other authorised person would be proper discharge as against such transferee as also any other dealings by him. S.131 requires every notice of transfer of an actionable claim to be in writing signed by the transferor or his agent, or by the transferee or his agent. According to S.132, the transferee of an actionable claim takes it subject to all liabilities and equities of the transferor. Negotiable instruments are exempted from the chapter on transfer of actionable claims for obvious reasons. All contractual rights, in general, except where personal confidence or personal consideration of parties are of great importance, can be assigned. “Rights under a contract are assignable unless the contract is personal in its nature or the rights are incapable of assignment either in law or under agreement between the parties,” according to the Supreme Court in Khardah Co. Ltd. v. Raymon & Co. Ltd. [(1963) 3 SCR 183]. Rights under a contract can be assigned, but not the right to sue for compensation or specific performance on breach of the contract. Assignment of contractual rights may also take place under the special laws of insurance, bills of lading etc. Negotiable instruments are transferable in the exceptional ways contemplated under that Act. 153
Assignment of contractual rights may also take place not by act of parties but by operation of law such as by devolution on intestate or testamentary succession, or in insolvency. It should not also be forgotten that even in India, equitable assignment without recourse to the Transfer of Property Act, may also take place in exceptional circumstances such as creation of trusts and be enforced by courts of law.
into A’s account with C a bank. B also has an account in the Bank X. B directs C to transfer the amount from his account to A’s account and this is done. Before A is aware of the transfer, the bank C fails. There has been a good payment by B. Further illustrations to the section state where two persons are mutually indebted and agree to set off their debts and net balance is paid by one to the other both stand discharged from their liabilities.
2.4 TIME AND PLACE OF PERFORMANCE
Performance of Reciprocal Promises :
Questions of time of performance arise in contracts. According to S.46 of the Contract Act, where no time for performance is specified and a promisor is to perform the promise without application by the promisee, the promise must be performed within a reasonable time. S.46 adds that what is a reasonable time is, in each particular case, a question of fact. It may depend on the intention of the parties, the usage of the trade or any special circumstances of the case. A contract to keep a ship insured was held broken by delay of three days but in a contract of sale of shares two months time was held reasonable for completion.
According to S.2, promises which form the consideration or part of the consideration for each other are called reciprocal promises. Questions may arise of the sequence of performance of such promises.
According to S.47 when a promise has to be performed on a certain day, without application by the promisee, the promisor may perform it during the usual hours of business on such day. Where the day fixed happens to be a public holiday, so far as the Negotiable Instruments Act is concerned, performance should be offered on the prior day. In other cases it may depend on the usages of the trade. According to S.48, when a promise is to be performed on a certain day and the promisee has to apply for performance, it is the duty of the promisee to apply for performance within the usual hours of business and at a proper place. Here again, what is proper time and place is a question of fact in each particular case. According to S.49, where a promise is to be performed without application by the promisee, and no place is fixed, it is the duty of the promisor to apply to the promisee to appoint a reasonable place and perform at such place. According to the illustration to the Section, A undertakes to deliver a thousand maunds of jute to B on a fixed day. A must apply to B to appoint a reasonable place and deliver it at such place. It is an ordinary rule of common law that a debtor should seek the creditor and repay the loan. In L.N. Gupta v. Taramani [AIR 1984 Delhi 49], a promissory note stated that it would be payable at the place of its execution or at any place in India. The payee settled at some other place and demanded payment there. Held, under S.49 it was the duty of the debtor to seek his creditor and pay him there. According to S.50, the performance of any promise may be made in any manner, or any time which the promisee prescribes or sanctions. This section enables the parties to leave the entire time and manner of performance to the promisee if they so desired. An illustration to the section gives the following examples. B owes Rs.2000 to A. A asks B to pay the amount 154
Lord Mansfield in Jones v. Barkley [4 Douglas 659] has classified such promises as follows : (a) mutual and independent (b) mutual and dependent (c) mutual and concurrent According to S.52, where the order in which reciprocal promises are to be performed is expressly fixed they shall be performed in that order, and where the order is not expressly fixed they shall be performed in that order which the nature of the transaction requires. For example, if in a contract of sale B agrees to pay the price of the goods on 10th and S agrees to supply the goods on 20th. But if A and B agree that A shall build a house for B at a contract price, A must build the house before B has to make payment for it. Thus in Hashman v. Lucknow Improvements Trust [(1927) 101 IC 847], a person took a lease of land from a municipality on condition that he will pay Rs.630 for levelling charges and possession was to be given after levelling. When the question arose whether the amount was to be paid before or after levelling, the agreement being silent on the point, the Allahabad High Court came to the conclusion “in the ordinary course of business work is not usually paid for before it is done”. According to S.51, where a contract consists of reciprocal promises to be simultaneously performed, no promisor need perform his promise unless the promisee is ready and willing to perform his reciprocal promise. For example, S and B agree that S shall deliver goods to B at a price by instalments the first instalment to be paid on delivery. S need not deliver unless B is ready and willing to pay the first instalment. According to S.54, when a contract consists of reciprocal promises, such that one of them cannot be performed, or its performance cannot be claimed till the other has been performed, and the promisor of the last mentioned promise fails to perform it, he cannot claim the performance of the reciprocal promise, and must make compensation for any loss sustained by such non-performance. For example, A hires B’s ship to convey from Calcutta to the Mauritius a cargo provided by A and B to receive a certain freight. A does not provide the cargo. A cannot claim performance from B. A must compensate B for loss which B may sustain by the non-performance of A.
Thus in Ubroy Mohindar Singh v. State of Haryana [(1991) 2 SCC 362], a contract for quarrying off the river Yamuna, the contractor was prevented from performing his part, because of the failure of the Flood Control Department to give no objection. Held, the contractor was entitled to refund the deposit money. According to S.53, in a contract of reciprocal promises, if one party prevents the other from performing his promise, the contract becomes voidable at the option of the party so prevented and such party is entitled to compensation from the other for any loss as a result of the non-performance. Thus in Kleineri v. Aboisso. Gold Mining Co [(1913) 59 SOL JO 45], an appeal from the Gold Coast before the Privy Council, in order to get his mine cleared of a rock, B had to supply a crusher. The crusher supplied was inadequate. Held, A was prevented from his performance and he was allowed to recover expenses and loss of profits. The inadequacy of the crusher was sufficient obstruction to performance. According to S.57, where persons make reciprocal promises, firstly to do certain things which are legal, and secondly under specified circumstances, to do certain other things which are illegal, the first set of promises is a contract, but the second is void. For example, A and B agree that A shall sell his house to B for Rs.50,000, but if B uses it for a gambling club he shall pay a price of Rs.1,00,000. The agreement to sell the house for 50,000 is a contract but the other agreement is void. According to S.58, in the case of an alternative promise, one branch of which is legal and the other illegal, the legal branch alone is enforceable. For example, A and B agreed that A shall pay Rs.1,000 and B shall deliver either rice or smuggled opium of equal value. There is a valid contract only for the purchase of rice. When is ‘time’ essence As seen above parties to a contract may specify the time for its performance. The parties are expected to perform at the stipulated time. But if one of them failed to do so, the question arises as to what is the effect on the contract. The answer depends on whether it was the intention of the parties that time should be of the essence. According to S.55, when there is a promise to do a certain thing or certain things at or before a specified time, and the promisor fails to perform before the specified time, the contract or so much of it as has not been performed becomes voidable at the option of the promisee, if the intention was that time should be of the essence of the contract. If such was not the intention, the contract does not become voidable, but the promisee is entitled to compensation for any loss. If, in such a voidable contract the promisee accepts performance at any time other than agreed, he cannot claim compensation for any loss unless at the time he accepts performance he gives the promisor notice of his intention to so claim. Whether time is of the essence of the contract is a mixed question of law and fact [Municipal Corporation of Delhi v. Jagan Nath Ashok Kumar, (1987) 4 SCC 497]. Time is generally considered to be of the essence where the parties expressly agreed so, or where delay operates as injury,
or where the nature and necessity of the contract requiries it to be so construed. In Indian law, Bhudra Chand v. Betts [(1915) 22 Cal. LJ 566 33 IC 347] is a well known authority. P stipulated with D to engage his elephant for khedda operation to capture wild elephants and that the elephant should be delivered on 1 October 1910. D obtained an extension of time till 6 October 1910. Yet he did not deliver the elephant till 11 Octover 1910. P refused to accept the elephant and sued for damages for breach. Held, P was entitled to recover as parties had intended time should be of the essence. Mookerjee J. said, “this conclusion is confirmed by the circumstances that D obtained an extension of the time”. Commercial Contracts: Generally, in business contracts which provide for performance within a specified time, time is ordinarily presumed of the essence. “In commercial contracts time is ordinarily of the essence” [China Cotton Exporters v. B.R.C. Mills. AIR 1961 SC 1295]. In this case, A carrying on import business at Bombay promised to supply to R a quantity of Italian staple fibre cotton. The shipment was to be in October or November. The contract contained a remark `this contract is subject to import licence therefore the shipment date is not guaranteed’. A part of the goods was supplied but the rest not supplied in the specified time. R wanted to avoid the contract. Held, the remark that shipment date was not guaranteed was qualified by the word `therefore’ in its natural grammatical meaning, and remembering that in commercial contracts ordinarily time is of the essence the shipment in October or November was any way guaranteed apart from delay in import licence, and as failure was due to seller’s own failure to supply in time, R was entitled to avoid the contract on the ground that time is of the essence. Similarly, in Mahabir Prasad Rangta v. Durga Datt [AIR 1961 SC 1990], there was a contract to transport coal from a colliery to the railway station. The colliery owner had to keep the road in repair and arrange for petrol. He also had to pay for the work done on the 10th of the next month. It was alleged that these things were not done in time and the other party could not go on with the work. He rescinded the contract and sued for damages. The Supreme Court held that in commercial transactions ordinarily time is of the essence. In this contract the time of payment and the time of arranging other things was so important that S.55 was invocable. It held the contract could be rescinded and compensation claimed. In contracts for sale or purchase of goods prices of which fluctuate rapidly, the time of delivery, and payment are considered to be of the essence. Time may be made of the essence even by a subsequent notice, but such notice ought to fix the longest time that could reasonably be required for performance of acts remaining to be done [(Crawford v. Tooqwood, 13 Ch. 153]. It means the subsequent notice making time of the essence ought to fix a reasonably long time for the other party to perform. In contracts of sale of goods, the time of shipment is of the essence [Bowes v. Shand (1877) 2 AC 455 HL]. In a contract of sale of rice to be shipped at Madras during March or April of 155
a year by the ship “Rajah of Cochin”, the contract was held not satisfied by shipment made a month earlier in February. However, the matter depends upon the intention of the parties. Even where a specific date is mentioned one has not to look at the letter but at the substance of the contract to ascertain the real intention of the parties. In Hind Construction Contractors v. State of Maharashtra, [AIR 1971 SC 720], it was held that where a contract includes clauses for extention of time or fine or penalty for every day or week, the work remains unfinished on the expiry of the time fixed in the contract, such clauses render ineffective the express position that time is of the essence. Any application for extension of time does not take effect unless accepted, and extension may not amount to a waiver within the meaning of S.53 of the right to insist on the stipulated time. In a Gujurat High Court case,the undertaking was to ship by a particular ship in August. The party failed to do so and requested extension of time to September 10. The party failed to ship even within the extended time. The other side repudiated the contract. The defaulting party sued for breach. Bhagwati J. held time of shipment was of the essence and it was the plaintiff and not the defendant who had committed breach of contract. The Supreme Court of the United States laid down in Norrington v. Wright (1855) that, “in the contracts of merchants time is of the essence”. Construction Contracts : Since construction is a commercial service, time may be of the essence. Land and Property Contracts : When there is a contract for the sale of land or other immovable property there is a presumption, that time is not of the essence. This is the English law and many decisions of the Supreme Court have held that the law under S.55 is not different. Though if it is shown that the intention of the parties was that time sould be of the essence it would be considered so [Indira Kaur v. Sheo Jal Kapoor [AIR 1988 SC 1074]. The mere incorporation of a clause imposing penalty in case of default does not by itself show an intention to make time of the essence [Gomathi Nayagam Pillai v. Palaniswamy Nadar [(1967) 1 SCR 227, 231-32]. In such cases the intention of the parties has to be gathered from factors like the nature of the property, the possibility of the price fluctuation, the need for the contract, the conduct of parties before and after the contract and other circumstances. But the renewal of a lease, or an option for the purchase or repurchase of a property must be exercised strictly within the time limited for the purpose, otherwise it will lapse. The reason is that such rights are privileges which must be exercised within the limited time. In such cases, relief is not given in equity except on very unusual ground like fraud, unavoidable accident, inequitable preclusion by the lessor and the like. Sale of Shares : Sale of Shares is of a commercial nature. The time of completion of the transaction is an important factor. According to S.113 of 156 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
the Companies Act 1956, every company shall within two months after the application for the registration of the transfer of any of its shares, debentures or debentures stock, deliver in accordance with procedure laid down in the Act, the certificates of the shares, debentures and debentures stock. But the Company Law Board may on application by the company extend the period to a further period not exceeding nine months if satisfied that it is not possible for the company to deliver within the said period. Transfer here means a valid transfer and excludes any transfer which the company is for any reason entitled to refuse to register and does not register. Thus in Company Law a statutory rule regulates effective time of valid transfers of shares, debentures and debentures stock. Where there was an agreement for the sale of shares of unquoted private companies trading in a violative market, it was held in British and Common Wealth Holdings pie v. Quadres Holdings [(1989) 3 AER 492 CA], that if a completion date had been named in the agreement that would have been of the essence provided a reasonable time. Effect of Failure According to S.55, where time is of the essence, and performance fails, the contract becomes voidable at the option of the promisee. But if it was not the intention of the parties that time should be of the essence, the contract does not become voidable but the promisee may sue for any loss caused by the delay. If time is not of the essence delay by itself does not put an end to the contract. The innocent party will have to accept performance even if delayed but can sue the other party for loss caused by the delay. This does not however mean the performance can be indefinitely delayed. Such delay would discharge the contract itself by lapse of time in case the aggrieved party does not take action within the period of limitation prescribed for such contracts by the law of limitation which is codified in the Limitations Act, 1963. For example, the price of goods sold without stipulation of credit should be paid within three years of the delivery of the goods. If the seller does not take action for recovery of price within the period, the debt would become barred by time and irrecoverable. The effect of this is to discharge the contract by lapse of time. 2.5 APPROPRIATION OF PAYMENTS When considering questions of time and place of performance, we may in fitness of context consider the law relating to apropriation of payments since this is a mixed question of both place and time of performance. The rule in common law is that a debtor has to seek out the creditor and repay the debt which rule thus has a bearing on place of performance. It has been held even under S.49 that this rule of common law applies as to place of performance. When a debtor owes several distinct debts to a creditor and makes payment or payments insufficient to discharge all the debts, the question arises to which particular debt a payment is to be applied. Obviously this involves the question of time of performance. The rules are laid down in sections 59 to 61 of the Contract Act and incorporates the law laid down in the leading English case called Clayton’s case [(1816) 1 Men 572].
According to S.59, where a debtor owing several distinct debts to one creditor, makes a payment to him either expressly or under certain circumstnaces impliedly intimating that the payment is to be applied to the discharge of some particular debt, the payment must be applied accordingly. To illustrate, D owes to C among other debts some of which were borrowed earlier, a sum of Rupees 567 borrowed on a later date. D sends to C a sum of Rs.567 and directs that the debt of that sum should be discharged. The payment has to be applied accordingly. As Lord Campbell stated in Craft v. Jumley [(1858) SE & B 648], “there is an established maxim of law that, when money is paid, it is to be applied according to the expressed will of the payer, not of the receiver”. According to S.60, where the debtor has omitted to ‘intimate, and there are no circumstances indicating to which debt the payment is to be applied, the creditor may apply it at his discretion to any lawful debt due payable to him from the debtor including any debt whose recovery may be barred by the law of limitation for the time being in force’.
balance Rs.2000 and the next payment of Rs.4000 have to be applied as follows, Rs.2000 to the debt Rs.3000 due in 1992 and Rs.4000 to the debt of Rs.6000 due in 1992. As a result, Rs.1000 in the debt of Rs.3000 due in 1992 and Rs.2000 in the debt of Rs.6000 due in 1992 will remain unpaid. The debt of Rs.4000 due in 1993 will also remain unpaid. The rule has been applied to current accounts between banker and customer as follows. The presumption is that the sum first paid was drawn out, and the first item on the debit side is reduced by first item on the credit side [Deeley v. Lloyds Bank Ltd (1912) AC 756, see also Clayton’s case (1816) 1 Mer 529]. A firm of bankers had five partners. The senior partner died. The surviving partners carried on the business of banking under the same name. The executors of the deceased partner objected to the use of his name in the firm’s name. After a year the firm became bankrupt. Various creditors of the firm placed claims against the estate of the deceased partner.
It is generally also a rule, subject to contract to contrary, that a payment when appropriated should first be applied to the interest and after interest is fully paid off to the principal [Rulia Devi v. Raghu Nath Prasad, AIR 1979 Pat. 115]. The procedure has been extended to interest and costs also before application to the principal [See for details (1970)1 SCR 523].
Clayton was one of those creditors who had continued to deal with the surviving firm by making payments and receiving payments. At the time of the death of the senior partner, Clayton’s balance was £ 1,713. During the next few days he withdrew several times and the balance was reduced to £ 453. There after the surviving partners paid more than £ 1,713 to him and subsequently his deposits exceeded the amounts withdrawn by him. Thus his credit balance at the time of the bankruptcy was larger than the amount due to him at the time of the death of the senior partner. Clayton claimed that the amount of £ 453 was due to him from the estate of the deceased partner. His contention was, the withdrawals from the account after the death of the senior partner were paid out of deposits made in the same period and therefore the credit balance standing at the time of that partner’s death was recoverable from his estate.
According to S.61, where neither party makes any appropriation, the payment shall be applied in discharge of the debts in order of time, whether barred or not by the law of limitation in force for the time being. If the debts are of equal standing, the payment shall be applied in discharge of each proportionately. It means when neither the debtor nor the creditor appropriates the court should appropriate the payment or payments towards one debt after another in the order of time not withstanding that some of them are barred by limitation. Where any debts are of equal standing in such order of priority, the amount should be distributed among them proportionately.
Sir William Grant, Master of the Rolls, rejected the contentions of Clayton and his claim and laid down the since famous Rule in Clayton’s case as follows : “this is the case of a banking account where all the sums paid in blend in one fund the parts of which no longer have any distinct existence. In such a case there is no room for any other appropriations that which arises from the order in which the receipts and payments take place and are carried into the account. Presumably, it is the sum first paid in that is first drawn out. It is the first item on the debit side that is discharged or reduced by the first item on the credit side”.
To illustrate, D owes to C the following debts, Rs.1000 due in 1990, Rs.2000 due in 1991, Rs.3000 and another Rs.6000 due in 1992, and Rs.4000 due in 1993. In 1994 D makes the following payments, Rs.2000, Rs.3000 and then Rs.4000. Neither D nor C make any appropriation. The Court also finds that the debt of Rs.1000 due in 1990 is barred by limitation. The Court has to apply the payments as follows Rs.1000 out of payment of Rs.2000 to the time barred debt of Rs.1000 due in 1990. The balance of Rs.1000 plus Rs.1000 from the second payment of Rs.3000 to the debt of Rs.2000 due in 1991. The
This is the reason why banks close the old account of a firm and open a new account in the name of any reconstituted firm. There by the liability of any deceased, retired or insolvent partner, as the case may be is determined at such time and the bank may hold him liable for the same. Thus banks take care to avoid the operation of the Rule in Clayton’s case.
The creditor has a right until he has declared the appropriation to the debtor, to alter the appropriation [Simson v. Inqham (1823) 2 B & Co 65]. However, the creditor cannot appropriate to a disputed or unlawful debt. The creditor is not also bound to appropriate the payment immediately. He may wait till a last moment. He may appropriate even during the pendency of a suit concerning the payment [Uthup v. Kathanar, 1960, Ker.90].
2.6 TENDER OF PERFORMANCE As seen, according to S.37, the parties to a contract must either perform or offer to perform, their respective promises. Such 157 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
offer to perform is called tender of performance or attempted performance. According to S.38, where a promisor has made an offer of performance to the promisee, and the offer has not been accepted, the promisor is not responsible for non-performance nor does he thereby lose his rights under the contract. Thus tender of performance is equal to actual performance and discharges the contract. However, a valid tender requires certain conditions to be fulfilled, as follows : (a) Tender must be unconditional : According to S.38(1), it must be unconditional. This means an offer to perform must be completely in accordance with the terms of the contract. For example, many cases have held that tender of an amount less than what is due under the contract is not an effective tender. Even payment by cheque will not constitute valid tender unless the other party has agreed to such payment. It is this aspect of valid tender of payment which created historically the statutory rules of currency notes and coins constituting legal tender money according to certain laws of the land. A tender of a debt before the due date is not a valid tender and will not prevent the accrual of interest on the loan. (b) Tender must be at proper time and place : The rule under S. 38(2) was established as early as Startup v. Macdonald [(1843) 64 RR 810]. D brought from P 10 tons of linseed oil to be delivered within the last 14 days of March. P tendered on the last of the 14 days at 9’o clock at night. D refused to accept. But, held there was time for D to have taken in and weighed the goods before mid-night. There was a valid tender. In Afovos Shipping Co. v. R. Pagnan [(1982) 1 Lloyd’s Rep 562 (CA)], in an international trade contract, the agreement
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was that payment should reach on 14th of the month. Held, that defendant should have waited upto the mid-night of 14th before repudiating the contract. (c) Tender must be of the whole quantity or of the whole obligation according to the contract : Further it must be under circumstances that the other party gets a reasonable opportunity of ascertaining whether the person tendering is able and willing to fulfil the whole of his obligation. In case of tender of goods, there must be a reasonable opportunity for the promisee to inspect the goods. According to S.38(3), if the offer is to deliver anything, the promisee must have a reasonable opportunity of seeing that the thing is what the promisor is bound to deliver. Cases have held that if the goods tendered are not of the contract description, the tender is not valid. However, where the deviation from the terms of contract is “microscopic”, that is, very negligible, Courts have held the tender valid. in Shipton, Anderson & Co. v. Weil Bros & Co. [(1912) 1 K B 574], a contract required delivery of 4,950 tons of wheat. The seller delivered 4,950 tons and 55 lbs. The buyer was not allowed to avoid the contract. (d) Tender to one of several joint promisees has the same effect as tender to all of them : According to S.38(3), an offer to one of several joint promisees has the same legal consequences as an offer to all of them. It may be recalled here that, on the contrary, according to S.45 when a person has made a promise to two or more persons jointly, unless a contrary intention appears, the right to claim performance rests with them jointly during their lives. In this regard there is a contrast between the right to claim performance and the tender of performance with respect to contracts entered with joint promisees.
3. DISCHARGE BY AGREEMENT SUB TOPICS 3.1 Introduction 3.2 Novation 3.3 Rescission and alteration 3.4 Remission 3.1 INTRODUCTION As contract arises out of agreement of parties that binds them, it may also be discharged by further agreement or consent between them or between them and others. It may also be discharged by the parties giving up their mutual rights and duties by consent which is known as Waiver. Such process is based on the rule of law ‘Eodem modo quo quid constituiter codem modo destruitur”, that is, a thing may be destroyed in the same manner in which it is constituted. Discharge by agreement may be express or implied. Discharge by agreement may be by (a)Novation, or by (b)Remission or Waiver. 3.2 NOVATION According to S.62, if the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed. Lord Selborne explained novation in the well known case Scarf v. Jardine [(1882)7 App Cas, 345], "there being a contract in existence, some new contract is substituted for it either between the same parties or between different parties, the consideration mutually being the discharge of the old contract. A common instance of it (occurs) in partnership cases”. In this case a firm consisted of A, B and C. C retired without notice to creditors. A new partner D joined the firm. A creditor advanced money to the firm after the retirement of C. He sued A, B, C, and D for recovery. Held, that he could either on the principle of estoppel sue A, B and C having no notice of the retirement of C Or, he could sue A, B and D who now were the actual partners there having been a novation by which the firm had become reconstituted before he advanced the money. Novation may take place by (a) a new contract being substituted for an existing contract between the same parties, or (b) the contract between the parties being rescinded in consideration of a new contract on the same or similar terms between some or all of the parties and a new party or parties. Illustration: (a) D owes to C Rs.10,000. D enters into a new contract with C by which he gives a mortgage of his estate of Rs.5,000 to C in place of the previous debt. The new contract extinguishes the old contract. Illustration: (b) D owes Rs.1,000 to C. It is agreed between D, C and N that D may repay this sum as a debt to N. By this new contract the old debt of D to C is ended and a new debt of D to N is created.
When novation takes place by substitution of a new contract for the old, between the same parties, the original contract is discharged and need not be performed. For such a novation two things are necessary. One is the original contract must be subsisting when the novation takes place. Novation is not possible when the original contract is broken. In an early case, Manohar Koyal v. Thakur Das Nasker [(1888) 15 Cal 319], P sued D to recover Rs.1173 due on a bond. After the due date P agreed with D to accept Rs.400 in cash and a new bond for Rs.700 payable in instalments. Subsequently D neither gave Rs.400 nor the bond. P sued D on the original bond. When novation was pleaded the Calcutta High Court held that the original contract was discharged not by novation but by breach and P was entitled to sue for such breach of the original bond. Secondly, the new agreement should be valid and enforceable. Thus, where an existing mortgage was replaced by a new mortgage which was not enforceable for want of registration, it was held the parties were still bound by the original mortgage. Novation betwen the same and the new parties often takes place in reconstitution of partnership firms. Often a new partner is admitted into an existing firm. Sometimes an old partner retires and by public notice or agreement with creditors the liabilities of the old firm are assumed by the new firm which has become reconstituted. In this connection it may be pointed out that according to the Partnership Act, 1932, a firm is reconstituted by admission of a new partner, retirement, expulsion, insolvency or death of a partner, or transfer of a partner’s share. A dissolution of a firm takes place only where there is dissolution of partnership between all the partners of the firm. In other cases there is only a reconstitution of the firm which involves an express or implied novation. Novation is not confined to partnership. It may take place in any contest and it may be as already stated express or implied. In re European Assurance Society [(1876) 3 Ch D 391], a person insured his life with X Co. Subsequently X Co. amalgamated with Y Co. A memorandum was endorsed on the policy that Y Co. would be liable for the policy. Held, there was novation and the policy money could be recovered from Y Co. In this connection it must be recollected that generally there cannot be an assignment of a contractual liability except with express or implied consent of the promisee which makes it really a novation. 3.3 RESCISSION AND ALTERATION According to S.62, the parties to a contract may agree to rescind or alter it, when the original contract will be discharged. Rescission may take place by mutual consent of parties by which they may cancel all or any of the terms of a contract. They may also substitute new terms for some terms which are rescinded. A party to a contract may also rescind it without prejudice to his right to claim compensation for breach when the other party fails in the performance of his obligations if the contract lends 159 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
itself to such a rescission. For example, S agrees to supply certain goods to B by 15th and B agrees to pay the price on 30th, S fails to supply the goods on 15th. B need not pay the price and may procure the goods even the next day from any other source and claim compensation for any loss that may have been sustained. In Syed Israr Masood v. State of Madhya Pradesh [(1981) 4 SCC 289], there was a contract for sale of forest coupes. There was a substantial variation between the quantity and quality of timber held out at the time of auction and the timber actually available. The Supreme Court allowed rescission under S.62 and allowed refund of his deposit to the contractor. No compensation was allowed only because there was a clause against such compensation in the contract. According to S.67 if a promisee neglects or refuses to afford the promisor reasonable facilities for the performance of his promise, the promisor is excused by such neglect or refusal, as to any non-performance, thereby. Illustration: A agreed with B to repair B’s house. B neglects or refuses to point out to A the places in his house requiring repairs. A is excused for non-performance if caused by such neglect or refusal. This means A is allowed to rescind the contract under such circumstances. According to S.66, the rescission of a voidable contract may be communicated or revoked in the same manner, and subject to the same rules, as apply to the communication or revocation of a proposal. According to S.64, when a person rescinds a voidable contract, the other party need not perform any promise therein on his part. The party rescinding a voidable contract, shall, if he has received any benefit from any party to such contract, restore such benefit, so far as may be, to the person from whom received. The principle behind this section had been explained in Clough v. L.& N.W.R. [(1871) L R 7 Ex 27], “no man can at once treat the contract as avoided by him ............ and at the same time keep the money or other advantage which he has obtained under it.” According to S.62, parties to a contract may agree to alter it. If so the original contract need not be performed. Alteration may be of all or some or any terms of a contract. The effect will be accordingly. Alteration can be made only by mutual agreement. There cannot be any unilateral alteration of a contract. In Magnum Films v. Golcha Properties Limited [AIR 1984 Del 162], the parties had fixed by mutual agreement the rates of hiring a cinema hall. One of them was not allowed to alter the rates unilaterally. If any party makes any alteration which is material in a contract without the consent of the other party, the result would be that the other party would be discharged with respect to the contract. The alteration should be material that is one which alters the legal affect of the contract. Thus where the date of a bond was altered, in an early case, the Calcutta High Court held that the bond was avoided. Similarly an alteration on a bill of exchange from “Documents against payment” to “Documents against acceptance” was held to avoid the contract. It may be noted here that under S.87 of the Negotiable Instruments Act, a material alteration of negotiable 160 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
instrument will discharge persons who become parties to it prior to such alteration subject to statutory exceptions under that Act. 3.4 REMISSION According to S.63, every promisee may dispense with or remit, wholly or in part, the performance of the promise, or may extend the time for such performance, or may accept instead of it any satisfaction which he thinks fit. The Indian Law of Remission is at complete variance with the corresponding part of the English law of contract where in the doctrine of Accord and Satisfaction obtains in this regard. According to the English law, consideration is necessary not only for the information of a contract but as well as for the discharge of a contract for all parol contracts which are not specialities, namely signed, sealed and delivered by formal deed. Accordingly, in English law where a promisee wants to waive and discharge a promisor from performance, consideration is necessary from the other side in order to sustain the promise to waive. Otherwise, the waiver is not effective and he can still hold the promissor liable for non-performance. Even according to the English law if a contract is wholly executory and subsisting as reciprocal promises, it can be discharged by mutual waiver or consent because the waiver of each is sustained by the consideration of the waiver of the other. Thus the mutual promises to waive are locked in consideration and satisfy the common law requirement that consideration is necessary also for the discharge of parol or simple contract. However, if a contract is executed by one of the parties having done his part and the other remains liable, if the promisee were to waive the obligation of the promisor, in simple and parol contract a fresh consideration is necessary from the other side to sustain the promise of waiver. There must be some new satisfaction from the promisor. This rule of the English law is called the doctrine of Accord and Satisfaction. Accord is the consent to waive and satisfaction is some consideration to support it. There must be some consideration or satisfaction be it a pepper corn. Such waiver could be valid only if it were reduced to a speciality. Otherwise if it were only simple and parol, some satisfaction is necessary. At one time in the English common law, it was also required that ‘accord executed is satisfaction but not accord executory’. This meant that the contract could be discharged by waiver only if the promisor whose promise is to be remitted does something else in return to make the release binding on the promisee but if he only promises to do something else in return the release would not be binding on the promisee and he may nevertheless enforce the promise. But in modern cases this question is regarded as only one of construction of the agreement. In Morris v. Baron [(1918) A C 135], the House of Lords held that the promise only, as distinct from the actual performance of it, may be a good satisfaction and discharge the contract which has been waived, if it clearly appears that the parties so intended. The judgement of Lord Atkinson was affirmed in British Russian Gazette v. Associated
Newspapers [(1933) 2 K B 643]. English law stands modified about this qualification to the doctrine of Accord and Satisfaction. However, there is another qualification to the doctrine known as the Rule in Pinnel’s case [5 Co Rep117], which had laid down that the part payment of a debt can never amount to a satisfaction of the whole debt. If along with a part payment anything of a different specie is delivered and accepted there would be satisfaction and the waiver would be valid. It was remarked thus in Pinnel’s case, “the gift of a horse, a hawk or a robe, in satisfaction is good ................ or otherwise the plaintiff would not have accepted it in satisfaction”. The rule in Pinnel’s case was approved by the House of Lords in Foakes v. Beer [9 A C 605]. In this case the plaintiff who had previously accepted from the defendent instalment payments of the principal amount in full satisfaction of a decree for principal and interest subsequently was held entitled to take out execution for the interest. The rule in Pinnel’s case has however been criticised especially as running counter to commercial practice. When taken in conjunction with the rule that the law will not go into the adequacy of consideration, the result may be absurd. As Jessel M.R. stated, ‘a creditor might accept anything, any satisfaction of his debt except a less amount of money. He might take a tomtit if he choose, and that was Accord and Satisfaction; but he could not take 19 s 6 d in the pound’. There is a tendency to circumvent the rule in recent cases by applying possible principles of equity. As stated above, S.63 allows a promise to dispense with or remit wholly or partly the performance of a promise, or extend the time for it or accept instead of it any satisfaction. Thus the Indian law of remission has no place for the doctrine of Accord and Satisfaction. In Matthew Henry Abraham v. The Lodge “Goodwill” [(1910) 34 Mad 156],P was the holder of a promissory note executed in his favour by D and agreed to abandon his claim if the “Lodge Goodwill” which was burnt was resuscitated. The building was resuscitated. P made a subsequent claim upon the promissory note. Dismissing the claim, the Madras High Court explained that S.63 differs from the English law in that it does not require consideration to support a release while under English law a release without consideration is a nudum pactum. Similarly in Manohar Koyal v. Thakur Dass Naskar [ILR (1888) 15 Cal 319], the Calcutta High Court had already stated that it is quite clear that S.63 not only modifies but is in direct antagonism to the law in England. It was pointed out, they said, in Foakes v. Beer [LR 9 AC 605] that for nearly 300 years it has been law in England that if A owes B 500 pounds and B consents to take 200 pounds in payment of the debt there is a nudum pactum and B can subsequently claim the unpaid 300 pounds. They said the law in this country is different by virtue of S.63. Thus, in Kapur Chand Godha v. Mir Nawab Himayatali Khan [(1963) 2 SCR 168], there was a liability of above twenty
seven lakhs rupees before the princely state of Hyderabad was taken over. A committee was appointed to clear certain matters and it offered twenty lakhs to the creditor in full satisfaction and he accepted it. Afterwards, the creditor sued for the balance. S.K. Das J. of the Supreme Court held that the facts are completely covered by S.63 and that the creditor having accepted payment in full satisfaction of his claim was not entitled to sue. Similarly, in Harichand Madan Gopal v. State of Punjab [AIR1973 SC 381], where the Government had decided to recover only forty percent and nothing more, held it would amount to remitting a part of the debt due and the Government cannot thereafter ask to recover more than forty percent. It is not necessary that there must be some consideration for the remission of a part of the debt. However, there must be proof that the lesser sum has been accepted. In Union of India v. Gangaram Bhagwandas [AIR 1977 MP 215], the railways sent a cheque for an amount less than the claim by a party. The party retained the cheque but did not issue any receipt that he was accepting it in full satisfaction. Neither did he stop pursuing the matter. It was held there was no agreement to accept a lesser sum. Under S.63, “dispense with” means waiver. Waiver is the abandonment of a right or rights. In W.I.Alan & co. Ltd. v. El Nasr Export and Import Co., [(1972) 2 Q B 189], Lord Denning explained waiver as an application of estoppel. Waiver may be implied. If a party, by his conduct leads another to believe that strict rights arising under the contract will not be insisted on, intending that the other should act on that belief, and he does act on it, then the party will not afterwards be allowed to insist on the strict legal rights when it would be unequitable for him to do so. In this case, a contract for the sale of goods contained a stipulation for bank credit for the price in a certain manner. But the offer made by the confirming bank varied in several respects with what the sellers were entitled to require. For example, the bank offered sterling currency. The sellers accepted by sending invoices and drafts. Afterwards sterling was devalued but Tanzanian currency was not. The sellers wanted to enforce their right to payment in Tanzanian currency. But they were not allowed. it was observed that it was not a concession which the sellers could thereafter unilaterally abrogate any more than the buyers would have been entitled to alter the terms of the credit if the relative values of the currencies had changed in the opposite way. There is a distinction between waiver and extension of time by mutual consent. This distinction was sharply outlined in M. Sham Singh v. State of Mysore [(1973) 2 SCC 303]. M was granted state scholarship for higher studies in the United States on a bond that he would serve the state on his return provided the state offered him a job within six months of his return failing which the bond was to be taken as waived. If M failed to comply he was to refund the money. On his request, the state agreed to extend his stay for one year for practical training. During this year he came home on a domestic visit but was allowed by the state to rejoin his practical training. On completion of training he took up service in the United States. The state claimed refund. M pleaded there had been a waiver by the state. The Supreme 161 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
Court held there was nothing to show any such intention on the part of the state and there was no waiver whatever. There had only been an extension agreed mutually. M was liable to refund. It may also be noticed that waiver of compliance with a requirement of the contract may in some circumstances be withdrawn by giving reasonable notice. In Charles Rikards Ltd. v. Oppenheim [(1950) 1 A E R 420], there was a contract to supply a car chassis and build a body on it within seven months time stated to be of the essence. The body work was directly entrusted to a third person who was to take instructions directly from the buyer. There was no delivery within time.
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The buyer extended time liberally but after about two months he gave notice that if the car was not delivered in 4 weeks he would not accept it. Delivery was offered 3 months afterwards but he declined. Held, he had again by reasonable notice made time of the essence after waiving it and he was now entitled to damages for breach. Under S.63, a promisee may before breach gratuitously release the promisor from the obligation to perform the promise. The promisee may also after breach gratuitously release the promisor from his liability arising on such breach.
4. IMPOSSIBILITY OF PERFORMANCE SUB TOPICS 4.1 Introduction 4.2 General Principles of Frustration 4.3 Grounds of Frustration 4.4 Limitations of the doctrine of Frustration 4.5 Consequences of Frustration 4.1 INTRODUCTION A contract may be discharged by impossibility of performance which may occur at any stages of the contract. In a contingent contract the parties may stipulate a contingency which may be impossible itself and cannot happen. In section 36 it is provided that where such a contingency is provided in the agreement,the agreement is itself void. As for example, A agress to pay B Rs.1000/- if two straight lines enclose a space. This is a void agreement. Similarly certain contingency become impossible to happen but parties to the agreement may commit mistakes about such contingencies. Such an agreement is void due to the mistake of parties. As for example, A agrees to pay B Rs.1000/- if B will marry A’s daughter C, C was dead at the time of agreement not to the knowledge of both parties. Therefore the contingency is impossible to happen. Therefore section 20 read with section 36 makes the agreement void ab initio. Sometimes an impossibility may be supervened after the contract is entered into, but before its performance. In such cases this impossibility may be either due to act of God or due to change of circumstances on account of acts of a party including a third party but not on the fault of anybody. It is
simply a situation of frustration that both the parties suffer from either due to accident or an act of God called in law supervening impossibility or due to act of any person including the act of state but not due to the fault of the parties, known in law as subsequent impossibility. The following flow chart shall give a wider perspective of the doctrine of frustraton which is substantively followed in India in absence of wide gap in the Indian legal system. In India section 56 deals with such a situation. According to this section a contract to do an act which, after the contract is made, becomes impossible, or by reason of some event, which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful. The first part of the section indicates to the supervening impossibility whereas the later part the subsequent impossibility. But where in the agreement parties under a mistake of belief stipulated a contingency on which the performance of the agreement dependable, such agreements are void ab initio provided the contingency is impossibility in itself from the very beginning [S.36]. Again where one person promised to do something knowing on reasonable diligence might have known that it is impossible or unlawful to peform the agreement which other party was not aware, the party aware of the impossibility has to pay compensation for the loss sustained by the other party. This is an equitable principle. As for example, A agrees to marry B being already married to C and forbidden by law to practice polygamy. Here A may compensate B for the loss sustained by her due to non peformance of his promise. Out of the four illustrations given in section 56 one relates to supervening impossibility and two to subsequent impossibility. Anyway the flow chart of the doctrine of frustration is as follows:
Doctrine of Frustration Impossibility at the beginning of the agreement
Contingency impossible itself (S.36)
Mistake of essential fact (S.20)
Death of a party
frustration through Commercial practice
Impossibility of Performance
Supervening impossibility
Subsequent impossibility
Destruction of subject matter
War
Non fulfilment of of conditions
Incapacity of parties by accident
Change of circumstances
Legislative or Executive intervention
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4.2 GENERAL PRINCIPLES OF FRUSTRATION A contract may be discharged by Impossibility of Performance. Impossibility of performance may appear on the face of the contract, or may exist, unknown to the parties at the time of making the contract, or may arise after the contract is made. If an agreement contains a promise to perform something which is ex facie impossible, it is void ab initio. The rule is based on two legal maxims. One, ‘lex non cogit ad impossibilia’, that is the law does not recognise what is impossible. Second, ‘impossibilium nulla obligato est’, that is, what is impossible does not create an obligation. S.56 embodies these rules by laying down that an agreement to do an act impossible in itself is void. Illustration: A and B agree to discover treasure by magic. The agreement is void. Sometimes, the contract may be impossible unknown to the parties at the time of making the contract. This could happen, for example, by mutual mistake of fact, as in Couturier v. Hastie [(1856) 5 H L C. 673] : There was a contract between a buyer and seller for a cargo of corn supposed to be on ship on a voyage from Salonica to England. Infact, unknown to the parties, the cargo had already become so heated that it was unloaded at Tunis and sold for what is worth. Thus the destruction of the subject matter unknown to the parties at the time of contract resulted in rendering the contract void. In this instance, it was a mutual mistake of fact which according to S.20 would render contract void as it was impossible to perform it though such impossibility was unknown to the parties when they made the contract. However, if when making the contract the promisor alone knew the impossibility, he shall have to compensate the promisee for any loss caused though the non-performance of such promise. S.56 lays down the law in its third paragraph as follows- that where a person promises to do something which he knew, or, with reasonable diligence, might have known, and which the promisee did not know to be impossible or unlawful, such promisor must compensate such promisee for any loss caused by non-performance of such promise. Illustration: A, already married to C, promises to marry B who does not know of the marriage of A to C. A is subject to the law against bigamy. A must compensate B for the non-performance of the promise for any loss caused. Where parties have made a contract to do or not to do anything if an uncertain future event happens, but such event becomes impossible, such contract becomes void. This is laid down by S.32 and is a contingent contract becoming void by impossibility. The law of discharge of contract has to deal with another kind of impossibility of performance, namely supervening impossibility or impossibility arising subsequent to the formation of the contract. The modern English law has meaningfully struggled to recognise such supervening impossibility by different theories of construction of such a contract including the application of supervening impossibility to commercial contracts called frustration. The Indian law 164 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
though persuaded by these theories has found more direct ground in the words of S.56 paragraph two as adumburated by the Supreme Court in a leading decision. Both English and Indian law has had also to deal with the consequences of discharge of contract by supervening impossibility. According to the earlier English law impossibility arising subsequently to the formation of a contract does not excuse a promisor from performance. The rule was laid down in Paradine v. Jane K.B. [(1647) Aleyn 26]. Paradine sued Jane for rent due upon a lease. Jane pleaded that a certain German prince by name Prince Rupert an alien born enemy to the kins and kingdom invaded the realm and with force entered on possession and expelled the defendant and held him out of possession so that he could not take the profit and pay the rents. The Court held that this was no excuse. It said if there is a covenant to repair a house, though it be burnt by lightning, or thrown down by enemies yet he ought to have repaired it, because he might have provided against it in the contract. This rule came to be known as the “do or die rule” and was followed in a line of English cases down to the early part of this century whenever the Courts thought that the contract entered into by the parties was an absolute one and gave no room to any express or implied condition that it could be discharged by supervening impossibility. As observed by Scrutton L.J. in Ralli Bros. v. Compania Naviera etc [(1920) 2 K B 287], “Impossibility of performance, as a rule, is not an excuse for non-performance”. But subsequently the English law developed the theory that even though parties to a contract have not expressly made a condition that a supervening impossibility would discharge the contract, there are cases in which though there is no such express provision, the Courts will interpret the contract as containing such a provision by implication. This is known as the “doctrine of implied term” and was explained by Lord Loreburn in Tamplin v. Anglo - Mexican Coy’s case [(1916) 2 AC 397] “ A Court ought to examine the contract and the circumstances in which it was made not to vary but only to explain it, to see whether or not it can infer from the nature of the contract and the surrounding circumstances that a condition which was not expressed was a foundation on which the parties contracted .............'if that happens, of course, it is over between us’ ......, in most of the cases there was an implied condition in the contract which operated to release the parties from performing it ..................What, in fact, was the true meaning of the contract?”. The exposition of the doctrine of implied term in Tamplin v. Anglo Mexican Co., case is accepted by judicial opinion in many latter English cases as the true principle underlying the law of impossibility of performance. No court has an absolving power but can infer from the nature of the contract and surrounding circumstances that a condition which was not expressed was a foundation on which the parties agreed that if the altered circumstances are such that if the parties thought of them they would have freed themselves from the contract and that it is therefore a question of ascertaining the true meaning of the contract. The theory was confirmed as latter as in British
Movietone Ltd v. London and District Cinemas Ltd [(1957) 1 KB 190] by the House of Lords and the observation of Lord Loreburn that no court has an absolving power was approved. Viscount Simon said that the principle remains the same though particular application of it may vary greatly. He said in his view it is a question of construction. But there has been another view and theory in English cases that the doctrine of implied term was really a positive rule of law requiring the court to import into the contract, irrespective of the intention of the parties, in the circumstances that have arisen a term that there is such an impossibility that the contract is discharged. There is a line of English cases which emphasise that the implied term is a legal fiction courts have to import as a positive rule of law in the changed circumstances. Thus in Russkoe v. Strik [(1922) 10 Lloyds L.R 214], Alkin L.j. stated “there are many positive rules of law imposed upon on contracts quite independent of the intention of parties”. According to him when the contract is terminated consequences follow as a matter of positive law and not from any express or implied agreement of the parties. Goddard J. took a similar view in Tatem v. Gamboa [(1939) 1 KB 132]. Lord Wright in Denny, Moth & Dickson v. Fraser, [(1944) AC 275] thought the courts have formulated the rule by virtue of their inherent jurisdiction just as they have developed the rules of liability for negligence, or for the restitution of the money where otherwise there would be unjust enrichment. The theory of positive rule of law was also supported by Denning L.J. (though unsuccessfully in the House of Lords) in the British Moveitone Ltd case when he said “the court really exercises a qualifying power - a power to qualify the absolute, literal or wide terms of the contract - in order to do what is just reasonable in the new situation. The day is done when we can excuse an unforseen injustice by saying to the sufferer it is your own folly”. As Lord Wright said in Joseph Constantine Steamship Line Ltd. v. Imperial Smelting Corporation Ltd, [(1942) AC 154] “In ascertaining the meaning of the contract and its application to the actual occurrences, the court has to decide not what the parties actually intended but what as reasonable men they should have intended”. Thus there are two views of the doctrine of implied term in English law. One that it is a question of construction of the contract in the changed circumstances, the other that it is a positive rule of law obliging the court to import such a term in the changed circumstances. Whatever be the basis of theory, the English courts have applied the theory of frustration to various circumstances which have been classified as particular classes of cases. 4.3 GROUNDS OF FRUSTRATION The principle of impossibility of performance, or frustration of contract is applicable to a great variety of contracts. It is therefore not possible to lay down an exhaustive list of situations in which the doctrine is going to be applied to excuse performance. This view is expressed in the Harvard Law
Review. Yet certain grounds of frustration are well established as follows : 1. Destruction of subject matter 2. Death or incapacity for personal service 3. Non-existence or non-occurrence of a particular state of things 4. Intervention by legislative or executive authority 5. Intervention of war 6. Change of circumstances or of particular state of things 7. Frustration in commercial contracts In this module it is only possible to examine a few authorities for each variety of cases. 1. Destruction of subject matter of contract In Taylor v. Caldwel [(1863) 3 B & S 826] D had agreed to give P the use of a music - hall for certain concerts. The music hall was destroyed by fire through no fault of D before the date of the first concert. P sued D for breach of contract. Held, the contract is subject to an implied condition that performance become impossible if the thing perishes without default of the promisor. Similarly in Howel v. Coupland [(1876) A.B.D. 258] there was a contract for sale of 200 tons of potatoes to be grown in a particular field. The crop failed as it was destroyed by a disease. Mellish L.I., excused a non-delivery of 126 tons. In V.L. Narasu v. P.S.V. Iyer [ILR 1953 Mad 831] there was a contract to exhibit a film in a cinema hall. On account of heavy rains the rear wall of the hall collapsed and licence was cancelled until the building was reconstructed to the satisfaction of the authorities. The building was demolished. The picture could be continued to be exhibited only if the building was reconstructed which the owner was under no liability to do and even if done as Venkatarama Iyyar J. pointed the attraction of film being ephemeral it would lose it appeal. The Madras High Court held the contract discharged. 2. Death or disablement of party to do personal service The well known authority is Robinson v. Davison. There was a contract between P and Mrs. Davision who was the wife of D and an eminent pianist that she would play at a concert to be given by P on a particular day. On that morning she was too ill and informed P that she could not play. P lost a sum of money by the postponement of the concert . P sued D for damages. It was held that the illness of Mrs. Davison excused her from playing and performing the contract. In this connection Illustration (c) to S.56 of the contract Act in the Indian law may be noticed. A contracts to act at a theatre for six months in consideration of an advance by B. On several occasions A is too ill to act. The contract becomes void on those occasions. In Stubbs v. Holywel Railway Co. [L.R. 2 Exch 311] it was held that a contract for personal services was put an end to by the death of the party. Martin, B. stated, “the man’s life was an implied condition of the contract”. 165 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
On the otherhand, there could be circumstances when a contract of service could be held not frustrated by illness and incapacity. Thus in Storey v. Frulham Steel Works Co. Ltd [(1907) 24 TLR 89] S was employed as a works manager under a five year contract. After two years he became ill and was absent from work for five months. After four months absence the company terminated the employment. S sued for breach of contract. It was held a five year contract of service could not be considered terminated by frustration by five months illness. The application of the doctrine to industrial relations was examined by the English National Industrial Relations Court in Marshal v. Horland & Wolff Ltd [(1972) 2 AER 175]. M was in the employment of a company since 1946. He fell ill in 1969 and did not attend till 1971. The company retrenched him after giving usual benefits. M had still to undergo an operation before he could resume work. The court held the contract of service had not been frustrated. It said in considering whether further performance has become impossible, regard must be had to the terms of employment, the nature of the illness, its duration and prospects of recovery, and the period of the past employment. On the facts of this case for which the court gave the details, it held the contract had not become frustrated. 3. Non existence or non occurrence of a particular state of things The rule of implied term laid down in Taylor v. Caldwell was not limited to contracts ‘de certo corpore’ where the existence of a specific thing as subject matter was involved. It was extended in Krell v. Henry [(1903) 2 KB 740], one of a series, known as the Coronation cases, to the non existence or non occurrence of a particular state of things forming the foundation of a contract. D agreed to hire the rooms of P for June 26 and 27. The coronation of King Edward VIIth and the procession was to take place but the contract contained no reference to it. The coronation took place but the procession which was to pass by that flat was cancelled by the illness of the King. P sued D for the rents. The court came to a conclusion that it was obvious that there were “rooms to view the procession” and as it did not take place the substance of the contract the existence or occurrence of a particular state of things was gone. It held the contract discharged by frustration and no rents were payable. However, unless the foundation of the contract has been destroyed the rule cannot be applied. In Henry Bay Steam Boat Co. v. Hutton [(1903) 2 KB 683 (CA)] also one of the coronation cases, D chartered a steam boat for two days to take out passengers for viewing the naval review and a cruise round the fleet for a day. There was unpaid balance for hire. The Royal Navy Review was cancelled. D had no use for the ship. Yet the court held that in this case the naval review was not the foundation of the contract. It is a little difficult to reconcile the later decision with the earlier on the nice distinction that naval review was not the real object of both the parties as basis of the contract. It was held D was liable to pay the unpaid balance of hire less the profit of the owner of the ship in the ordinary course. 166 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
4. Intervention by Legislative or Executive Authority The performance of a contract is sometimes made impossible by a change in the law or by executive action. The principle was recognised in Baily v. De Crespingny [(1869) 4 AB 180]. P was lessee to D for a term of eighty nine years of a plot of land. D retained the adjoining land and covenanted that neither he nor his assigns would during the term erect any buildings on it. A Railway Company acting under statutory powers took the land compulsarily and built a station on it. P sued D on the convenant. It was held Legislative compulsion had created a new kind of assignee of the land for whose acts D could not be held responsible. In Metro politon Water Board v. Dick Kerr & Co. Ltd [(1918) AC 119], there was a contract by a firm in 1914 with the Water Board to construct a reservoir within six years. But they were asked to stop the work in 1916 by a notice under the Defence Acts and Rules. They claimed that the contract was put an end to and could not be resumed after the War. The House of Lords held that the interruption by the executive authorities and its duration until the War ended was of such a character that the contract if resumed would be a different contract from the contract broken off and therefore it has been discharged by impossibility. In the Indian law, S.56 lays down in paragraph two a positive rule of law on the discharge of contract by supervening impossibility. This appears to be nearer the second and later English theory of the doctrine of implied term being a positive rule of law. The Supreme Court of India in a landmark decision in the leading case of Satyabrata Ghose v. Mugneeram Bangur & Co. [AIR 1954 SC 44] has clarified that the law of supervening impossibility is self-contained in S.56 of the Act as a positive rule of law and discharge by frustration is only an interchangeable term and the English theories of implied term need not concern us as S.56 lays down a positive rule of law. Mukherjea J. in an illuminating judgement in the said case laid down the following points of Indian law : 1. The Indian law of frustration which term is interchangeable with supervening impossibility is embodied in S.56 as a positive rule of law which does not leave the matter to the intention of the parties and casts the duty on the court to decide whether a contract is ended by frustration. 2. To the extent the Indian Contract Act deals with a particular matter it is exhaustive and it is not permissible to import English principles de hors the provisions in the Act. The English decisions have a persuasive value but the several theories of frustration of English law do not bind us. 3. When the whole purpose or basis of a contract is frustrated by the intrusion or occurrence of an unexpected or change of circumstances beyond contemplation of the parties, it is the duty of the court to give relief and hold the contract frustrated and ended as it is really a rule of positive law under S.56. 4. As S.56 lays down a rule of positive law, not dependent on the intention of the parties, the belief, knowledge and
intention of the parties are evidence, but only evidence, and the court has to form its own conclusion by examining the contract and the circumstances. 5. When there is frustration, the contract is dissolved automatically and does not depend on rescission or repudiation or breach or choice or election of either party, and the court has to decide expost facto. The aforesaid point five is in direct line with the important decision of the Privy Council in Hirji Mulji v. Chenoy Yue Steamship Co. [(1926) AC 497] that once there is frustration there is an automatic dissolution of the contract. 5. Intervention of War Intervention of war or war like conditions have raised questions of impossibility of performance of contract. A good illustration is Horlock v. Beal [(1916) 1 AC 486], A ship owner engaged a seaman under articles for two years. While the articles were running, the ship was seized by Germany in a Belgian port and the crew interned for an indefinite period. The contract was held to be discharged and the ship owner under no obligation to continue the payment of the seaman’s wages. In an Indian case Basanti Bastralaya v. River Steam India Navigation [AIR 1987 Cal. 271], in a contract of carriage by river, the enemy seized the boat along with the cargo during hostilities between India and Pakistan. The plea of impossibility of performance was allowed. But if war prevents only one of the many ways of performing a contract, and that way was in the mind of one of the parties only and had not been made the basis of the contract as known to the other party, the doctrine of frustration cannot be invoked. Thus in Twentsche Overseas Trading Co. Ltd. v. Uganda Sugar Factory Ltd [AIR 1945 PC 144], there was a contract for the supply of “Krupps” steel rails. The appellant claimed that the rails specified were to be obtained from a German firm and that firm only. They could not deal with alien enemies due to the outbreak of the Second World War. The performance of the contract became illegal and impossible. But the Privy council held the reference to “Krupps” was merely a specification of the rails. The appellants no doubt intended Germany as the source of supply but it was not made the basis or foundation of the contract as known to the other party. There were other sources of supply. The appellant could not invoke the doctrine of frustration. Similarly, in Tskiorglou & co. Ltd. v. Noblee & thorl G. m. b. H. [(1962) AC 93], the appellants agreed to sell three hundred tons of Sudan groundnuts c.i.f. Hamburg. The usual and normal route was the Suez canal. The shipment was to be in November/ December, 1956. On November 2, 1956, the Suez Canal was closed because of the Anglo-French War with Egypt. It was reopened only in April, 1957. The appellants said it was an implied term that shipment should be through Suez. As that was not possible, there was frustration. But the House of Lords held that no such term could be implied. The customary or usual route was no doubt closed, S.32 of the English Sale of Goods Act required shipment by a reasonable and practical
route. The appellants might have been put to greater expense to ship the goods via the Cape of Good Hope. But that was no reason to claim frustration of the contract. 6. Frustration in Commercial Contracts Originally, the doctrine of implied term was called “frustration of the adventure” in commercial contracts and the term frustration was reserved for such contracts. The modern usage is to use the term “frustration” to cover all classes of cases of subsequent impossibility. The principle was applied in Jackson v. Union Marine Insurance Co. [L.R. 10]. P’s ship was chartered to proceed to New Port and load a cargo for San Francisco. On the way to New Port the ship ran aground. After some weeks the charterers chartered another ship and P lost the freight under the charter-party by perils of the sea. The question of total loss depended on whether the charterers found the contract impossible without waiting for the ship to be repaired which would have taken a long time. Bramwell B. said, “the adventure was frustrated by perils of the sea. Both parties were discharged. A loading of the cargo after repairing the ship would have been a new adventure, a new agreement”. In the result, the insures had to pay a total loss to P. In the case Bank Line v. Capel Co. Ltd [(1919) AC 535] the ship had been chartered for twelve months. Before the ship had been handed over, a few months earlier to the concerned date, the ship was requisitioned by the Government but released within the period of the charter. The charterers called on the owners to deliver her or pay damages. The owners pleaded frustration of the charter. Lord Summer discussed the principles of frustration in a valuable way and said in cases of such delay the question must be considered by the court as it had to be considered by the parties at the time they came to know the cause and probabilities of the delay and had to decide what to do. He said, “rights ought not to be left in suspense to hang on the chances of subsequent events. The contract binds or does not bind. The law ought to be that the parties can gather the facts then and there”. He held that the charter party was discharged. 7. Change of Circumstances As Lord Sumner remarked in the case Bank Line v. Capel,” the doctrine of frustration ought not to be extended but to cases that really fall within the rule it must be applied as a matter of course even under novel circumstances”. The courts have to apply the rule carefully to change of circumstances which make the performance of the contract impossible. In Joseph Constantine Steamship Line Ltd. v. Imperial Smelting Corporation Ltd. [(1942) AC 154], a ship was chartered to load a cargo. But on the day before she could have proceeded to her berth an explosion occurred in the auxillary boiler. It was impossible for her to undertake the voyage at the stated time. The House of Lords held that frustration had taken place by the change of circumstances. Though every change of circumstances cannot become frustration as held in many cases especially regarding abnormal 167 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
rises or falls in prices, or a sudden depreciation of currency, or revision of prices, yet when the new circumstances are extreme, a court may have to come to a conclusion of frustration. This happened in Essan Engineering Co. Ltd. v. Fertilizers and Chemicals (Travancore) Ltd. [AIR 1991 Mad. 158], where certain transformers were to be supplied on a firm basis at certain prices. Owing to a war there was a 40% escalation of prices. The court held the contract ended.
held that the situation like this is one of commercial hardship and did not frustrate the contract. The Madras High Court followed the same principle in Samuel Fitz & Co. v. Standard Cotton Co. [AIR 1945 Mad 291], D placed orders with P for supply of tapestries of a certain kind stating they intended to sell them in Australia. But the Australian Government prohibited the import of such goods. D lost the market and therefore cancelled the orders. P sued for breach. Horwill J. held that it was not possible to say that the foundation of the contract was that the goods should be resold in Australia.
However, there are changes of circumstances which may create commercial hardship but cannot be recognised by courts as frustrating and discharging a contract. A good illustration occurred in Davis Contractors Ltd. v. Fareham Urban District Council [(1956) AC 696 HL]. There was a contract to build certain houses for the council for a fixed price to be completed within eight months. Bad weather and labour strikes intervened. It was completed in twenty two months at a cost much more than contract price. The contractor claimed the original contract was discharged by frustration by change of circumstances. He claimed payment on a quantum meruit action of the actual cost for the work done. The House of Lords did not agree. Lord Radcliffe explaining the law of frustration said that it occurs when the law recognises a contract becomes impossible because without fault of either party change in circumstances render performance of a thing radically different from that undertaken. This must be decided from the terms and conditions read in the light of the surrounding circumstances and on the other hand the events which have occurred. It is not hardship or material loss itself which calls the principle of frustration into play.
Firstly, according to English law as the doctrine of implied term was based on the presumed intention of the parties (see Anglo Mexican Co case) no term can be implied which would be inconsistent with any express terms of the contract. As Viscount Simon L.C. stated in Constantine S.S. Line v. Imperial Smelting Corporation [(1942) A.C. 163], “there can be no discharge by supervening impossibility if the express terms of the contract bind the parties to performance not withstanding that the supervening event may occur”.
The Supreme Court of India recognised the same principle in Alopi Parshad & Sons Ltd. v. Union of India [(1960) 2 SCR 793], P acting as agents to the Government of India purchased ghee for the army. P was to be paid on cost basis for the work. The work was in progress. Second World War intervened. The rates fixed in peace time were totally altered by the war time conditions. The agents demanded revision of rates. They received no replies. They kept up the supplies. The Government terminated the contract in 1945. The agents claimed payment at enhanced rates. They did not succeed. The Supreme Court said “there is no general liberty for the courts to absolve a party from liability to perform the contract merely because on account of an uncontemplated turn of events the performance may become onerous”.
Secondly, according to English law doctrine of implied term, the presumed intention must be common to both the parties. The principle was illustrated in Blackburn Bobbin Co. v. Allen [(1918) 1 K.B. 540]. There was a contract for the sale and delivery at Hull of Finnish Birch Timber. The War broke out. The vendor intended to ship the timber from a Finnish port to Hull. The buyer was unaware that Finnish timber had to be got only like this as timber merchants in England did hold stocks. The out break of the War made it impossible for the vendor to perform the contract. What had happened was an unforeseen event but not provided for in the contract. It was held for the contract to be dissolved there must have been a failure of a basis which was in the intention of both the parties which was not so in this case.
Courts have taken the view that the alteration of circumstances must be such as to upset altogether the purpose of the contract. As Lord Loreburn said in the Anglo Mexican Co. case some delay or some change is very common in all human affairs. So commercial hardship will not by itself support frustration and excuse performance. In Sachindra Nath v. Gopal Chandra [AIR 1949 Cal 240], P let certain premises to D for a restaurant at a higher rent as British troops were stationed in Calcutta. A clause in the contract stated it will be in force so long as the British troops remain in the city. D agreed to pay the higher rent. After some months, the locality was declared out of bounds for the British troops. Henderson J. at the Calcutta High Court
There must be a failure of something which was the basis of the contract in the minds of both the parties but not in the mind of only one of the parties. This was also demonstrated clearly in Twentsche Overseas Trading Co. Ltd v. Uganda Sugar Factory Ltd. [AIR 1945 PC 144].
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As Lord Simonds said in the Fareham Urban District Council case, “disappointed expectations do not lead to frustrated contracts”. 4.4 LIMITATIONS OF THE DOCTRINE OF FRUSTRATION There are the following limits to the doctrine of frustration apart from the constraints imposed by the courts in particular classes of cases:
Thirdly, and most important of all, it is well established that the doctrine of frustration cannot be applied where the frustration is self-induced. If the event alleged to frustrate a contract arises from an act or election of a party, the doctrine cannot be applied. In Maritime National Fish Ltd. v. Ocean Travelers Ltd. [(1935) AC 524 (PC)], A hired R’s trawler, the “St. Cuthbert” to be employed in the fishing industry. Both parties knew that
the trawler could be used only under a licence from the Canadian Government. A was using five trawlers. They therefore applied for five licences. The Canadian Government granted three licences and asked to A to name three trawlers. A named three trawlers other than “St.Cuthbert”. When R sued for hire A repudiated the charter and pleaded frustration. But the Privy Council held that the frustration in this case was self-induced. It was the result of A’s own choice of excluding R’s trawler from the licences. Therefore, A was not discharged from the contract. However, self-induced frustration can come into play only where the act of a party amounts to a breach of duty owed to the other party under the contract. If such an act were not intentional but merely negligent, it is unlikely to be construed as a self-induced frustration. Anson, the authority on contract, thinks so, and the dicta of Lord Russell in the Constantine S.S. Line case that the default might range “to the thoughtlessness of a primadonna who sits in a draught and loses her voice”, only confirms this qualification. Fourthly, the English law may be said to be still not finally settled on the application of the doctrine of frustration to leases. In the leading case Cricklewood Property and Investment Trust v. Leighton’s Investment Trust [(1945) AC 221], the House of Lords, on the facts of the case, held frustration cannot arise in the lease which was for 99 years. A building lease was executed for 99 years. More rent was payable after the erection of certain buildings. But under the Defence Regulations the building operations could not be continued. The lessors sued for rent. The lessees pleaded that the lease had been frustrated. But the House of Lords unanimoulsy held that as the lease had still more than 90 years to run and the interruption may cover only a small part of that period, there had been no frustration in this case. Lord Russell pointed out that a lease is more than a contract. It vests an estate in the land for the lessee. The contract obligations are only incidental to the relation of landlord and tenant. Even if some of them become impossible the lease would remain. But Viscount Simon L.C also said that because a lease is more than a contract and amounts to an estate it cannot be said it can never end prematurely by frustration. He gave examples of a complete natural calamity or a permanent legislative preclusion making any operation of the lease unlawful. So the English law will allow frustration of a lease only in very exceptional cases. Such a view was reiterated in National Carriers Ltd v. Panalpina (Northern) Ltd. [(1981) 2 WLR 45 HL], A warehouse was demised to D for ten years. The premises were not to be used for any other purpose except as warehouse without consent of the lessors. The only access by vehicles was by one street. The local authority closed the street because of the dangerous condition of an old Victorian warehouse opposite to the one under demise. The period between the closure and opening of the street after the demolition of the old warehouse was likely to be twenty months. During such period the warehouse under demise was useless for D. D refused to pay any further rent and claimed the lease as
frustrated. But D was held liable. According to the House of Lords, the nature of the transaction and the duration after the interruption did not significantly damage the contract and the lease to apply the doctrine of frustration. The law is the same in India. In Raja Dhruv Dev Chand v. Raja Harmohiner Singh [AIR 1968 SC 1024], there was a lease of agricultural land for one year. The rent was paid and the lessee was given possession. Before any crops could be raised the partition of the country left the land in Pakistan. The parties migrated to India. The action was to recover the rent paid. The Supreme Court took the view that S.56 of the Contract Act is not applicable to rights and obligations of parties under a transfer of property under a lease. They said completed transfers are outside the scope of S.56. No recovery was allowed. However, where the demise has not taken place but there is only an agreement the principle of frustration can be applied. Thus in Sushila Devi v. Hari Singh [(1971) 2 SCC 288], there was an agreement to lease but the parties could not go to Pakistan to give or take possession because of partition. The Supreme Court held that the agreement came within the scope S.56 and there was frustration of contract. 4.5 CONSEQUENCES OF FRUSTRATION English law : The question arose in some of the coronation cases (See Krell v. Heury) as to what are the remaining rights of parties once there is frustration. It was decidecd in Chandler v. Webster [(1904) 1 KB 493] that on frustraton any loss must lie where it has fallen. In this case where the rent of the rooms was payable in advance and £ 100 had been paid on account of it was held that not only could it not be recovered back but the balance due £ 141 sh 15 must also be paid. The reason given by Romer L.J. was that the contract could not be considered void ab initio. This line of decisions caused hardship. But the House of Lords in the leading case of Fibrosa Spolka Akeysna v. Fairbairn Lawson Combe Barbour Ltd [(1943) AC 32] overruled Chandler v. Webster and the line of decisions. English sellers agreed to make and deliver certain machinery to Polish buyers, part of the price to be paid in advance. £ 1000 was paid. Performance became impossible as the Second World War broke out and Germany occupied Poland. It was held the contract was frustrated and discharged by War. Lord Russell of Killowen thought Chandler v. Webster was wrongly decided. It was held that because of total failure of consideration on a contract that had ceased to exist, the action by the sellers for the recovery of the advance sum paid was not an action on the contract, as supposed in Chandler v. Webster. It was an action in quasi-contract and the money was recoverable. Lord Simon drew a distinction between a promise being consideration in the law of formation of contract and in the law of discharge of contract by failure of consideration and quasi-contract. The performance of the promise being the consideration that has failed. Even after the decision in Fibrosa’s case, the law was considered unsatisfactory regarding the adjustment of rights of parties of frustrated contracts. The party prepaid may have incurred expenses or be left with goods of no value. 169 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
Therefore, the Law Reform (Frustrated Contracts) Act of 1943 was passed. The Act provides that where a contract has become impossible of performance or otherwise frustrated and the parties are discharged from further performance: (a) all sums paid or payable to any party before the discharge shall if paid be recoverable as money had and received for the use of the party who has so paid, or if payable cease to be so payable, (b) but if the party who has received such payment or to whom payable, has incurred expenses before the discharge the Court may allow him to retain or recover the whole or part of it considers just, (c) where a party has obtained a valuable benefit other than money, before the discharge, the other party may recover such sum not exceeding the value of the benefit, as the court considers just, (d) the Act will not apply if there is an agreement to the contrary, (e) the Act does not apply to freight paid in advance under a voyage charter party which is not recoverable by custom even if the completion of voyage is frustrated. Indian law : The position reached in English law after the decision in Fibrosa’s case and the above Act of 1943, is already secured in the Indian Law by s.65 of the Contract Act. According to S.65 when an agreement is discovered to be void, or when a contract becomes void, any person who has received any advantage under such agreement or contract is bound to restore it, or to make compensation for it, to the person from whom he received it. Illustration ‘d’ to S.65 explains the position. A contracts to sing for B at a concert for Rupees thousand which is paid in advance. A is too ill to sing. A is bound to compensate B for loss of profits at the concert. But A must refund to B the advance of Rupees thousand. S.65 covers agreements which never amounted to contracts being void ab initio but discovered to be so at a later stage. This wll cover benefits passed under a contract found void by initial mutual mistake. Indian decisions have consistently held that the intention of S.65 is to prevent a party to a void agreement to retain benefits received under it. S.65 will also cover contracts
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becoming void, that is, valid at inception but subsequently becoming void. The principle has been applied by the Indian courts even in cases where a contract is void by reason of “unlawful object” unknown to the parties and therefore the parties are not in pari delicto that is not equally at fault. In effect, both are not at fault. Indian law also allows under S.65 actions on Quantum Meruit which is a well settled quasi contractual claim. Quantum Meruit literally means “as much as earned”. The principle of quantum meruit is well illustrated in Craven Ellis v.Cannon Ltd [(1936) 2 K.B. 403], CE was employed as managing director in a company. After three months, it was discovered that the directors were not qualified to appoint him. Held, CE could recover remuneration for the services rendered by him. A claim on quantum meruit allowed in Indian law under S.65 is a remedy of restitution. It is not a compensatory remedy for damages. It is available only to a party who himself has not discharged the contract by breach but who may have partly performed or passed benefits to the other party which party has now put an end to the contract and therefore the first mentioned party has elected to be no longer bound for futher performance. The Supreme Court has explained the correct application of S.65 in State of Rajasthan v. Associated Stone Industries [(1985) 1 SCC 575], By stating that it is not as if S.65 works in one direction only. Any restoration of advantage and payment of any compensation, if any, have necessarily to be mutual. It approved the decision of the Privy Council in Govindram Seksaria v. Edward Radbone [AIR 1948 PC 56]. that the result of S.65 was that each of the parties was bound to restore to the other any advantage which the restoring party had received under the contract. The facts in the Supreme Court case were as follows : There was a contract for the grant of a quarry by the state to the other party. It was found to be void because the parties were mistaken about the application of income tax laws in the area. The Supreme Court said the state could recover from the contractor the value of the rough stone excavated but make good the expenses incurred in the quarring operations. The net profits realised by the company could not be the measure of compensation under S.65.
5. BARE TEXT OF THE RELEVANT SECTIONS STATUTORY LAW: INDIAN CONTRACT ACT 1872 (EXTRACTS) 31. “Contingent contract” defined. — A “Contingent contract” is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen. 32. Enforcement of contracts contingent on an event happening - Contingent contracts to do or not to do anything in an uncertain future event happens, cannot be enforced by law unless and until that event has happened. If the event becomes impossible, such contracts become void. 33. Enforcement of contracts contingent on an event not happening - Contingent contracts to do or not to do anything if an uncertain future event does not happen, can be enforced when the happening of that event becomes impossible and not before. 34. When event : on which contract is contingent to be deemed impossible, if it is the future conduct of a living person - If the future event on which a contract is contingent is the way in which the person will act at an unspecified time, the event shall be considered to become impossible when such person does anything which renders it impossible that he should so act within any definite time, or otherwise than under further contingencies 35. When contracs become void which are contingent on happening of specified event within fixed time - Contingent contracts to do or not to do anything, if a specified uncertain event happens within a fixed time, become void if, at the expiration of the time fixed, such event has not happened, or if, before the time fixed, such event becomes impossible. When contracts may be enforced, which are contingent on specified event not happening within fixed time- Contingent contracts to do or not to do anything, if a specified uncertain event does not happen within a fixed time, may be enforced by law when the time fixed has expired, and such event has not happened, or, before the time fixed has expired, if it becomes certain that such event will not happen. 36. Agreements contingent on impossible events, void Contingent agreements to do or not to do anything, if an impossible event happens, are void, whether the impossibility of the event is known or not to the parties to the agreement at the time when it is made. 37. Obligation of parties to 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 this act, or of any other law. Promises bind the representation of the promisors in case of death of such promisers before performance, unless a contrary intention appears from the contract. 38. Effect of refusal to accept offer of performance - Where a promisor has made an offer of performance to the promisee,
and the offer has not been accepted, the promisor is not responsible for non-performance, nor does he thereby losse his rights under the contract. Even such offer must fulfil the following conditions : (1) it must be unconditional (2) it must be made at a proper time and place, and under such circumstances, that the person to whom it is made may have a reasonable opportunity of ascertaining that the person by whom it is made is able and willing there and then to do the whole of what he is bound by his promise to do ; (3) if the offer is an offer to deliver anything to the promisee, must have a reasonable opportunity of seeing that the thing which the promisor is bound by his promise to deliver. An offer to one of several joint promisees has the same legal consequences as an offer to all of them. 39. Effect of refusal of party to perform promise whollyWhen a party to a contract has refused to perform, or disabled himself from performing, his promise in its entirety, the promise may put an end to the contract, unless he has signified, by words or conduct, his acquiescence in its continuance. 40. Person by whom promise is to be performed - If it appears from the nature of the case that it was the intention of the parties to any contract that any promise contained in it should be performed by the promisor himself, such promise must be performed by the promisor. In other cases, the promisor or his representatives may employ a competent person to perform it. 41. Effect of accepting performance from third person When a promisee accepts performance of the promise from a third person, he cannot afterwards enforce it against the promisor. 42. Devolution of joint liabilities - When two or more persons have made a joint promise, then, unless a contrary intention appears by the contract all such persons, during their joint lives, and, after the death of any of them, his representative jointly with the survivor or survivors, and, after the death of the last survivor, the representatives of all jointly, must fulfill the promise. 43. Any one of joint promisors may be compelled to perform - When two or more persons make a joint promise, the promisee may, in the absence of express agreement to the contrary, compel any [one-or more] of such joint promisors to peform the whole of the promise. Each promisor may compel contribution - Each of two or more joint promisors may compel every other joint promisor to contribute equally with himself to the performance of the promise, unless a contrary intention appears from the contract. Sharing of loss by default in contribution - If any one of two or more joint promisors makes default in such contribution, the remaining joint promisors must bears the loss arising from such default in equal shares. 171 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
Explanation - Nothing in this section shall prevent a surety from recovering form his principal, payments made by the surety on behalf of the principle, or entitle the principal to recover anything from the surety on account of payments made by the principal. 44. Effect of release of one joint promisor - Where two or more persons have made a joint promise, a release of one of such joint promisors by the promisee does not discharge the other joint promisor or joint promisors, neither does it free the joint promisors so released from responsibility to the other joint promisor or joint promisors. 45. Devolution of joint rights - When a person had made a promise to two or more persons jointly, then, unless a contrary intention appears form the contract, the right to claim performance rests, as between him and then with them during their joint lives, and after the death of any of them, with the representative of such deceased person jointly with the survivor or suvivors and, after the death of the last survivor, with the representatives of all jointly. 46. Time for performance of promise, where no application is to be made and no time is specified. - Where, by the contract, a promisor is to perform his promise without application by the promisee, and no time for performance is specified the engagement must be performed within a reasonable time. Expalanation : The question “what is a reasonable time” is, in each particular case, a question of fact. 47. Time and place for performance of promise, where time is specified and no application to be made - When a promise is to be performed on a certain day, and the promisor has undertaken to perform it without application by the promisee, the promisor may perform it at any time during the usual hours of business on such day and at the place at which the promise ought to be performed. 48. Application for performance on certain day to be at proper time and place. When a promise is to by performed on a certain day, and the promisor has not undertaken to perform it without application by the promisee, it is the duty of the promisee to apply for performance at a proper place and within the usual hours of business. Explanation : The question “what is a proper time and place” is, in each paticular case, a question of fact. 49. Place for performance of promise, where no application to be made and no place fixed for performance” When a promise is to be performed without application by the promisee, and no place is fixed for the performance of it; it is the duty of the promisor to apply to the promisee to appoint a reasonable place for the performance of the promise, and to perform it at such place. 50. Performance in manner or at time prescribed or sanctioned by promisee The performance of any promise may be made in any manner, or at any time which the promisee prescribes or sanctions. 51. Promisor not bound to perform, unless reciprocal promisee ready and willing to perform - When a contract 172 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
consists of reciprocal promises to be simultaneously performed, no promisor need perform his promise unless the promisee is ready and willing to perform his reciprocal promise. 52. Order of performance of reciprocal promises - Where the order in which reciprocal promises are to be performed is expressly fixed by the contract they shall be performed in that order; and where the order is not expressly fixed by the contract, they shall be performed in that order which the nature of the transaction requires. 53. Liability of party preventing event of which contract is to take effect. When a contract contains reciprocal promises, and one party to the contract prevents the other from performing the promise, the contract becomes voidable at the option of the party so prevented; and he is entitled to compensation from the other party for any loss which he may sustain in consequence of the non-performance of the contract. 54. Effect of default as to that promise which should be first performed, in contract consisting of reciprocal promises - When a contract consists of reciprocal promises, such that one of them cannot be performed, or that its performance cannot be claimed till the order has been performed, and the promisor of the promise last mentioned fails to perform it, such promisor cannot claim the performance of the reciprocal promise, and must make compensation to the other party to the contract for any loss which such other party may sustain by the nonperformance of the contract. 55. Effect of failure to perform fixed time, in contract in which time is essential - When a party to contract promises to do a certain thing at or before a specified time, or certain things at or before the specified time, the contract, or so much of it as has not been performed becoems voidable at the option of the promisee, if the intention of the parties was that time should be of the essence of the contract. Effect of such failure when time is not essential - If it was not the intention of the parties that time should be of the essence of the contract, the contract does not become voidable by the failure to do such thing at or before the specified time; but the promisee is entitled to compensation from the promisor for any loss occasioned to him by such failure. Effect of acceptance of performance at time other than that agreed upon- If in case of a contract voidable on account of the promisor’s failure to perform his promise at the time agreed, the promisee accepts performance of such promise at any time other than that agreed, promisee cannot claim compensation for any loss occassioned by the non performance of the promise at the time agreeed, unless at the time of such acceptance, he gives notice to the promisor of his intention to do so. 56. Agreement to do impossible Act - An agreement to do an act impossible in itself is void. Contract to do act afterwards becoming impossible or unlawful - A contract to do an act which, after the contract is made, becomes impossible, or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful.
Compensation for loss through non-performance of act known to be impossible or unlawful Where one person has promised to do something which he knew, or with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promisee for any loss which such promisee sustains through the non performance of the promise. 57. Reciprocal promise to do things legal, and also other things illegal- Where persons reciprocally promise, firstly, to do certain things which are legal and secondly, under specified circumstance, to do certain other things which are illegal, first set of promises is a contract but the second is a void agreement. 58. Alternative promise, one branch being illegal- In the case of an alternative promise, one branch of which is legal and the other illegal, the legal branch alone can be enforced. 59. Application of payment where debt to be discharged is indicated- Where a debtor, owing several distinct debts to one person, makes a payment to him, either with express intimation, or under circumstances implying, that the payment is to be applied to the discharge of some particular debt, the payment, if accepted must be applied accordingly. 60. Application of payment where debt to be discharged is not indicated-Where the debtor has omitted to intimate, and there are no other circumstances indicating to which debt the payment is to be applied, the creditor may apply it at his discretion to any lawful debt actually due and payable to him from the debtor, whether its recovery is or is not barred by the law in force for the time being as to the limitation of suits. 61. Application of payment where neither party appropriates- Where neither party makes any appropriation the payment shall be applied in discharge of the debts in order of time, whether they are or are not barred by the law in force for time being as to the limitation of suits. If the debts are of equal standing, the payment shall be applied in discharge of each proportionately. 62. Effect of novation, rescission and alteration of contractIf the parties to a contract agree to substitute a new contract for it, or to rescind or alter it, the original contract need not be performed. 63. Promise may dispense with or remit performance of promise- Every promisee may dispense with or remit, wholly or in part, the performance, or may accept instead of it any satisfaction which he thinks fit. 64. Consequences of rescission of voidable contract. - When a person at whose option a contract is voidable rescinds it, the other party there to need not perform any promise therein contained in which he is promisor. The party rescinding a voidable contract shall, if he has received any benefit there under from another party to such contract, restore such benefit, so far as may be, to the person from whom it was received. 65. Obligation of person who has received advantage under void agreement or contract that becomes void- When an agreement is discovered to be void, or when a contract becomes
void, any person who has received any advantage under such agreement or contract is bound to restore it, or to make compensation for it, to the person from whom he received it. 66. Mode of communicating or revoking rescission of a voidable contract- The rescission of a voidable contract may be communicated or revoked in the same manner, and subject to the same rules, as apply to the communication or revocation of a proposal. 67. Effect of neglect of promisee to afford promisor resonable facilities for performance- If any promisee neglects or refuses to afford the promisor reasonable facilities for the performance of his promise, the promisor is excused by such neglect or refusal as to any non-performance caused thereby. 68. Claim for necessaries supplied to person incapable of contracting, or on his account- If a person, incapable of entering into a contract, or any one whom he is legally bound to support, is supplied by another person with necessaries suited to his condition in life, the person who has furnished such supplies is entitled to be reimbursed from the property of such incapable person. 69. Reimbursement of person paying money due by another, in payment of which he is interested. A person who is interested in the payment of money which another is bound by law to pay, and who therefore pays, it is entitled to be reimbursed by the other. 70. Obligation of person enjoying benefit of non-gratuitous act - Where a person lawfully does anything for and her person or delivers anything to him, not intending to do so gratuitously, and such other person enjoys the benefit there of, the latter is bound to make compensation to the former in respect of, or to restore, the thing so done or delivered. 71. Responsibility of finder of goods. - A person who finds goods belonging to another, and takes them into his custody, is subject to the same responsibility as a baile. 72. Liability of person to whom money is paid, or thing delivered, by mistake or under coercion. - A person whom money has been paid or anything delivered, by mistake or under coercion, must repay or return it. 73. Compensation for loss or damage caused by breach of contract.- 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, the compensation for any loss or damage caused to him thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach. Compensation for failure to discharge obligation resembling those created by contract. - When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge it is entitled to receive the same compensation from the party in 173 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
default, as if such person had contracted to discharge it and had broken his contract.
Explanation : A stipulation for increased interest from the date of default may be stipulation by way of penalty.
Explanation - In estimating the loss or damage arising from a breach of contract, the means which existed of remedying the inconvenience caused by the non-performance of the contract must be taken into account.
Exception : When any person enters into any bailbond, recognizance or other instrument of the same nature or under the provisions of any law or under the orders of the [Central Government] or of any [State Government] gives any bond for the performance of any public duty or act in which the public are interested, he shall be liable, upon breach of the condition of any such instrument, to pay the whole sum mentioned therein.
74. Compensation for breach of contract where penalty stipulated for.- When a contract has been broken, if such is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipualtion by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for.
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Explanation ; A person who enters into a contract with Government does not necessarily thereby undertake any public duty, or promise to do an act in which the public are interested. 75. Party rightfully rescinding contract entitled to compensation : A person who rightfully rescinds a contract is entitled to compensation for any damage which he has sustained through the non-fulfillment of the contract.
6 CASE LAW 1. AERIALADVERTISING CO V. BATCHELORS PEAS, LTD (MANCHESTER) [(1938)2 ALL ER 788]
3. D & C BUILDERS LTD V. REES [(1966) 2 Q B 617 (CA)]
The plaintiff agreed to advertise the defendants' products by flying in an aeroplane over various towns trailing the words “Eat Batchelors' Peas”. The plaintiffs aeroplane flew over Manchester on the Armistice day while Armistice service was in progress and over the crowded main square in Manchester during the 2 minutes’ silence. There was such a vigorous denunciation and boycott of defendants' goods that the defendants had to apologise in the papers and stop the aerial advertising. Petitioners filed suit for advertising charges already earned and the defendants filed counter claim for damages, for wrongful performance.
The plaintiffs were a two-man firm of jobbing builders, who had done work on the defendant’s premises. The account for this came to some £ 732, of which the defendant had paid only £ 250. The plaintiffs were facing bankruptcy if they were not paid the balance, but the defendant’s wife, who was acting for him, refused to pay more than £ 300, alleging that the workmanship was bad. Because of their financial straits, which the defendant’s wife allegedly knew about, the plaintiffs reluctantly accepted a cheque for £ 300, marked ‘in completion of account’. They later brought an action for the balance. On a preliminary issue of whether there was a binding settlement, the trial judge held that there was not, and the defendant appealed.
The Court held the defendants were discharged from further performance of the contract by reason of the conduct of the plaintiffs' pilot, as it was not possible to fly anywhere near Manchester thereafter and though the period had not elapsed the same contract cannot be carried out reasonably from a business point of view, and awarded damages to the defendants. The basis of the doctrine of frustration was held to be that the parties have impliedly agreed that in case the contract when performed would be different from the contract as agreed to be performed, then the contract need not be performed. 2. CHARLES RICKARD V. OPPENHEIM [(1950) 1 ALL ER 420 (CA)] The defendant had agreed to buy a Rolls-Royce chassis, which was to be fitted with a coach-built body and delivered to him by 20 March 1948. The car was not delivered on time, but the defendant pressed for delivery. On 29 June the defendant gave notice that if the car was not delivered within four weeks he would not accept it. The car was ready in October, and the defendant refused to take it. The main point at issue before the Court of Appeal was whether defendant was justified in refusing to take delivery. The Court held from the fact and circumstances of the case it is found that the original contract made time of the essence. In this case not only the defendant press continually delivery, not only was he given promise of speedy delivery, but, on the very day before he gave the notice, he was told by the sub contractors’ manager, who was in charge of the work, that it would be ready within two weeks. He then gave four weeks’notice. The judge found that it was a reasonable notice and, in my judgment there is no ground on which this court could in any way differ from that finding. The reasonableness of the notice must, of course, be judged at the time at which it is given. It cannot be held to be a bad notice because, after it is given, the suppliers find themselves in unanticipated difficulties in making delivery. The notice of June 29, 1948 was therefore, a perfectly good notice so as to make time of the essence of the contract. Appeal dismissed.
Danckwerts L.J. Foakes v. Beer, applying the decision in Pinnel’s Case settled definitely the rule of law that payment of a lesser sum than that the amount of a debt due cannot be a satisfaction of the debt, unless there is some benefit to the creditor added so that there is an accord and satisfaction. In Foakes v. Beer, Lord Selborne, while approving Cumber v. Wane, did not overrule the cases which appear to differ from Cumber v Wane, saying: “All the authorities subsequent to Cumber v. Wane, which were relied upon by the appellant at your Lordships’ Bar (such as Sibree v Tripp, Curlewis v Clark and Goddard v. O’Brien) have proceeded upon the distinction, that, by giving negotiable paper or otherwise there had been some new consideration for a new agreement, distinct from mere money payments in or towards discharge of the original liability”. Lord Selborne was distinguishing those cases before the House. But the giving of a cheque of the debtor for a smaller amount than the sum due is very different from ‘the gift of a horse, hawk, or robe, etc’ mentioned in Pinnel’s Case. I accept that the cheque of some other person than the debtor, in appropriate circumstances, may be the basis of an accord and satisfaction, but I cannot see how in the year 1965 the debtor’s own cheque for a smaller sum can be better than payment of the whole amount of the debt in cash. The cheque is only conditional payment, it may be difficult to cash, or it may be returned by the bank with the letters ‘RD’ [Refer to Drawer] upon it, unpaid. I think that Goddard v O’Brien, either was wrongly decided or should not be followed in the circumstances of to day. I agree also that, in the circumstances of the present case, there was no true accord. The Rees really behaved very badly. They knew of the plaintiff’s financial difficulties and used their awkward situation to intimidate them. The plaintiffs did not wish to accept the sum of £ 300 in discharge of the debt of £ 482, but were desperate to get some money. It would appear also that the defendant and his wife misled the plaintiffs as to their own financial position. Rees, in his evidence, said : ‘In 175 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
June (1964) I could have paid £ 700 odd. I could have settled the whole bill’. There is no evidence that by August, or even by November, their financial situation had deteriorated so that they could not pay the £ 482. In my views the country court judge was right in applying the rule in Foakes v. Beer, and I would dismiss the appeal. 4. FOAKES V. BEER [(1884) [1881-5] All ER Rep 106 (HL)] Julia Beer got a decree against Foakes for £ 2,090-19-0 with interest. the defendant paid £ 2,090-19-0 in instalments and it was accepted in full satisfaction. But nevertheless the plaintiff took out execution for the interest. In view of the doctrine of frustration having been definitely extended to the discharge of the contract, the House of Lords gave judgement in favour of Mrs. Beer for the amount of interest. Earl Selbourne, L.C. said : “The doctrine laid down in Pinnel’s case has since the 16th century been accepted as law, It so, I cannot think that your Lordships of Appeal proceeding upon a doctrine which has been accepted as a part of the law of England for over 280 years’ 5. KRELL v. HENRY [(1900-03)All ER Rep 20 (CA)] The plaintiff, Paul Krell, sued the defendant, C.S. Henry to recover £ 50, being the balance of a sum of £ 75, at which price the defendant had agreed to hire from the plaintiff some rooms at 56A, Pall Mall, London, of which the plaintiff was tenant, on June 26 and 27, 1902, to view the processions which it had been intended to hold on those days in connection with the coronation of His Majesty King Edward VII. The defendant denied that he was liable to pay the £ 50, and counterclaimed for the return of £ 25 which he had paid as a deposit, on the ground that, the processions not having taken place owing to the illness of the King, there had been a total failure of consideration for the contract entered into by him. On August 11, 1902, the action came on for trial before Darling J, sitting without a jury, when the learned judge gave judgment for the defendant on both claim and counterclaim. The plaintiff appealed. The question for decision whether contract could be enforced and the rent due under it could be recovered when the contract did not contain any clause as to the object with which it was entered into The court held that the rooms of themselves had no value for the parties who had hired them and both parties had contracted on the underlying and fundamental assumption, that the processions would take place on the said dates. In other words, the contract was for “two rooms to view the processions and since they ceased to be” rooms from which the processions could be viewed” the contract became impossible of performance. Hence Appeal dismissed. 6. MARITIME NATIONAL FISH LTD V. OCEAN TRAWLERS LTD [(1935)PC 128] The appellants hired the respondents’ trawler, called “St.Cuthbert” to be employed for in fishing industry only. Both 176 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
parties knew that the trawler could be used for that purpose only under a licence from the Canadian Government. The appellants were using five trawlers and, therefore, applied for five licences. Only three were granted and the Government asked the appellants to name three trawlers and they named trawlers other than 'St.Cuthbert'. They then repudiated the charter and pleaded frustration in response to the respondents' action for the hire : The judicial committee of the Privy Council held that the frustration in this case was the result of the appellants' own choice of excluding the respondents’ trawler from the licence and, therefore, they were not discharged from the contract. Lord Wright in decreeing the claim observed : “If there was frustration of the adventure, it resulted from the deliberate act of the appellants in selecting three trawlers for which they desired licences to be issued ..... The essence of “frustration” is that it should not be due to the act or election of the party .... a self inducted frustration” 7 M/S CHINA COTTON EXPORTERS V. BEHARILAL RAMACHARAN COTTON MILLS LTD [AIR 1961 SC 1295] The appellants who carried on import business at Bombay contracted to supply to the respondent mill a quantity of Italian staple fibre cotton. The shipment was to take place in October or November. The contract concluded with the remark :”This contract is subject to import licence and therefore the shipment date is not guaranteed”. A part of the goods were supplied and accepted, but the rest were not supplied in the time mentioned. The appellant averred in his written statement that the non supply of goods arose by reason of “intermediary parties failing to supply and deliver goods to the defendant and also of the circumstnaces beyond his control”. Appellants further pleaded that the shipment time mentioned was not guaranteed and the time of shipment was not of the essence of the contract : The trial judge held that shipment time was guaranteed, except so far as delay in shipment might be due to delay in obtaining licence, which however was obtained in good time. The time of shipment was of the essence of the contract and there is no case here of the intermediary parties without having any specific provision in the contract to this effect. Hence the trial court held that there had been wrongful breach of the contract which entitles the plaintiff for damages. Appeal at the High Court by the defendant also fails and thus this is an appeal in the Supreme Court. It was held that inspite of the remark that shipment date was not guaranteed, time was the essence and the buyer was entitled to avoid the contract. Dass Gupta J said : Remembering, as we must, that in commercial contracts time is ordinarily of the essence of the contract and giving the word “therefore” its natural grammatical meaning, we must hold that what the parties intended was that to the extent that delay in obtaining licence stands in the way of keeping to the shipment date October/November, 1950, this shipment date was not guaranteed, but with this exception, October/November, 1950
was guaranteed. The sellers contended that the parties were mentioning only one of the many reasons which might cause delay in shipment and the conjunction “therefore” was used only to show the connection between one of the many reasons - by way of illustration and a general agreement that the shipment date was not guaranteed. We do not consider this explanation of the use of the word “therefore” acceptable. If the parties intended that quite apart from delay in obtaining import licence, the shipment date was not guaranteed, the natural way to expressing such intention would be to say : “The contract is subject to import licence and the shipment date was not guaranteed”. The ordinary rules of grammar would not use the word “therefore” in such a context except to mean that only to the extent that dealy was due to delay in obtaining import licence, shipment time was not guaranteed”. The delay in this case was due to the failure of the seller’s own supplier to supply in time. This cannot be a defence unless it was condition of the contract that the goods would be supplied when received from the sources of supply. Hence the appeal was dismissed. 8. OCEAN TRAMP TANKERS CORPN. V. SOVRACHT, THE EUGENIA [(1964)1 All ER 161(CA)] By a charter party dated 8 September 1956, the Eugenia, which was then in Genoa, was let to the charterers ‘for a trip out to India via the Black Sea’. Both parties realized at the time of the negotiations that there was a danger of the Suez Canal being closed, but they came to no agreement on that eventuality. On 25 October the Eugenia, having loaded, sailed from Odessa. At that time the customary route to India was still via Suez. By the time the vessel reached the vicinity of the canal it had become a ‘dangerous’ zone, but in breach of contract the charterers failed to take steps to prevent the ship entering Port Said. The ship entered the canal on 31st October, and became trapped when the canal was closed. The charterers claimed that the contract had been frustrated by the closure of the canal. It was held that the closure of the normal route for transport of goods after the contract was made thereby necessitating resort to a larger route entailing much delay and heavy expenditure will not constitute such a fundamental change in the contractual obligation as would justify a plea for frustration for non performance. Hence the appeal was allowed. 9. REILLY V. THE KING [(1934) AC 176] Reilly, a member of the Quebec Bar, was appointed in August 1928 by Letters Patent a member of the Federal Appeal Board for a term of five years on a specified salary, but he was subsequently dismissed in October 1930 as the office was abolished by Statute. Reilly filed Petition of Right and claimed Damages for breach of Contract. It was held that so far as the rights and obligations rested on contract, further performance of the contract had been made by statute impossible, and the contract was discharged. It is perhaps unnecessary to add that discharge means put an end to and does not mean broken. Hence Reilly is not entitled for damages.
10. SATYABRATA GHOSE V. MUNGEERAM BANGUR & CO [(1954) SCR 310] M & Co. started a scheme for the development of a large area of land for residential purposes. They divided it into plots for sale. A small part of the price was accepted as earnest money on agreement, and after the company developing the plot, within one month, the purchaser was to complete the conveyance by paying one third price on registration and the balance within six years at 6% interest. Time was deemed of the essence. B entered into the contract with M & Co. in 1940 and later assigned it to Satyabrata Ghose. Shortly before such assignment, the land was requisitioned for military purposes under the Defence of India Rules. M & Co. informed B that as there was no knowing how long the government would retain possession, they could not take up development during the War and possibly for many years afterwards. They asked B either to cancel the contract and take back the earnest money, or complete the conveyance within one month by paying balance of price, the company under taking to develop the plots after the War as possible. They also said if B did not choose either alternative, the contract would be deemed cancelled and earnest money forfeited. B passed on the letter to the assignee S. S refused to accept either alternative and sued for a declaraton that the 1940 contract was subsisting and M &Co. should proceed on the same terms with him. M & Co. contended that the contract had been discharged by frustration by supervening impossibility. The Court of first instance rejected the plea of frustration. So also the court of first appeal. The Calcutta High Court on second appeal upheld the plea of frustration. But the Supreme Court held that having regard to the terms of the contract, the war time conditions when it was entered, the extent of work involved in the development scheme, and the absence of any definite period of time in the contract for the completion of the work, the contract cannot be said to have been frustrated by performance becoming impossible. Accordingly, they reversed the decision of the High Court and upheld the decree of the lower courts. 11. SHANKARLAL DAMODHAR V. AMBALAL AJAIPAL [AIR 1946 NAG 260] On 21st December 1932 the defendant and his father executed a document described as a conditional deed of sale of immovable property in favour of the plaintiff for a consideration of Rs.700. Certain creditors had obtained a decree in a mortgage suit against the defendant and his father, and the plaintiff had paid this decree by payment of Rs.700. According to the terms of this deed, the defendant and his father sold a house to the plaintiff subject to the conditions that if they paid off the principal sum without interest within two years they would be the owners of the house and if they failed to pay off this principal sum within the time the plaintiff was to be the owner of the house. It is admitted that the plaintiff was never placed in possession, and it was alleged in the plaint and not denied by the defendants that on 22nd December 1932, the defendant and 177 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
his father agreed to pay rent for the house at the rate of Rs.10 per mensem and executed on that date “a pronote in respect of that interest”. Subsequently the matter was referred to arbitrators who gave an award on 9th January 1935. They treated the transaction as a mortgage, and it is conceded that it was a mortgage. They calculated that Rs.831 was due on this mortgage including Rs.10 per mensem by way of interest, and they decided that the plaintiff should take a portion of the mortgaged house by way of payment of Rs.600 and that the remaining amount should remain a mortgage charge on the southern half portion of the house and should carry interest at the rate of 1 percent per mensem. They further directed that the defendant and his father should pay off this principal and interest within four years and if they failed to do so the southern portion“shoud be put into the possession of the plaintiff after the same being foreclosed. The plaintiff should, according to the above condition, get a preliminary decree passed for the amount in the proper court.” This award was filed in Court, and a decree was passed on 29th April 1935 of which the relevant portion is : “There remains a balance of Rs.231 due to the defendant (i.e., the present plaintiff). For this amount there shall be lien of mortgage on the remaining share on the southern side of the house which is now in possession of the plaintiffs 1 and 2 (i.e., the present defendant and his father). The amount shall carry interest at 1p.c./p.m. and repayable in four years. If plaintiffs 1 and 2 failed to repay the amount in fixed period the defendant can get it foreclosed”. Subsequently the plaintiff applied to have this decree amended on the ground that it was not in accordance with the award and
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that it ought to be a preliminary decree for foreclosure. The Court held on 25th February 1938 that the decree was in accordance with the award, that it was not intended that this should be a preliminary decree for foreclosure, that the decree could at most be treated as a mortgage deed and that the defendant (i.e., the present plaintiff) had only a right to bring a suit on this mortgage. There was a second application to amend and the Court held on 20th March that its previous order was conclusive, and the condition in the award was made to create a mortgage, and that the defendant (i.e., the present plaintiff) had a right to bring a suit on the mortgage, and then claim the preliminary and final decrees. An application to this Court in revision was dismissed. It has been suggested that the plaintiff could at least have sued on the decree to enforce a personal liability, but when the plaintiff applied for amendment of the decree it was held that the decree could at most be treated as a mortgage decree and he had only a right to bring a suit on that mortgage. It has also been contended that there was no agreement in the so called deed of sale to pay interest, but it was pleaded and not denied that there was an agreement to pay interest at the rate of Rs.10 per mensem. Interest at 7 per cent per annum is claimed. I, therefore, agree with the lower appellate Court that the plaintiff is entitled to fall back on the original mortgage. At the time of the award he accepted a portion of the mortgaged property in lieu of Rs.600 and he is now claiming the balance with interest at the rate of 7 per cent per annum. To that, in my opinion he is entitled, and the appeal will, therefore, be dismissed with costs. There will be a fresh preliminary decree for foreclosure in the usual form, allowing time for payment upto 15th February 1946. The amount then payable will include interest up to that date. Counsel’s fee Rs.25. Appeal dismissed.
7. PROBLEMS 1.
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A entered into a contract with C whereby C had to construct a certain line of five shops as a frontage to a vacant plot. Six months time was allowed. Time was mentioned as of the essence. However, a clause was inserted that after watching the execution for a month, the additional work of constructing a house in the plot would be allotted to the same contractor, which was done. C could finish all the work only in nine months. After two months, A seeks your advice to repudiate the contract. Advise with reasons. P, a shoe import company, entered into a contract to supply A, a national shoe chain store company, a certain quantity of a certain design and quality of ladies’ shoes made in Italy. Shipment was to take place from Italy in June and July. The contract stated it is subject to import licence “and therefore” the shipment date is not guaranteed. Only a third of the goods were supplied on time. A wanted to repudiate the contract. P contended that as the shipment date was guaranteed, the delay which was really caused by the failure of the seller’s own supplier, was protected. Decide with reasons. A, B & C, jointly undertake a municipal contract to construct a new bus stand. A leaves the country and is untraceable but sends rupees fifty thousand to C. B neglects to attend to the contract. C builds the bus stand at a cost of rupees six lakhs. He seeks your advice how much he can recover from B by suit. Advise quoting the section and stating the law Two professors in the same faculty of a university were given a contract by a publishing firm to co-author a book on a certain subject of their speciality. One of them received an invitation from a university abroad to come as a visiting professor. He wrote to the publishers that in his absence, his colleague will write the entire book. The colleague made the manuscript ready in a reasonable time but the publishers refused to accept it. What is the legal position ? Explain clearly. There was a contract for the supply of timber to make furniture for a Government Department. The timber had to be approved by the Superintendent of the Government furniture making factory. The supplier supplied correct quality samples. But the Superintendent did not approve the timber. The supplier sued the Government for breach of contract. Decide with cogent reasons. N owned a factory constructed on agricultural land nominally held in the name of his brother. N sold the factory
to P. P paid half the price at once and was put in possession. The balance was payable at a fixed date. P defaulted. N rescinded the contract and sued for recovery of possession. What is the defence of P ? Explain with reasons. 7. D owed the following debts to C Rs.10,000 due in 1989. Rs.30,000 due in 1990. Rs.40,000 due in 1991. Two debts of Rs.5,000 and Rs.20,00 of equal standing in 1992. After selling his estate, D made the following payments to C in 1993. Rs.20,000 in January, Rs.30,000 in March, and Rs.40,000 in July. Neither the debtor nor the creditor made any appropriation before the matter came to court. The debt of Rs.10,000 due in 1989 is barred by limitation. How should the court make the appropriation ? Give the solution explaining the legal grounds. 8. There was a partnership firm consisting of the partners X, Y and Z. Z retired without notice to creditors. A new parter, Q was admitted to the firm. A creditor C advanced a loan to the firm after the retirement of Z. The loan became overdue. C sued X, Y, Z and Q together having learnt of the changes in the firm. Explain what is the decision and what are the principles of law involved in the facts of this case. 9. S, fruit importers, agreed to sell to B 100 tons of Arabian dates c.i.f.Bombay, May, 1994. S made arrangements for shipment from Aden in April/May, 1994. But the civil war in Yemen broke out and made the shipment impossible. Arabian dates could however be shipped from Muscat. B, who had entered into consequential contracts for supply of Arabian dates to Bombay fruiterers, sued S for compensation for breach of contract. S pleads discharge by frustration. Decide explaining the law in the requisite depth. 10. T, a tourist agency, hired from O, omnibus owners, in October, 1993, their luxury omnibus ‘Dream” for six months from January, 1994. O owned five omnibuses including “Dream”. Both parties knew at the time that licences of omnibuses had to be renewed before January. O applied for renewal of licences of their five buses. The Government stated renewal in January would be given for three and asked them to specify three buses. O left out "Dream”. O stated to T in January that “Dream” was not available as licence was refused for five buses. Meanwhile, T had booked parties and suffered loss. T sued O for compensation for breach of contract. O pleads discharge by frustration. Decide with reasons.
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8. SUPPLEMENTARY READINGS 1. Avtar Singh, Law of Contract, (1994), Eastern Book Company, Lucknow. 2. Anson, Law of Contract, (1986), English Language Book Society Press and Oxford Press, London. 3. Beale, H.G. Biship W.I.,Furmstorn, M.P., Conract Cases and Materials, (1990), Butterworths, London, Edinburgh. 4. Chitty, on Contracts, (Vol.II 1983), Sweet and Maxwell, London. 5. Cheshire and Fifoot, Law of Contract, (1986), Butterworths, London. 6. Iyer, Venkatesh, The Law of Contracts, (1987), Asia Law House, Hyderabad. 7. Joga Rao S.V. Contract Law General Principles, (1991),NLSIU, Bangalore. 8. Kapur, J.L. (etd), Mulla's Contract Act and Specific Relief Acts, (1986), N.M. Tripathi Private Ltd. Bombay. 9. Puri and Ponusmay, Cases and Material on Contract, (1974), Eastern Book Co., Lucknow. 10. Trietal, G.K., Law of Contracts, (1966), Steven & Sons, London
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Master in Business Laws Law of Contracts Course No: I Module No: VI
BREACH OF CONTRACT AND REMEDIES
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 181 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
Materials Prepared By: 1.
Prof. S. Jagapathy, B.Com. (Hons), B.L., Advocate.
Materials Checked By: 1.
Ms. Sudha Peri, M.A., LL.M.
2.
Ms. Archana Kaul, B.Sc., LL.M.
Materials Edited By: Prof. N. L. Mitra, M.Com., LL.M., Ph.D. Prof. P.C. Bedwa, LL.M., Ph.D.
© National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore-560 072.
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INSTRUCTIONS In the previous module we have given a flow chart regarding discharge of contract. Breach of contract is mentioned there as one of the grounds of discharge. In that module we have also explained what is a discharge. When a party either does not perform his part of the contract or refuses to perform, it is said that a party has committed a breach of contract. Some times a party may by act or omission induce another party to believe that former is not interested to perform the respective part of the contract. In such situations, the latter party may also treat the contract as breached. The question may arise as to why a party after entering into the contract may be interested in not performing it. There are various reasons for that. The most important reason is perhaps economic reason. When the economic background of the contract changes in such a way that a party by not performing the contract will sustain less loss than by performing the contract he prefers to commit breach of contract... as for example, A promised on 1.1.94 to supply 100 bags of rice to B at 1000 rupees per bag. The rice is to be supplied say in the middle of March. Suppose due to failure of Khariff season the price of rice has gone very high and A thought that price could be further high during March. In the early February itself, A refuses to perform the contract. In fact, A has two options in February. Firstly, to wait till March and to procure rice at the market price and perform the contract sustaining a loss of rupees 600 per bag, assuming the price by the time is raised to rupees 1600 per bag. His second option is to commit the breach as soon as he feels that he will sustain more loss by performance than by committing a breach. This is of course an economic explanation of commission of breach. There may be other reasons as well. But business community take their course of action basically on economic reasons. In case of a breach of contract a person is expected to reasonably compensate the opposite party. In calculating the reasonable compensation courts take into consideration various factors for committing the breach as on the day of commission of the breach of contract. In countries like U.K. or France the court relies upon the liquidated damages as stipulated by the parties. But in India the court itself evaluates the loss and awards reasonable compensation only. In several case laws the reasonableness and the basic principles of calculating compensations are laid down. In this module these issues will be discussed thread bare in such a way that you can acquire the skill of calculating the amount of damages in specific fact situations. It is necessary for you to carefully examine the reasoning given in those cases for determining the amount of compensation. One has to critically look at this stage the various grades of losses sustained by the other party. Some are immediately due to the breach of contract and some may be remotely connected. A judicial application of mind in processing these losses is what one should aim at. I hope after reading the material you will apply your mind in this regard to solve the problems given at the end of the module.
N. L. Mitra Course Co-ordinator
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Breach of contract and remedies
TOPICS
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Breach of Contract .........................................................................................................
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Consequences of Breach ................................................................................................
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Remedies of Breach ........................................................................................................
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Case Law .........................................................................................................................
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Problems..........................................................................................................................
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Supplementary Readings ...............................................................................................
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1 BREACH OF CONTRACT SUB TOPICS 1.1 Introduction 1.2 Forms of Breach of Contract 1.3 Renunciation or Repudiation 1.4 Anticipatory Breach 1.5 Restitution 1.6 Actual Breach or Breach When Performance Due or During Performance 1.1
INTRODUCTION
We have seen in Module V that one of the ways in which a contract may be discharged is Breach of Contract. We have also noted that Breach is the antithesis of Performance; nevertheless it may result in Discharge. However, Discharge by Breach brings in its wake other consequences. It gives rise to remedial rights resting on the fundamental juridical principle that where a right is broken, there must be a remedy, ‘Ubi jus ibi remedium’, Discharge by Breach of contract gives rise to Remedies for the innocent party. The most common form the Remedy may take is a right to claim compensation. There may also be circumstances of Breach which entitle the innocent party to treat himself as discharged from any performance due from him. However, not every breach operates as a discharge. When the party at default has repudiated his obligations or made himself unable to perform or failed to perform this is usually the effect. There is a qualification to the principle of breach by default of a party. The default does not strictly itself ‘discharge’ the contract. It enables the innocent party, if he chooses, to absolve himself as discharged from performance or further performance on his side. He may be said to have ‘accepted’ the repudiation. ‘Acceptance’ here, of course, is used in an entirely different sense from acceptance of a proposal. He may, on the other hand, choose to consider the contract as not discharged and continue to insist on performance, and carry on his part. Such a situation is illustrated in White and Carter (Councils) Ltd v. Mc Gregor [(1962) A.C. 413]. Appellants, advertising contractors, agreed with respondents, garage proprietors, to display advertisements for the garage for three years. Same day, respondents refused to perform and requested cancellation of the contract. But the appellants refused so to do and elected to treat the contract as subsisting. They displayed advertisements as agreed and sued for full amount due. Respondents argued that appellants were not entitled to do so but only to claim damages. The House of Lords rejected the argument and held appellants entitled to the full sum. But it is clear even from the judgment in this case that the party not in breach will not always thus be entitled to carry on with the contract and sue for full money. Firstly, a contract cannot be carried on without the co-operation of the other party. For example, an employee wrongfully dismissed cannot claim employment and salary but only damages. Secondly, unless
the party has a legitimate interest, financial or otherwise, in performing rather than claiming damages, which normally should be an adequate remedy, he cannot be allowed to do so but only to claim compensation. Another limitation occurs when there is failure of performance by one party which goes to the root of the contract. The contract is not determined by the breach. It is open to the innocent party to treat the contract as continuing or accept defective performance when tendered. When he does so he is said to have affirmed the contract and not treated it as discharged for himself also. He retains, however, the right to claim damages. Affirmation may be express or implied, but must be total and cannot be partial. It is a voluntary act and requires knowledge of the breach waived. It is also subject to estoppel. When repudiation is accepted by the innocent party, he is absolved from all further contractual obligations. So also the primary obligations of the party in default are discharged. However, there arises on his part the secondary obligation to compensate in damages for the breach. The replacement of the primary obligations by the secondary obligation is by operation of law and cannot be obviated. The nice chain of consequence thus linking the primary and secondary obligations was argued out and brought out well in the judgment in Moschi v. Lep Air Services Ltd. [(1973) A.C. 331]. Rolloswin Investments Ltd was indebted to respondent for £ 40,000 and had agreed to pay atleast £ 6,000 a week. Appellants were guarantors of the obligation to the respondents. The company defaulted at the very outset. After three weeks they paid £ 10,000 out of £ 18,000 then due. Respondents elected to treat the default as a repudiation. The company went into liquidation. Respondents sued the appellants as guarantors for both accrued and future instalments. The appellants advanced the argument that since the repudiation had been accepted, the company’s obligation to pay future instalments came to an end and so their obligation also came to an end. The House of Lords put aside this argument and held there was liability on the guarantee. Firstly, the repudiation being treated as such, though the company’s primary obligation to pay future instalments came to an end, it was replaced by operation of law by a secondary obligation to pay damages for breach. Secondly, the appellants who were guarantors of the performance of the obligation were now in breach of their contract of guarantee. The measure of the damages for which they were liable was the unpaid balances of instalments. 1.2 FORMS OF BREACH OF CONTRACT Discharge of contract as understood above may arise in three ways : (a) A party renouncing his obligations under the contract. (b) A party by his own act making it impossible that he should fulfil his obligations under the contract. (c) A party may fail to perform what he has promised. 185 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
The first two ways of breach may take place in the course of performance or even when performance is not yet due by either party. In such a case it is called ‘anticipatory breach ‘. The last way of breach can take place only at or during the time of performance. Authors classify breach in a general way as (a) Actual breach or present breach, and (b) Anticipatory breach. In this, the stress is on the time of breach in the ‘life’ of a contract. The more scientific classification is to approach breach in the three ways as above. A working definition of breach was given in an American case, Associated Cinemas of America, Inc. v. World Amusement Co. (sup. Court of Minnesota) [(1937) 201 Minn. 94], “A breach of contract occurs when a party thereto renounces his liability under it, or by his own act makes it impossible that he should perform his obligations under it or totally or partially fails to perform such obligations”. To give a summed-up view of Breach Breach by any one party always gives rise to right to claim damages by the innocent party. However, whether it would also enable the party not in default to absolve himself from further performance, depends. A long line of authorities have recognised that the party in default has such a right only in two circumstances : Firstly, where the party in default has repudiated the contract before performance is due (called anticipatory breach), or before it has been fully performed. Secondly, where the party in default has committed what in modern judicial parlance is called a ‘fundamental breach'. This has also been expressed for the last nearly one and a half centuries of English law as breach ‘going to the root of the contract’. To constitute ‘fundamental breach’ two tests have been developed by English law. One had always been to determine whether the part of the contract broken is such as has been attached sufficient importance by the parties depending on the ‘true construction of the contract as a whole’ as to conclude that it is a major term that could be viewed as a ‘condition’. Or, whether it is only of a relatively minor term which could be viewed as a ‘warranty’. The other and more useful test may be, after the exposition of the law in this regard in Hongkong Fir Shipping Co. Ltd v. Kawasaki Kisen Kaisha Ltd. [(1962) 2 QB 26], and the reconsideration of the whole question in The Mihalis angelos [(1971) 1 QB 164], to consider both the term and the breach together in the light of the seriousness of the consequences that have resulted. The two tests are not however really necessarily alternative, it may be more correct to describe them as alternate to be applied as necessary according to the nature of the breach and the circumstances of the case. 1.3 RENUNCIATION OR REPUDIATION Renunciation takes place when one of the parties shows the intention not to go on with the contract. This amounts to 186 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
repudiation of the contract on his part. If there is an express and unqualified refusal the intention will be clear and obvious. But, it may also be implied by conduct. Then the test is whether the party has acted in such a way as to lead a reasonable person to the conclusion that he does not intend to fulfil his part of the contract. The establishment of such intention is important. Only then will it entitle the other party to treat himself as discharged from any further performance of his obligations. Otherwise, it will not justify the other party in repudiating his part of the contract. Thus, in Freeth v.Burr [(1874) L.R. 9 C.P. 208], there was a failure on the part of the buyer to pay for one instalment of several deliveries of iron, under a mistaken impression that he was entitled to withhold payment as a set-off against damages for non-delivery of an earlier instalment. It was held the seller was not thereby discharged. Similarly, in Mersey Steel and Iron Co. v. Naylor, Benzon & Co. [(1884) 9 A.C. 434], respondent bought from appellant company 5,000 tons of steel to be delivered at the rate of 1,000 tons each month from January, 1881, payment to be made within three days of receipt of shipping documents. The company delivered part of the first instalment, and another in February. Shortly before payment was due, a petition was presented for winding up of the company. The respondents wrongly advised not to pay without leave of the court, refused payment. The appellant company informed them that they would treat this as breach. But the respondents expressed their willingness to take delivery and make payments if possible. The House of Lords held the appellants were not entitled to treat themselves as discharged. On the other hand, an unequivocal refusal by words or conduct to perform the contract will entitle the other party to treat himself as discharged from further performance by himself. Thus in sale of goods, an instalment buyer who has agreed to pay cash but demands credit in future deliveries, enables the seller to refuse further delivery [Withers v. Reynolds (1831) 2 B. & A. 882]. In a contract of employment, a school teacher who refuses to supervise school meals when required to do so, may be terminated by the employer [Gorse, v. Durham County Council (1971) 1 W.L.R. 775]. Default or Act of Party Making Performance Impossible Even though a party has not by his words or conduct renounced (repudiated) a contract, if by his own act or default he makes performance or further performance impossible, the other party will be discharged. Repudiation is easier to establish. But such default of a party as to make his performance impossible is an independent ground of discharge. Such default is illustrated in Universal Cargo Carriers Corporation v.Citati [(1957) 2 QB 401] P chartered a ship to D who agreed to nominate a berth and a shipper, and to provide a cargo, all before a certain day. Three days before the due date he had done none of the things. He remained willing to perform if he could. But P cancelled it and found another charterer. Devlin. J, held that though D had not renounced the contract he
could not perform before such delay as to defeat the commercial purpose of it and this entitled P to treat his obligations discharged. 1.4 ANTICIPATORY BREACH The repudiation may be explicit or implicit even before the performance is due. A leading case on explicit repudiation is Hoschster v. De la Tour [(1853) 2 E & B 687]. Defendant engaged the plaintiff on 12 April to enter into his service and accompany him on a tour. The sevice was to commence on 1 June. On 11 May itself, the defendant wrote to the plaintiff and informed him his services would not be required. Plaintiff sued for breach immediately without waiting for the time for performance. It was held there had been an “anticipatory breach” by the defendant and the plaintiff was entitled to bring the action immediately. It could be implicit even where the performance was contingent. The leading authority is Frost v. Knight [(1872) L.R. 7 Ex.111]. D, a bachelor, promised to marry P on the death of his father. Even during his father’s lifetime D broke off the engagement. Cockburn C.J. held that what apparently is ‘anticipatory breach’ is really in such cases, a present breach of an obligation to keep the contract subsisting until the time for performance. He explained that this is the principle of anticipatory breach so called. He allowed P to sue immediately for damages. (Action for breach of promise to marry has since been abolished by the Law Reform (Miscellaneous Provisions) Act 1970 but the principle of the above decision is still of general application.) A breach of contract, therefore by repudiation before the time for performance, is ‘anticipatory breach’. The innocent party is entitled to treat the contract as discharged and sue for damages immediately. It is also open for him not to treat the contract as repudiated until the time for performance arrived. If he does so, the contract is subsisting. The status quo ante remains. It has been held that in that case he keeps the contract alive not only for his own benefit whatever he expects but also for the benefit of the other party as well. The other party can therefore not only change his mind and proceed with performance at the due time but also take advantage of any supervening developments that may discharge the contract otherwise than by breach. This has been laid down and demonstrated in the leading case Averry v. Bowden [(1855) 5 E & B. 714]. P chartered his ship to D. The ship was to sail to the Black Sea port of Odessa and receive a cargo from the agents of P to be loaded in forty five days. The vesel reached Odessa. The agent was not able to supply the cargo. The master of the ship continued to remain in port demanding the cargo. Before the specified number of days had elapsed, the Crimean War broke out. Performance became impossible in law. P sued D for breach. It was held the contract had been discharged not by breach but by impossibility of performance by out-break of war.
However, it is not as if all anticipatory breaches will entitle the other party to treat the contract as at an end. The case Afovos Shipping Co. Sa v. Pagnan [(1983) 1 AER 449] has found as per Lord Diplock that if one party states to the other in advance that he will not perform a particular primary obligation, the question whether the other may treat it as a repudiation depends on the non performance having the effect of depriving substantially the whole benefit which was intended he should obtain from such primary obligation. Following up anticipated breach further, a refusal to treat such breach as discharge may some times operate to disadvantage of the party in default. In Roper v. Johnson [(1873) LR 8 CP 167], Michael v. Hart [(1902) 1 KB 482], and Jai Hing Cotton Mill Ltd v. Kamsing Knitting Factory [(1979) AC 91], where in a contract for sale of goods for delivery at a certain time, the seller announces in advance that he will not make delivery, but the buyer does not accept the repudiation and finally sues for breach at or after date of performance, the measure of damages has been held to depend on the market price of the goods not at the date of repudiation but the time of performance, and if the market price is then higher the damages will be higher. Another possibility is that where there is refusal to treat an anticipatory breach as a discharge, and the affirming party is subsequently in breach, the repudiating party may escape liability. In Fercometal SARL v. Mediterranean Shipping Co. SA. [(1988) 2 A.E.R. 742], the charterer refused to load the ship. But the owner affirmed that the contract was still alive. He failed to make the ship ready to loan on the specified date. It was held the owner had become liable for breach. The making of commercial performance of the contract impossible by a party by his own act or default even though he has not renounced it and thereby entitling the other party to discharge himself, may also take place before performance, and is another form of anticipatory breach. If the promisor, before the time for performance, makes it impossible that he should perform the promise, the effect is the same as repudiation. The aggrieved party may sue at once. The classic authority is Lovelock v. Franklyn [(1846) 8 AB 371]. D promised to assign to P within seven years all his interest in a lease for the sum of £ 40. Before seven years, he assigned the interest to another person. It was held P need not wait for seven years to sue for breach. Similarly, in Omnium D’ Enterprises v. Suthurland [(1919) 1 KB 618], D chartered a ship to P to be placed at his disposal as soon as she was released from Government service in which engaged at the time. D sold her to another person before the release. Held, the contract was then at an end and P may bring his action for breach forthwith. Indian Law S.39 of the Indian Contract Act embodies the principles of ‘anticipatory breach’. It lays down : “When a party to a contract has refused to perform, or disabled himself from performing, his promise in its entirety, the promisee 187 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
may put an end to the contract, unless he has signified, by words or by conduct, his acquiescence in its continuance”. S.39 provides two illustrations as follows : (a) A, a singer, enters into a contract with B, the manager of a theatre, to sing at his theatre two nights in every week during the next two months, and B engages to pay her 100 rupees for each night’s performance. On the sixth night A wilfully absents herself from the theatre. B is at liberty to put an end to the contract. (b) A, a singer, enters into a contract with B, the manager of a theatre, to sing at his theatre two nights in every week during the next two months, and B engages to pay her at the rate of hundred rupees for each night. On the sixth night, A wilfully absents herself. With the assent of B. A sings on the seventh night. B has signified his acquiescence in the continuance of the contract, and cannot now put an end to it, but is entitled to compensation for damages sustained by him through A’s failure to sing on the sixth night. S.39 requires that the promisor must have repudiated his obligations in entirety to enable the other party to put an end to the contract. Indian cases have held that where this is not so the other party cannot put an end to the contract. By way of illustration, even as early as 1878 in Sooltan Chund v. Schiller [(1875) 4 Cal.252], there was a contract for sale of 200 tons of linseed oil in April and May to be paid for on delivery. Some deliveries were made. Plaintiffs made part payment but withheld the balance for adjustment of claims. The defendants taking that as an anticipatory breach refused further supplies. The plaintiffs sued them for breach. It was held that the withholding of a part payment under a bonafide claim cannot be regarded as refusal to perform the contract in its entirety. It appears as if the decision is at variance with the illustration ‘a’ to S.39 above. But Garth C.J. explained that the illustration is perhaps not a happy one because it may be mistaken. The singer by wilfully absenting herself on one night refused to perform an integral and essential part of her contract. Thereby she could not perform her contract in its entirety. But in this case the plaintiff never refused to perform any part of the contract. They were willing to pay the due sum as soon as a cross claim was adjusted. 1.5 RESTITUTION When there is an anticipatory breach, the aggrieved party may put an end to the contract. He may sue for breach. Meanwhile, he may have received benefits under the contract. What about them ? S.64 of the Contract Act requires that a party rescinding a voidable contract shall restore any benefit received thereunder from any party to it, as for as may be, to such party. When under S.39, the aggrieved party sets aside a contract, what is the position ? This question was answered by the Privy Council in Muralidhar Chatterjee v. International Film Co. [AIR 1943 PC 34]. D, a firm of film importers agreed with P to supply them films at the rate of one a month. P were to pay a fixed 188 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
amount of rent and some other charges. One film was supplied and a sum of Rs.2000 was paid against it. Due to the exhibition difficulties, the film was returned. Later another sum of Rs.2000 was paid against which no film was supplied. P wrote to B that for breach of contract they would stop dealings. B accepted the repudiation. P sued them for refund of money. Sir George Rankin explaining the relationship between S.39 and S.64 said the contract which may be ‘put an end to’ under S.39 is ‘voidable’. The right to recover damages for a contract rescinded as it has been rendered voidable by the wrongful act of a party is given by statute. This is no objection to apply s.64 to a contract rescinded under S.39 and the liability to make restitution attaches. It was held the amount was refundable under S.64. The case was referred back to the High Court to determine the damages. 1.6 ACTUAL BREACH OR BREACH WHEN PERFORMANCE DUE OR DURING PERFORMANCE Renunciation or Repudiation If at the time performance is due, a party by words or conduct makes known his intention not to perform his part of the contract, the question whether the other party can treat himself as discharged from his obligations depends on whether time is of the essence in the contract. The right for damages is there. In English law, the common law generally regarded time fixed as of the essence. Equity did not originally so regard a condition as to time. But the Judicature Acts of the nineteenth century fused the rules of common law and equity. In mercantile contracts time will be normally assumed to be of the essence. In contracts for sale of land or other immovable property it will be presumed that time is not of the essence. The provisions in Indian law is S.55 of the Contract Act regarding voidability for failure of performance of a contract in which time is of the essence has been discussed under time of performance in Module V, 'Discharge of Contract'. If during the performance of a contract one of the parties by words or conduct (expressly) refuses to perform the contract, there is breach, and the other side is forthwith released from obligation for further performance and is entitled to sue at once for damages. In Cort v. Ambergate etc Railway Co. [(1851) 17 QB 127], P contracted with D company to supply 3,900 tons of railway chairs on a certain price, to be delivered in certain quantities at specified dates. 1,787 tons had been delivered. The company now requested him to deliver no more as they would not be wanted. P sued for breach averring he was ready and willing to complete performance but D had prevented it. The court rejected the argument for D that P should have proved actual delivery of the entire lot. It held as the contract had been repudiated by D, P could sue for breach. Impossibility created by Act of One Party If during the performance of a contract, one party, by his own act or default, makes further and complete performance
impossible, there is breach, and the other side is forthwith released from obligation for further performance and is entitled to sue at once for damages. Thus the rule is similar in this case also.
cannot be withheld on the ground that the landlord has failed to repair the premises [Taylor v. Webb (1937) 2 K.B. 283], Courts tend against construing contracts as containing independant promises but the structure of some contracts as such.
In O’Neil v. Armstrong [(1895) 2 QB 418], P, as British subject, was engaged by the captain of a war-ship belonging to Japan to act as a fireman on a voyage from Tyne to Yokohama. During the voyage, Japan declared war on China. P was informed that the performance would bring him under penalties of law. P therefore left the ship. P sued the master for the wages agreed. It was held he was entitled to succeed for the action of D’s principals, the Japanese Government had made his performance of the contract legally impossible.
Ordinarily, in the structure of most contracts, the obligations of each party are interdependant. For example, an employee is not bound to observe a covenant in restraint of trade that would have applied on termination of service when he has been wrongfully dismissed by his employer [General Billposting Co. Ltd. v. Atkinson (1909) A.C. 118]. The clearest example is offorded when the parties have agreed that performance of their promises shall be simultaneous each to be ready and willing to perform at the same time. This makes the mutual promises concurrent. For example, under the law of Sale of Goods (both in England and in India), unless otherwise agreed, delivery of the goods and payment of the price are concurrent conditions. This is what is intended in most transactions of sale of goods for cash across shopping counters. Failure to tender the goods discharges the buyer from payment of the price and failure to tender the price discharges the seller from delivery of the goods.
Discharge by breach will occur not only where one party disables himself from performing the contract, but also where he prevents completion of the contract by the other. Courts are ready to imply a term in contracts that each party undertakes to do all that is necessary to secure performance. For example, if a licence is required for the export of goods, and the buyer fails to provide the seller with the information necessary to obtain the licence, the buyer cannot sue the seller for non-delivery [Kyprianou v. Cyprus Textiles Ltd. (1958) 2 Loyd’s Rep. 60]. Failure of Performance Failure of performance, which may be total or partial, is the most common ground for the discharge of a party by breach. Failure of performance obviously can occur only during performance. It is not every failure of performance by one party which entitles the other to be discharged from his own obligations under it. In order to determine when this would result we have to look at the contract and the failure in the following ways : (a) Are the mutual promises independant or interdependant or concurrent ? (b) Is the obligation subject to failure an ‘entire’ one or ‘divisible’ ? (c) Is the broken part a term of ‘condition’ ? (d) Does the breach go to the ‘root of the contract’ ? (a) Relationship between the mutual promises Way back, Lord Mansfield in Jones v. Barkley [4 Doug. 659] classified reciprocal promises in contracts as : 1. Mutual and independant 2. Mutual and dependant 3. Mutual and concurrent. The usefulness of the classification holds good even today. There are certain contracts in which the obligations of each party may be independant of each other in the sense that neither party can claim to be released from his promise by the failure of the other to perform his part. For example, in the contract covering a lease, the covenant of the tenant to pay rent is independant of the covenant of the landlord to repair. Rent
(b) ‘Entire’ obligation and ‘divisible’ obligation Certain contracts can only be ‘entire contracts’ in the sense that the liability of one party is dependant upon the complete performance of obligations by the other. For example, when a suit of clothes is given to a tailor to be stitched in return for a promise to pay the charges, nothing less than a completed suit of clothes is expected. Complete performance is subject to the doctrine of substantial performance. In such cases, when failure of complete performance comes about whether by abandonment or negligence or even misfortune it results in discharging the other party from obligation. The case Culter v. Powell [(1795) 6 TLR 320] was decided on this basis. A seaman was engaged as a second mate on a voyage from Jamaica to Liver pool and 30 guineas was to be paid as a single payment on completion of the voyage. Unfortunately when the ship was 19 days from Liverpool the second mate died. The widow sued to recover a proportion of the sum but failed. But since then the Law Reform (Frustrated Contracts) Act 1943 has been passed. If that case were to be decided now, under S.1 of that Act, a proportionate sum may be recoverable by the widow as compensation. But the case is still used as an illustration for individual obligation. A modern example, occurs in Bolton v. Mahadeva [(1972) 2 AER 1322]. P contracted to install a certain heating system in D’s house for £ 800. He installed the system but it worked inefficiently. D refused to pay anything. The Court of Appeal held P could recover nothing. In 1983, the Law Commission (in England) proposed legislation to change the position since in such cases the defendant is left with an unwarranted profit. Such 'entire' contracts are the exception rather than the rule. Most contracts are ‘divisible’. A contract may be a complex one with different undertakings with different importance. A failure by a party to precisely perform an obligation will no doubt give a right for an action but will not necessarily discharge the other party from his own obligations 189 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
(c) Broken part of the contract being a term of ‘condition’ Assuming that a contract is divisible, the next question arises whether the particular term which has been broken is a condition of the contract. Here, it may be stated that a term in a contract will be considered a condition according to its importance in the contract and the effect of its breach. A term will be classified as a condition if fixed by statute or recognised by judicial decision, or if the parties have so agreed in their contract expressly or by implication. A term will be a condition by its import and not description. A breach of a condition entitles the innocent party to be discharged from the contract. Right to claim damages remains. The imputation of condition to a term, whether it is precedent, subsequent, or concurrent to or with liability in a contract depends on the contractual intention of the parties. In Bannerman v. White [(1861) 10 CB NS 844], B offered hops to W for sale. W asked if sulphur had been used in growing them as brewers did not want such hops. B told W that sulphur was not used. W purchased the crop of that year. The crop was weighed in W’s warehouse to calculate the price. W now repudiated the contract on the ground that the hops contained sulphur. B sued W for the price. It was found that sulphur had been used in five out of three hundred acres for trying new machine and B had forgotten or thought the matter not important. But the court concluded that a condition of a contract had been broken and W would reject the hops and B could not claim the price. In this case the condition happened to be a condition precedent. After the decision in Hongkong Fir Shipping Co. Ltd v. Kawasaki Kisen Kaisha Ltd. [(1962) 2 QB 26], some terms of a contract may be classified as ‘intermediate terms’ the breach of which will not necessarily entitle the innocent party to be discharged from his obligations in the contract. An intermediate term may perhaps be described as more than a warranty but less than a condition. (d) Breach going to the ‘root of the contract’ If the term broken is not a condition proper, but an intermediate term, the discharge of the innocent party from further performance depends upon the nature and consequences of the breach. To ground this, courts have sought after different metaphors from time to time. But as Sachs L.J. said in DecroWall International SA v. Practitioners in Marketing Ltd [(1971) 2 AER 216], "at the risk of being dubbed old-fashioned” his preference is for the expression “goes to the root of the contract”. This has been the favourite expression for the last one and a half centuries. The question whether the breach goes to the root is for the court to decide on the facts of the case.
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Other phrases used by courts more recently are that the breach must be “fundamental”, that the breach must “affect the very substance of the contract”, or “frustrate the commercial purpose of the venture”. However called the substance the judges have had in mind is the same. It is that the breach must be far reaching in effect to justify discharge. The test laid down in Hangkong Fir Shipping Co. Ltd. v. Kawasaki Kisen Kaisha Ltd. [(1962) 2 QB 326], is, “does the breach deprive the other party of substantially the whole benefit which it was the intention of the parties that he should obtain as consideration for performing his undertaking ?”. Facts : P chartered to D the vessel Hongkong Fir for twenty four months that she was in every way fitted for ordinary cargo service. The vessel was old. P did not provide proper engine room staff. The chief engineer was addicted to drink. There were many break downs in machinery. The ship was only eight and half weeks at sea in the first seven months. The rest of the time was spent to make the ship seaworthy which was at last achieved. D refused to continue with the charter party. The court held on the facts that the delays and the steps taken to make the ship seaworthy considered together would not deprive D of substantially the whole benefits which it was the intention of parties that he should obtain from further use of the ship. D could not treat the contract as repudiated. The root of the contract approach has been adopted to contracts to deliver and pay for goods in instalments. The breach may amount to express or implied repudiation under the sale of goods law. But if there is a failure of performance it must go to the root of the contract in order to justify discharge. In Maple Flock Co. Ltd v. Universal Furniture products Ltd [(1934) 1 KB 148], there was a contract to supply 100 tons of flock of certain standard to be delivered by instalments. The sixteenth delivery was below standard. The buyer wanted to treat it as repudiation. But the seller wanted to continue. Lord Hewart C.J. held that two tests, one the ratio quantitatively which the breach bears to the contract as a whole, and second, the degree of probability that such a breach will be repeated, must be applied. On the facts, the sixteenth delivery was only 11/2 tons out of 100 tons. 20 satisfactory deliveries had been made both before and after. It was held, therefore that the buyer could not discharge the contract, but only claim damages. It follows that the further the parties have proceeded with the performance, the less likely it is that one party will be able to claim discharge by a single breach in such contracts. But if it is going to the root it will discharged. Thus in Munro & Co. Ltd. v. Meyer [(1930) 2 KB (312)], in a contract for supply of 1500 tons of bonemeal by instalments, nearly half was delivered but found seriously adulterated. Held, the buyer was entitled to be discharged.
2. CONSEQUENCE OF DISCHARGE SUB TOPICS 2.1 General Principles 2.2 A Flow Chart 2.1
GENERAL PRINCIPLES
When there is such a breach of a contract by one party that the other party is entitled to discharge himself and does so, he is released from further performance. He is not also obliged to accept any further performance from the party in breach. The duty of the party in breach as well as his right of further performance comes to an end. The secondary liability to compensate in damages arises. So also the right of the injured party to claim damages. Traditionally, the main consequence has been described as ‘rescission’ of the contract. Also as ‘termination’ of the contract. However, these terms are not of sufficient accuracy. The rescission here is different from the rescission ab initio as for example, when there is a flaw in consent like misrepresentation or mistake. Here, it may be more accurate to say that the injured party can absolve himself from further performance, per Lord Porter in Heymans v. Darvin Ltd. [(1942) AC 356], approved unanimously by the House of the Lords in Johnson v. Agnew [(1980) AC 367]. Vendors agreed to sell a house and some grazing lands. The properties were separately mortgaged. The purchase price was sufficient to pay them off and also a bond loan which vendors had secured to buy another property. The purchaser failed to complete on the agreed date. A fortnight later vendors issued notice making time of the essence and fixed 21 January 1974. The purchaser failed to complete on this date. It was clear that vendors were entitled to terminate the contract. But instead they sued for specific performance and obtained it on 27 June 1974. but before the order was entered, both mortgagees of house and grazing land took possession and sold the properties for much less than purchaser had agreed. Vendors there upon applied to court to proceed against purchaser in damages for breach. The House of Lords held that the vendors in suing for specific performance had not made a final election and it was open to the court to allow them to sue for damages if it appeared equitable. Lord Wilberforce stated that it is necessary to clear a confusion. when an injured party is said to rescind a contract the rescission is quite different from rescission ab initio as may arise for flaw in consent. In those cases the contract is treated in law as never having come into existence. In the case of a repudiatory breach being accepted, it is now quite clear, under the general law of contract, there is no rescission ab initio but the contract has come into existence and has been put on end to or discharged.
of the innocent or the guilty party alike continue unaffected. Thus, if a time charter party of a ship is repudiated by the charterer, the ship owner can recover arrears of hire due up to the date of acceptance of repudiation. If building work is to be paid for by instalments, any instalment due but unpaid at the time of discharge can be recovered. If an employee repudiates a contract of employment, he can nevertheless recover wages already earned by him. If money has been paid by one party to the other under the contract, the money may be recoverable in restitution as money had and received. The Indian law is the same. When goods have been supplied or services performed under such a contract the innocent party can sue for the reasonable value of a quantum valebant or a quantum meruit claim, or include the value in the claim for damages for breach. Whether the party in breach can make any claim will depend on whether the contract is divisible. If divisible, he may be entitled to claim for completed part of performance, subject always to the counter claim for damages for loss suffered by the breach. The one consequence which is in common for every kind of breach is the secondary obligation that arises of the party in breach to pay compensation to the injured party in damages in respect of loss suffered by the breach. And that leads us to the next section, Remedies for Breach of Contract. 2.2 A FLOW CHART Consequence of Breach of Contract Types of Breach Renunciation or Repudiation
Anticipatory or Constructive
Restitution
Actual Breach
Consequences Contractual Remedies Statutory Remedies (Ss.73-75) Rescission of contract Unliquidated damages/ reasonable Compensation
Equitable Remedies
Liquidated damages & penalty other statutory remedies (Ss.55-61 sale of Goods Act)
Injunction (Ss 34-37 of Specific Relief Act)
unliquidatedpenalty
Specific performance Ss. 9-15, and Ss.20-25 of Specific Relief Act)
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3. REMEDIES OF BREACH SUB TOPICS 3.1 Introduction 3.2 Contractual remedy 3.3 Common Law and Statutory remedy 3.4 Equitable remedy 3.1 INTRODUCTION As seen above, where there is breach of contract, the primary obligations of the party in breach are replaced by the secondary obligation to compensate the other party in damages for loss in respect of the breach. This is irrespective of whether the injured party is entitled to absolve himself from performance of his part or not as a result of the breach. When he is able to do so, his claim for damages is in addition to it. Even otherwise the claim to damages remains, as for example, when a minor term, called traditionally a ‘warranty’ is broken, and loss has been caused to him. Apart from the remedy of damages, which the common law of England allowed for breach of contract, the courts of equity developed the remedies of specific performance and injunction as discretionary remedies in suitable cases only. After the Judicature Acts of the nineteenth century, both the common law remedy of damages, and the equitable remedies are administered by all the courts. In India, statutory provisions for damages are made in the Contract Act itself, and the equitable remedies are provided for in the Specific Relief Act 1963 (which has replaced the earlier Act of 1877). In India, from the beginning, the same heirarchy of courts administer both the legal and equitable remedies. 3.2
CONTRACTUAL REMEDY
Very often the parties to the contract stipulate the remedies in the event of breach of contract. One can find a clear exposition about the rights and duties of the parties in case one party commits a breach in any Contract drafted in America by an U.S. Lawyer. In USA law is taken as the tool of management of the whole affair. So, from the initial stage of the contract itself, parties to the contract take the help of specialist lawyers to clearly draft the contract document, in its entire form including all conditionalities, so that parties themselves in all situations solve their problems either directly or through mediators and arbitrators. Seldom parties keep any space for litigation to landup in the Court because of high cost of litigation and the uncertainty involved. But, in common law countries, especially in India, parties’ entering into the contract are in the 'honeymoon' stage. As such, they keep away their advocates and solicitors from the site of the contract. As a result, the contract document is often prepared by lay man with serious loopholes keeping many issues untouched specially issues arising out of breach of contract. Parties at the ‘Honeymoon’ stage hate to think about breach of contract by any party. The 192 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
absence of clear provisions and understanding, in such cases, compel the parties to landup in the court. Like commercial contracts, breach of contract in commercial cases are also determined by complicated, economic and market forces. If it is economically prudent and commercially viable a party to the contract often commits breach in a disperate bid to salvage his or her economic interests. It is therefore advisable that in all contracts particularly in commercial projects conditionalities must include position of parties in case of breach of contract, so that cost of mediation and arbitration becomes easy. Contractual remedies shall include : (1) Right to rescind the contract by the other party at a definite situation of breach of contract. (2) Quantum of damages or the method of calculation of damages. When the parties determine the quantum of damages to be paid by the party committing the breach it is known as liquidated damages. It may be difficult for the parties to stipulate the amount specially in international agreements. In some countries under their municipal law liquidated damages are not allowed. What is allowed is reasonable compensation. This statutory provision makes an inroad in to the power of the parties to the contract. Indian legal position is also like that which shall be discussed at the appropriate place. (3) Parties may even determine and stipulate a penalty clause in the contract. In such cases penalty becomes liquidated. As in the case of liquidated damages in some countries liquidated penalty is also not considered. We will discuss the situation at the appropriate place. (i)Rescission of Contract As already seen earlier when a contract is breached by one party, the other party may have the right to rescind the contract and treat himself as absolved from his obligations and hold the defaulting party liable in damages. The remedy of rescission may also be available in a contract which is voidable at the option of one of the parties. A party who has a right of rescission may, if necessary, sue for the remedy of rescission under the Specific Relief Act, 1963. According to S.27(1) of the Act, on a suit for rescission of a contract, the court may adjudge such rescission in any of the following cases : (a) where the contract is voidable or terminable by the plaintiff, (b) where the contract is unlawful for causes not apparent on the face of it and defendant is more to blame than the plaintiff. Thus the remedy of rescission is available to a party who is entitled to avoid or put an end to the contract or where the contract is unlawful and the plaintiff and defendant are not in pari delicto. The remedy of rescission is subject to certain important limits.
According to S.27(2) the court may refuse to rescind the contract in the following cases : (a) where the plaintiff has expressly or impliedly ratified the contract. The right to rescission is lost when the plaintiff has affirmed the contract. Affirmation may have been express or implied. (b) Or, where, owing to change of circumstances which has taken place since the making of the contract (not being due to any act of the defendant), the parties cannot be substantially restored to the position in which they stood when the contract was made. The right of rescission is lost when the position of the parties is altered such that restoration to status quo ante is not possible. For example, one party may have consumed goods or resold goods. (c) Or, where third parties have, during the subsistance of the contract, acquired rights in good faith for value without notice. The right of rescission is lost where the rights of third parties have intervened as for example, a bonafide buyer buying the goods for value without notice from a first buyer who obtained the goods by fraudulent misrepresentation. (d) or, where only a part of the contract is sought to be rescinded and such part is not severable from the rest of the contract. The right of rescission cannot be exercised when the concerned part of the contract cannot be severed from the rest of the contract. (Regarding S.27, “contract” means a contract in writing, in territories to which the Transfer of Property Act, 1882, does not apply). S.28 deals with rescission in certain circumstances of contracts for the sale or lease of immovable property, in which specific performance has been decreed. According to S.27, rescission of contract cannot be adjudged for mere mistake, unless the party against whom it is adjudged can be restored to substantially the same position as if the contract had not been made. This means that though rescission is possible on the ground of mistake without any other vitiating elements, it will not be allowed unless the parties can be restored to the status quo ante, or where a third party has in good faith without notice and for value acquired any interest under the contract. Restitution on Rescission According to S.30, on adjudging the rescission of a contract, the court may require the party to whom the relief is granted to restore, so far as may be, any benefit which he may have received from the other party and to make any compensation to him which justice may require. This provision gives effect to the principle that he who seeks equity must do equity and is in keeping with S.64 of the Contract Act.
Rectification of Instruments Another remedy provided by the Act is the rectification of instruments including written contract. According to S.26(1), when through fraud or mutual mistake, a written contract (not being articles of association of a company) does not express their real intention, then (a) either party or his representative - in- interest may sue to have the instrument rectified, or (b) the plaintiff, in any suit in which any right under it is in issue, may claim that the instrument be rectified, or (c) a defendant in any such suit, in addition to any other defence, may ask for rectification of the instrument. According to S.26(2), the court on finding in such suit on such pleading that the instrument through fraud or mistake does not express the real intention of the parties, may, in its discretion direct rectification so far as can be done without prejudice to rights acquired by third parties in good faith and for value. According to S.26(3), a contract in writing may first be rectified and then if the court thinks fit may be specifically enforced. For rectification, the true question is what was the intention of the parties at the time of writing the contract and executing it if necessary. There must have been mutual and not unilateral mistake or fraud. The mistake may be either of fact or of law although if a mistake of law relief will not be given unless it has resulted in inequity. Thus, where the final draft of a contract mentioned the price in weight when in fact it was agreed to be in count, rectification was granted. In New India Rubber Works (p) Ltd v. Oriental Fire and General Insurance Co. [(1969) 1 Comp. LJ 153 Cal.], “riot risk” was mentioned in an insurance cover by mistake. Rectification was allowed under S.26. Cancellation of Instruments Sections 31 to 33 of Act provide for the relief of cancellation of instruments including written contracts in suitable cases. According to S.31, any person against whom a written instrument is voidable, and who has reasonable apprehension that such instrument if outstanding may cause him serious injury, may sue to adjudge it void or voidable and the court in its discretion may so order it to be cancelled. Under this section, it is not necessary that the plaintiff must be a party to the contract. A suit is maintainable by a person against whose interest the instrument is. S.31 rests on the principle of protective justice and ‘quia timel’ or reasonable apprehension (fear) of injury. According S.32, the court may, in suitable cases cancel an instrument in part and allow the remaining part to stand. According to S.33, the relief of restitution may be given following the relief of cancellation of a written contract whether for the plaintiff or the defendant in the suit for the cancellation. Restitution under this section may also extend to compensation. 193 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
(ii) Liquidated Damages and Penalty (a) English Law Parties to a contract some times assess the damages to one or both of them which a breach will cause or estimate it or fix it and introduce it into the terms of the contract. By doing so, however they cannot exclude the application of the rule that damages are to compensate the plaintiff for actual loss. It is a question of the proper construction of the contract to decide whether a sum so fixed is a genuine attempt to liquidate the prospective damages and therefore recoverable, or , howsoever the parties describe it is a penalty and therefore irrecoverable. English law does not allow penalty though some legal systems may do so. The court will accept the sum fixed by the parties if it is a genuine pre-estimate of the damages likely on breach. The question is one of construction to be judged as at the time of making the contract not the time of breach. Even if parties have reduced the probable damages it will be accepted by the court. On the otherhand, if the sum fixed is interrorem, it will be considered a penalty and will not be enforced. The court will look to the real intent and not the form of expression. A leading case on penalties is Dunlop Pnuematic Tyre Co. Ltd v. New Garage & Motor Co.Ltd [(1915) AC 79] A, makers of motor tyres and tubes sold goods to R who agreed not to resell or offer to sell at a price below the manufacturer's listed prices. R further agreed to pay £ 5 as liquidated damages for every breach. R sold tyres at less than listed prices and was sued for damages. The House of Lords held that the sum fixed was not a penalty. Lord Dunedin laid down the following rules: 1. If the sum is extravagant compared to the greatest loss that could happen it is a penalty. 2. If the breach is in not paying money and the sum is greater than the sum which should have been paid it is a penalty. 3. There is a presumption that when a single sum is payable as compensation on one or more events some serious some trifling in damage it is a penalty. 4. Even if the consequences of the breach make precise preestimate impossible, it is no obstacle to a sum being a genuine pre-estimate. In English law the sum of liquidated damages is recoverable. But if it is interrorem and amounts to a penalty it is not recoverable. Damages will be calculated according to ordinary principle. An illustration of penalty is available in Ford Mottor Co. v. Armstrong [(1915) TLR 2671]. A retailer received from P supplies of cars and parts agreeing not to sell below listed prices. For every breach, £ 250 was payable as agreed damages. The Court of Appeal held this was a penalty as a part may be sold in breach which is of lesser value. Another illustration is London Trust Co. Ltd. v. Hurel [(1955)1 AER 839]. A car was purchased on hire purchase. The total price was £ 558. If the purchaser returned the car, or if on default the seller retook it, £ 425 including instalments paid must be given. The purchaser paid £ 302 and defaulted. 194 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
The seller retook the car and resold it for £ 270. He sued for recovering ( £ 425 - £ 302) = £ 123. The court rejected it as a penalty and not a genuine pre-estimate. Lord Denning L.J. said that £ 425 is three quarter of the price. Such a figure is inserted by hire-purchase companies as a rule of thumb. Supposing the car was to be taken back in a month would the hire or depreciation go up to £ 425 ? The House of Lords in Bridge v. Campbell Discount Co. Ltd [(1961) 1 AER 385] further held where 2/3 of the price is made payable on default it is a penalty. Cases have held that where the full amount or a fixed amount is payable whether the default takes place in the beginning or towards the end it is a penalty. So also where a sum of money is payable and on default a large sum is payable it is a penalty. In an old case Kemble v. Farren [(1829) 6 BING 141] where an artiste was to act as chief comedian at a theatre for a fixed period for £ 3 1/2 a night but on default was to pay £ 1000 it was held a penalty. Where a figure fixed by parties is sensible whether reasonable or not it will be a ceiling and nothing more is recoverable. In Cellulose Acetate Silk Co. Ltd. v. Widness Foundry Ltd. [(1933) AC 20], certain machinery was to be erected by a certain day. £ 20 was to be paid for everyday of default. There was default of 30 days. The liquidated damages was £ 600. £ 5850 was claimed as actual loss suffered but the House of Lords allowed only £ 600 as liquidated damages though underestimated by the parties. (b) Indian Law The Indian law on liquidated damages and penalties differs slightly from the English law in terms of the rule laid down in S.74 of the Indian Contract Act, 1872. S.74 states : “Compensation for breach of contract where penalty stipualted for - When a contract has been broken, if a sum is named in the contract as the amount to be paid in case of such breach, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage or loss is proved to have been caused thereby, to receive from the party who has broken the contract reasonable compensation not exceeding the amount so named or, as the case may be, the penalty stipulated for. Explanation - A stipulation for increased interest from the date of default may be a stipulation by way of penalty” Please see illustrations ‘a’ to ‘g’ to S.74 in the Act. In Indian law where a sum is named in the contract as amount to be paid for breach, whether it is a penalty or not, the injured party is entitled to receive reasonable compensation but not exceeding the named amount. Thus a court should allow reasonable damages for the breach in the circumstances of the case upto but not exceeding the sum stipulated by the parties. The court must award reasonable damages not beyond the fixed limit. The distinction between liquidated damages and penalty is not absent in the Indian law. Firstly, if reasonable damages fall short of the stipulated sum that sum will be reduced to that
extent as penalty. If it exceeds, only the stipulated sum is recoverable being liquidated damages. Secondly, the Explanation describes a stipulation for increased interest from date of default as a penalty. It may therefore be not allowable if excessive. Thirdly, courts have decided that where parties have provided for damages expressly, a right to claim any other damages under the general law is excluded by the liquidated damages. But it is clear that the Indian law as contained in S.74 is different from the English law in this regard. The words in S.74 “whether or not actual damage or loss is proved to have been caused thereby” should not mislead to think that actual loss is not necessary. S.74 is governed by the earlier section 73. The Supreme Court in Maula Bax v. Union of India [(1969) 2 SCC 554] said if no loss is proved both S.73 and S.74 are not attracted. The above referred words in S.74 are confined to cases in which it is not possible to prove the monetary value of the loss and therefore reasonable compensation even as fixed by the parties may be allowed. Where the loss in money can be determined it must be proved. This is the correct position in the Indian law. The principle of the decision was re-affirmed by the Supreme Court in Union of India v. Rampur Distillary & Chemical Co. Ltd. [(1973) 1 SCC 649] when it refused to allow any compensation by forfeiture of deposit or otherwise when the breach caused no loss to the Government. In India, many cases on penalty have arisen in stipulations for interest. Where for a loan at 12% interest payable biennially, on default 75% interest is payable it is a penalty. Compound interest at the same rate on default is not penalty per se. But compound interest at a rate exceeding the rate of interest may well be in the nature of penalty. Where a sum is borrowed payable by reasonable instalments and the bond provides that on a default the whole becomes due it is not a penalty. But where a sum is borrowed and the bond is given for double the sum and provides that in default of an instalment the whole becomes due, it is a penalty. Thus, in Subharama Sastri v. Raghavan [(1987) 2 SCC 424], where a sum of Rs.16,000 was advanced and a sum of Rs.28,000 had to be paid back in instalments under a chit fund scheme, and on a single default the whole was payable, the Supreme Court held it a penalty. There is a statutory power in India under the Usurious Loans Act, 1989 to releave a borrower from exhorbitant interest. Cases involving application of S.74 to forfeiture clauses for earnest money and security deposits have also arisen. In Fatechand v. Balkishan Das [(1964) 1 SCR 515], there was an agreement for sale of a land and bungalow for Rs.1,12,500. Buyer was to pay Rs.1,000 as earnest money and Rs.24,000 on delivery of possession. This was done. The agreement further provided that if buyer failed to pay balance and get registration by a certain date Rs.25,000 would be forfeited. Buyer defaulted. Seller forfeited the sum and sued for possession and compensation. The Supreme Court allowed forfeiture of Rs.1,000 as earnest money. It allowed the retention of Rs.24,000 not as forfeiture but as compensation for use. It distinguished
between earnest money which can be forfeited and a security deposit whose forfeiture will be a penalty. This view was reaffirmed by the Supreme Court in Maula Bux v. Union of India [(1969) 2 SCC 554]. P agreed to supply food materials to Uttar Pradesh military head quarters for one year and deposited Rs.18,500 for due performance. P persistently defaulted. The Government of India rescinded the contract and forfeited the deposit. The High Court of Allahabad held the deposit was an earnest money and did not amount to a penalty under S.74. But the Supreme Court held every deposit is not necessarily an earnest money. It quoted from the dictionary of English law by Earl Jowitt that it is only giving the vendor a nominal sum that is a token that the parties are in earnest. It also quoted the Privy Council in Chiranjit Singh v. Harswaroop [AIR 1926 PC 1] that earnest money is part of purchase price when the transaction goes forward but is forfeited when it falls through by default of the vendee. It ruled that Indian High Courts decisions that S.74 does not apply to forfeiture of deposits is no longer good law. It held if a forfeiture is in the nature of a penalty S.74 applies. It held the deposit cannot be forfeited. Identical facts came up again before the Supreme Court in Union of India v. Rampur Distillary & Chemical Co. Ltd [(1973) 1 SCC 649] for supply of rum. The Supreme Court did not alllow the security deposit to be forfeited holding that it was a penalty. Statutory damages If compensation is payable under a statutory provision, the Supreme Court has held that the provision at the time of the cause of action and not at the time of the contract is to be applied. In Padma Srinivasan v. Premier Insurance Co. Ltd. [(1982) 1 SCC 613], P’s husband was killed by a lorry which was insured with D Insurance Co. At the time of the policy the statutory compensation for loss of life under the Motor Vehicles Act, 1939, was Rs.20,000. The Act was amended and the compensation was raised to Rs.50,000 before the accident occurred. The Supreme Court allowed the revised figure and stated it did not amount to giving retrospective effect because the fatal accident had taken place after the Amendment. 3.3 COMMON LAW AND STATUTORY REMEDY (i) Common Law remedy Damages in the event of breach of contract is both a common law and a statutory remedy. The law relating to damages through Common law courts is explained here. The principles of damages for breach of contract was not fully considered by the courts until the leading case of Hadley v. Baxendale [(1854) 9 Ex 341]. The principles laid down in that great decision have been followed, expounded and affirmed again and again. These principles entered the Indian Contract Act in S.73 when it was codified in 1872. As damages are also awarded in tort, the question of the radius of its reach in contract which though sharing a common remedy with tort is essentially different in many respects, faced the courts of law in the nineteenth century. 195 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
In Hadley, plaintiff’s mill at Gloucestor was stopped by a broken crank shaft. It had to be sent to the makers at Greenwich as a pattern for a new one. Defendant, a common carrier, promised to deliver it at Greenwich on the following day. The only information given to him was that the thing to be carried was the broken shaft of a mill and that the plaintiffs were the millers. Owing to neglect, it was unduly delayed in transit. As a result the mill remained idle for longer than it would have been if the contract of carriage had not been breached. Plaintiffs lost profits and sued for damages to recover the same.
recoverable. What was ‘reasonably forseeable’ depends on the knowledge then possessed by the party who later commits the breach. For this purpose, knowledge is of two kinds, one imputed, the other actual. Every one, as a reasonable person, is taken to know what loss is likely to result in the ordinary course of things. This is the first branch of the rule. This knowledge is assumed. In a particular case, there may be knowledge of special circumstances as would be likely to cause more loss. This is the second branch of the rule making such loss recoverable.
Alderson B. in the Court of Exchequer laid down the foundation of the law of damages for contract. He laid down that when a party has broken a contract the damages the other party may receive should be such as may fairly and reasonably be considered either arising naturally according to the usual course of things from such breach or such as reasonably may be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of its breach.
In this case, an engineering firm delivered a boiler on 8 November which they should have delivered on 5 June to a certain launderers and dyers being made known full well that the business was to be extended and exceptionally profitable contracts were to be got by using the new boiler. Damages by loss of profit at £ 16 a week for extension and £ 262 a week of loss of profits of contracts were claimed. The Court of Appeal was of the opinion that the defendants with their engineering knowledge and knowledge of facts could not contend that the loss of business was beyond their vision. The case was referred to the Official Referee to ascertain the amount of both the damages to be allowed in this case.
This statement of the law is known as the rule in Hadley v. Baxendale. The rule has been codified in S.73 of the Indian Contract Act, 1872, as follows : “Compensation for loss or damage caused by breach of contract - 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 thereby, which naturally arose in the usual course of things from such breach, or which the parties knew, when they made the contract, to be likely to result from the breach of it. Such compensation is not to be given for any remote and indirect loss or damage sustained by reason of the breach”. Please see the Act for a number of Illustrations ‘a’ to ‘r’. Alderson B. went on to state that if the special circumstances were communicated by the plaintiffs to the defendants, and thus known to both parties, the damages they would reasonably contemplate would be the amount of injury so known and communicated. On the other hand, if these special circumstances were unknown to the party breaking the contract, he could only have had in his contemplation the amount of injury which would arise generally and in the great multitude of cases not affected by any special circumstances. Applying the principles, Alderson B. disallowed the loss of profits of the mill in this case. There are two branches in the rule in Hadley v. Baxendale. The two branches are inter related. They may also be considered as two branches of a single general principle. Asquith L.J. deciding Victoria Laundry (Windsor) Ltd. v. Newman Industries Ltd. [(1949) 2 KB 528], gave what is considered a classic exposition of the test of remoteness of liability laid down by Alderson B. He said the loss actually resulting from the breach as was at the time of the contract ‘reasonably foreseeable’ as liable to result from the breach was 196 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
However, there has been criticism of the way in which Asquith L.J recast the general principle. The principle of remoteness of damage expressed in terms of ‘reasonable foresight’ of ‘loss liable to result’ may confuse the rule with the rule in tort where there will be liability for all damages which can be reasonably foreseen. The House of Lords differed from the use of the phrase ‘reasonable foresight’ by Asquith L.J. in the Heron II, Koufos v. C. Czarnikow Ltd [(1969) 1 AC 350]. They stated the real question is not whether the damages should have been foreseen by the defendant but whether its probability should have reasonably been in the contemplation of both the parties at the time the contract was made. The law of contract and tort differ in this respect. A tort feasor is liable for any damage which should have been foreseen by a reasonable man. Intention of parties is irrelevant there. The party to whom answerable would generally be a stranger. But in contract it is only fair the assessment of damages should depend on the assumed common knowledge and contemplation of the parties who dealt with each other and at that time. When the same case was before the Court of Appeal before it went to the House of Lords, Sellers L.J. had remarked that the words and phrases of Hadley v. Baxendale have been hallowed by long usage and the ideas and factors conveyed by them are clear enough. Heron II has not laid to rest the exposition in the Victoria Laundry case except to clarify the test of liability and revitalise the rule of remoteness of damages laid down in Hadley v. Baxendale. Facts of the Heron II Respondents, a firm of sugar merchants, chartered the ship Heron II from appellants to carry a cargo of sugar from Costanza to Basrah. The ship deviated on the voyage. The cargo was delayed by nine days. As the sugar market fell at Basrah, respondents obtained £ 3,800 less than the price obtainable when
it should have been delivered. Appellant contended he had no special knowledge of the seasonal fluctuations of the sugar market. But the House of Lords held a shipowner must be presumed to know that prices in a commodity market would fluctuate. The relationship between the rule for damages in tort and in contract for remoteness of damage was considered further by the Court of Appeal in Parsons (H.) (Livestock) Ltd v. Uttley Iugham & Co. [(1978) QB 791]. Facts. D agreed to supply and erect on P’s pig farm a bulk good storage hopper for storing pignuts for the top grade pig herd. D failed to ensure that a ventilator at the top of the hopper supplied was open. The pignuts became mouldy. P fed them to the pigs thinking no harm would result. The pigs suffered an attack of E. coli, an intestinal infection. 254 pigs died. The decision in the first instance of Stanwick J. that the damage was not within the reasonable contemplation of the parties was reversed by the Court of Appeal. It held D liable for the loss of the pigs but not for loss of profits from future sale of pigs. Lord Denning M.R felt that where there is physical injury the test should be the same as in tort and he wanted to distinguish the economic loss from the physical injury. But the other judges did not agree with this view. The case may be said to have decided that ‘reasonably forseeable’ and ‘reasonable contemplated’ mean much the same and the test is that of contract only and not the same in tort. At this context, it is useful to summarise that in damages, the first question is that of what kind of damages governed by the principle of remoteness, stated in the rule in Hadley v. Baxendale. The law must draw a line on the ground of remoteness. As Lord Wright stated in a tort case in [(1933) AC 449], “the law cannot take note of everything ....... some subsequent matters are outside the scope of its selection because it were infinite for the law to judge the consequences of consequences”. This question concerns ordinary and special damages. The second question, distinct from the first, is the measure of damages. It is the attempt at its monetary quantification. Courts, atleast dating back to 1845, Robinson v. Harman [(1848) 1 Ex 850], had already adopted a basis for damages in the principle restitutio in integrum, namely that when an injured person has suffered damage, he must, so far as money can do it, be restored to the position before he suffered it. This principle has always been reaffirmed, in contract as for instance in Sunley Ltd v. Cunward White Store Ltd [(1940) 1 KB 740], “where a party sustains loss by reason of a breach of contract, he is, so far as money can do it, to be placed in the same situation with respect to damages, as if the contract had been performed”. In this connection, a terminology had been used first in the Yale Law Journal which attracted much attention, and was welcomed in Anglia Television Ltd v. Reed [(1972) 1 QB 60] and in many other cases. The Yale Law Journal article distinguished between expectation loss and reliance loss. Expectation loss is that which the plaintiff would have received if the contract had been properly performed. Of this the most
obvious is the loss of profit that would have been made on the contract. This may be quite speculative in many cases. This is not to say no loss has at all been suffered. Plaintiff relying on the contract being honoured would have been incurred expenses now wasted. Thus the two concepts are useful to assess the loss claimed. In Anglia Television Ltd v. Reid [(1972) 1 Q 60], P engaged D, an American actor, to appear in a film they were making for television. At the last moment, he repudiated the contract. P could not find a replacement. The project was abandoned. P claimed not the profits they would have made on the film as that could only be speculated in advance but the money spent in operation such as hiring other actors, engaging a script writer, looking for locations and so on. In other words, P quantified the loss not on ‘expectation’ but on ‘reliance’ basis. The claim 2700 £ was allowed on this basis in this case. Thus damages for breach of contract are meant to compensate the plaintiff for the loss suffered. If no loss has been in fact suffered, plaintiff may yet be given a verdict but the damages awarded will be purely nominal. In England it is usually £ 2. An illustration can be had in Charter v. Sullivan [(1957) 2 QB 117, D], having agreed to buy a Hillman car from a dealer, refused to buy. The car was sold to another within a week. Indeed, the dealer was able to sell as many cars as he wanted. So no loss was suffered. Even so, he sued for damages. The Court of Appeal held he was only entitled to nominal damages and 40 shillings was awarded. Nominal damages is allowed in India also in suitable cases. Since damages are meant to compensate, they will not be awarded to punish the defendant. Penal or punitive damages cannot be awarded in contract. As the Amercian Restatement of Law of Contract states in S.342, “punitive damages are not recoverable for breach of contract”. Vindictive or examplary damages have no place in law of contract except in two situations. Difficulty in accessing the measure of damages should not deter a court from making an attempt in the circumstances of the case Thus in Chaplin v. Hicks [(1911) 2 KB 786], D, a theatre manager, agreed with P that she would attend a meeting with forty nine other actresses, at which twelve out of fifty would be selected and employment given. D did not give her the opportunity to attend the meeting. D pleaded in the action by P that only nominal damages were payable as P would have had only a chance of one in four of being successful and there were other imponderables. But the Court of Appeal upheld the award of £ 100 given by the jury. Cases on the Two Rules in Hadley v. Baxendale : General or Ordinary Damages and Special Damages if in Contemplation. Damages as may fairly and reasonably be considered arising naturally according to the usual course of things from the breach as its probable result alone will be awarded unless any special damages by special circumstances are in the knowledge and contemplation of the parties. 197 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
Horne v. Midland Railway Company [(1876) LR 8 CP 131], P was to deliver military shoes in London for the French Army at a very high price by a particular date. P gave them to D to be carried with notice of his contract only as to date of delivery. The carrier delayed the shoes and they were rejected by the purchasers. P sought to recover the difference between the price the shoes were sold and the high price at which they would have been sold if delivered on the particular day. It was held such damages were not recoverable as the carriers were not informed of the exceptional loss. Ordinary loss for the delay was allowed. British Columbia Saw Mill Co. Ltd. v. Nettleship [(1868) LR 3CP 499] P shipped on D’s vessle certain cases of machinery intended for the erection of a saw mill at Vancouver. D failed to deliver one of the cases but was not aware that it contained a material part of the machinery without which the saw mill could not be erected at all. P claimed damages not only for replacing the lost part but also the loss for the time work was stopped by machinery remaining useless. The Court held the measure of damages could be only the cost of replacng the lost machinery at Vancouver. Please also see the Victoria Laundry Case and the Heron II case. Damages will not be too remote if they flow from the normal business position of the parties as the court assumes that this is known to both of them. In Monarch Steamship Co. Ltd v. Karlshamns Oljefabriker [(A/B) (1949) AC 196], a British ship was chartered in April 1939 to load soyabeans in Japan and discharge at Karlshamns in Swedan. The ship should have reached normally in July. But the boilers were defective and she was unseaworthy and reached European waters only in September. By the time War broke out and she was ordered to discharge at Glasgow. The respondent, a Swedish company who required the beans in Sweden incurred expenses in forwarding the cargo in neutral ships. The House of Lords allowed the expenses and said the possibility of the War must have been known and the damages were not too remote a consequence of the unseaworthiness of the ship. In India, the decision of the Privy Council, in Jamal v. Moola Dawood Sons & Co [(1916) AC 17 states S.73] is declaratory of the common law of damages. So also the Supreme Court of India in Pannalal Jankidas v. Mohandas [AIR 1951 SC 145] stated the party in breach must compensate the direct consequences flowing from the breach and not loss or damage indirectly or remotely caused. Under S.73 of the Act, an early illustrative case is Madras Railway Co. v. Govinda Rau [(1898) 21 MAD. 172] P, a tailor, delivered a sewing machine and cloth to the Railway consigned to a place where he expected to make special profit at a forthcoming festival. The goods were delayed in transit and delivered only some days after the festival concluded. P had not given notice of his special purpose. P claimed expenses and loss of profits he would have earned. The Court held the loss of profit was too remote. 198 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
Such damages as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the contract, as the probable result of it even, if they be special losses, may be allowed. Simpson v. London and North Western Railway Co. [(1876) 1 Q.B.D. 274] is a good illustration. P, was sending specimens of his goods for exhibition to agricultural shows. After a show at Bedford he entrusted samples to the railway company for carriage to a show at Newcastle. The company’s agent had knowledge of the special circumstance that the samples were meant for the show. P had written on consignment note “must be at Newcastle Monday certain”. By default, the samples arrived late for the Newcastle show. P claimed damages for loss of profits at the show. It was held the Railway was liable. Some times the breach may be a very unusual type not normally contemplated but that is immaterial because parties contemplate performance not breach. In Banco de Portugal v. Waterlow & Sons Ltd [(1932) AC 452], a firm agreed to print for the Bank of Portugal a quantity of banknotes. They negligently delivered to M the head of an international criminal band some 5,80,000 of these notes and they were subsequently put into circulation in Portugal. On discovery, the Bank ordered withdrawal from circulation of the notes and exchanged them for others. The Bank claimed from the printers the value of the notes exchanged and the cost of printing genuine notes. The House of Lords held the losses recoverable. Damages for Mental Pain and Suffering Damages may be recovered for substantial physical suffering arising from breach of contract. In Hobbs v. L. & S.W. Railway [(1875) L.R. 10 QB 111] a man and family were transported to the wrong station with the result they had to walk home several miles on a drizzling wet night. Damages were allowed. In Bailey v. Bullock [(1950) 2 AER 1167], P, his wife and child wre forced to live for two years in discomfort with the wife’s parents owing to failure of a solicitor to take steps to obtain possession of a house. Damages were recovered for the physical inconvenience. Ordinarily, in commercial contracts damages are not allowed for mental suffering. Damages, in principle cannot be recovered in a contract for injury to reputation. In Addis v. Gramaphone Co. Ltd [(1909) AC 488], A was employed by R as manager of their business in Calcutta with salary and commission. R wrongly dismissed A without giving the required six months notice. The House of Lords allowed salary and commission for the period but no damages for the way of dismissal. they listed the three exceptions to the general rule (a) wrongufl dishonour of cheque, (b) breach of pomise to marry, and (c) vendor of real estate failing to make title. The same principle was also followed in Watts. v. Morrow [(1991) 4 AER 937]. As a result of a negligent survey report a house was purchased at a higher price than it was worth and considerable time and money was spent to make it livable. But the Court of Appeal held that damages cannot be given for mental distress and awarded only £ 750 for physical discomfort cutting down £ 4000 awarded by the trial court.
It was thought in Haynes v. Dodd [(1990) 2 AER 815] that damages for mental distress in contract are limited to a certain class of cases namely where the contract itself is to provide peace of mind and not in commercial contracts. But it is now clear that in contract such damages may be allowed in every proper case as known from the wedding cases and holiday and other cases The American Restatement also says in S.341 such damages may be allowed in suitable cases. They may be allowed in special cases. In a Scottish case, Diesen v. Sampson [(1971) SL 749], a photographer having agreed to take photographs at a wedding failed to turn up. As a result the bride had no photograhs of her wedding. She was allowed damages for injury to feelings. In Hotson & Hotson v. Pazne [1988 CLY 1047], a motel was booked for P’s daughter’s wedding reception to which 105 guests were invited. The motel cancelled the booking 48 hours before the wedding. The only alternative was a small room at a public house. It was held on only daughter’s wedding reception is unique for a parent. General damages of £ 750 were awarded for mental factors and special damages £ 265 for extra expenses incurrred. Similarly, damages have been awarded where contracted holidays have been deprived. In Jarvis v. Swans Tours Ltd. [(1973) QB 233], P, a solicitor paid for a two week holiday with Christmas winter sports at a hotel in Switzerland on the faith of the attractive promises in the brochure of D. But the trip and stay was a complete disappointment. The Court of Appeal allowed damages of the amount paid and an additional sum of £ 60 for the disappointment. Lord Denning MR said the principle that damages cannot be recovered for mental pain is out of date.
Mitigation of Damages Another general principle which has a bearing on damages is the duty to mitigate damages. A person suffering loss from breach of contract must take any reasonable step available to him to mitigate the extent of damage. It is not exact to say the plaintiff is under a legal duty to mitigate his loss, but he cannot act unreasonably and hold defendant liable to loss. Whether plaintiff has used reasonable opportunities is a question of fact in each case and the burden of proof is on defendant. The principle of mitigation could be viewed as yet another dimension of the rule against remoteness of damages. The substance of the principle was expressed by Lord Haldane in British Westing House Electric & Manufacturing Co v. Underground Electric Railway Co. of London [(1912) AC 673], as that the first principle of compensation for the pecuniary loss naturally flowing from the breach is qualified by a second which imposes a duty of taking all reasonable steps to mitigate the loss consequent on the breach and debars the plaintiff from claiming any part of the damage which is due to his neglect to take such steps. S.73 of our Act states in the Explanation the rule of mitigation: “In estimating the loss of damage arising from a breach of contract, the means which existed of remedying the inconvenience caused by the non-performance of the contract must be taken into account”. The explanation to S.73 does not create an independent actionable duty to mitigate but a factor to be taken into account in assessing the damages naturally flowing from the breach.
Thus, the principle is now extended to all suitable cases. In Heywood v. Wellers [(1976) 1 AER 300] P engaged a firm of solicitors to obtain an injunction against a man who was harassing her. The solicitors obtained an injunction. But they failed to bring the man before the court. When he molested her again, P was allowed damages from the firm for the mental anguish.
Mitigation often has application in contract for sale or purchase of goods. On buyer’s refusal to take delivery, the seller should resell the goods at market price and may recover the difference if any between the price realised and the contract price [Ambalavana Chettiyar and Co. Ltd. v. Express Newspapers Ltd (1968) 2 SCR 239]. For the proposition that only difference at time of breach is recoverable, the well-known authority is the Privy Council decision in Jamal, A.K.A.S v. Moola Dawood Sons & Co [(1916) 43 IA 6]. P agreed to sell to D 23,500 shares, delivery and payment on 30 December 1911. On that date D declined to take delivery or pay. The shares would have then realised Rs.1,09,218 less than contract price. But P sold the shares only after February and realised only Rs.79,862 less than contract price as the market was rising. D contended that they were liable only for that loss but it was held D was liable for Rs.1,09,218. Lord Wrenbury said the loss to be ascertained is the loss at the date of the breach.
Similarly, in Fraser and Others v. Thames Television Ltd. [(1983) 2 AER 101] three actresses formed a rock group. They negotiated with a television company to produce a television serial based on their experiences contrasting their individual and collective character. A written agreement was entered into for their remuneration and forbidding the company from using the idea unless they were given an opportunity to act. The company without giving the opportunity produced their programme with great success. The company was held liable in damages for breach of confidence.
The Supreme Court of India has followed the same principle. In Muralidhar Chiranjilal v. Harishchandra Dwarakadas [(1962) 1 SCR 653], the contract was for supply of canvas to be consigned to Calcutta f.o.r. Kanpur. Transport charges to be borne by buyer. Seller failed to supply. Buyer claimed difference of prices of Calcutta. But Wanchoo J. held the seller failed to deliver the goods at Kanpur and he only knew they were to be booked to Calcutta from which it cannot be inferred he knew they were for resale at Calcutta. He distinguished the
In Western v. Olathe State Bank [(1925) 78 Colo 217], D, a bank agreed to lend P money with sums he may need for a trip to California by crediting his account after reaching his destination. P reached California but D refused to give the credit. The Supreme Court of Colorado awarded damages for mental suffering.
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Victoria Laundry case, and held the difference in prices at Kanpur should have been proved which was not and therefore, on the evidence, no damages arose in the usual course. Similarly, where seller breaches, the buyer should buy the goods from any alternative sources and cannot recover any further loss due to his own neglect. In Payzu Ltd. v. Saundars [(1919)2 KB 581], the goods were to be delivered by instalments, payment within a month of each delivery less discount. The buyers failed to make punctual payment for first instalment. The seller treated contract repudiated but offered to continue deliveries at contract price for cash. The buyers rejected the offer. The price of the goods rose. The buyers sued. Scrulton L.J. held seller liable in damages for unwaranted repudiation but also that the damages were only the loss the buyer would have suffered if he had accepted the seller’s offer which he should have. Buyer had failed to mitigate the loss. In Sotiros Shipping Inc. v. Samerat Solholt [(1981) Com. LR 201], in a contract for a sale of ship, where the seller defaulted but offered an alternative ship which the buyer refused, it was held the buyer had unreasonably failed to mitigate the loss. Where the injured party instead of mitigating increases the loss unreasonably, defendant cannot be held liable, Derbishire v. Warren [(1963) 3 AER 310]. P’s car was damaged due to D’s negligence. P got the car repaired at a cost double the value of an equally good new car. The Court of Apppeal allowed only the difference between the insurance money and the market value of a new car but not between the insurance money and the cost of repair. But in O’ Grady v. Westminister Scalffolding Ltd, [(1962) 2 LLoyd’s Rep. 238] the plaintiff was allowed the cost of repairing his car considerably exceeding its market price because the car was unique and could not be replaced. This case was distinguished in the aforesaid case. Mitigation also finds applications in the Contract of employment. In Brace v. Calder [(1895) 2 QB 253], a partnership of four agreed to employ P as a manager for two years. After five months the partnership dissolved by retirement of two partners. The other two continued and offered to employ P on the same terms. P refused and sued for salary for balance of two years. Held, he should have accepted the offer and only nominal damages was allowed. But where no alternative employment of equal standing is available, Indian High Courts have awarded as compnesation the renumeration the person would have earned but for the wrongful termination. Neither can an employee be expected to take up any available job of lesser status nor of different kind of work or go to a different part of the country. The duty of mitigation cannot impose any burden of an unusual nature. In Radford v. De Froberwille [(1978) 1 AER 33], P owned a house in a large garden. The house was divided into flats let to tenants who could use the garden. P got permission to build a house on a plot in the garden and sold the plot to D. D agreed to develop the plot and build a brick wall as a boundary. 200 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
D failed to do either and sold the plot to T who covenanted to do both but failed to do it. P sued D for damages for failure to build the wall. D argued that P should have mitigated the loss by building the cheapest wall as a boundary. But held in the circumstances it was reasonable for B not to have built any wall (though he intended to build one as boundary) before decision in the case and damages allowed. (ii) Other Statutory remedies (a) Compensation in Quasi-Contract According to S.73 of the Act, damages by way of compensation may be allowed in Quasi contract on the same basis as in contract. S.73 lays down the law as follows : “Compensation for failure to discharge obligation resembling those created by contract: When an obligation resembling those created by contract has been incurred and has not been discharged, any person injured by the failure to discharge is entitled to receive the same compensation from the party in default, as if such person had contracted to discharge it and had broken his contract”. (b) Tax Elements in Damages As damages are to compensate for actual loss and no more, the liability of the plaintiff to pay tax may have to be taken into account. In British Transport Commission v. Gourley [(1956) AC 185], in a claim for loss of earnings arising out of negligence, the House of Lords held damages to be awarded to the plaintiff on the basis of his gross earnings (£ 37,720) before tax could be reduced by the amount he had to pay as tax. The net amount was £ 6,695. Though a decision in tort, it has been applied to contract cases generally. However, the principle is subject to two conditions: 1. The earnings or profits of the claim must be subject to tax. 2. The sum awarded should not be subject to tax in the plaintiff’s hands. Remedies Under Law of Sale of Goods The law relating to sale of goods in India is contained in the Sale of Goods Act, 1930 and case law. Sale of Goods is a special contract. The Act provides in itself certain special remedies for breaches of the contract of sale of goods apart from the general remedies available in law of contract. The remedies in sale of goods law are outlined below. The following are the remedial rights of the buyer against the seller in breach: (1) suit for damages under S.57, (2) suit for recovery of the price in some cases, (3) suit for specific performance under S.58, (4) suit for breach of warranty under S.59, (5) repudiation of contract before due date and damages under S.60 when seller is in anticipatory breach, and (6) suit for interest under S.61.
The remedial rights of the seller are available against the buyer personally and in the case of unpaid seller against the goods. The following are the rights of the seller against the buyer in breach : (1) suit for price under S.55, (2) suit for interest under S.61, (3) suit for damages for non-acceptance under S.56, and (4) repudiation of contract before the due date and damages under S.60 when buyer is in anticipatory breach. The special remedies provided in the Act for an unpaid seller against the goods are as follows : (a) right of withholding delivery under S.46 where the property has not passed, (b) right of lien under S.46 and S.47 when goods still in possession after property has passed, (c) right of stoppage in transit under S.46 and S.50 when the goods are in transit to buyer, and (d) right of resale under S.46 and S.54. The following is an illustrative case for the exercise of one of the special remedial rights of an unpaid seller of goods under the sale of Goods Act, namely the right of stoppage in transit. G.I.P. Railway Co. v. Hanumandas [ILR (1889) 14 Bom 57] Goods consigned to buyer under R.R. reached the station of destination. The R.R was cleared by the agent of the buyer and the goods were being loaded into carts in the railway yard when the station master received telegraphic intimation from the unpaid seller of the exercise of right of stoppage in transit by notice to carrier. But, held the right could not be execised as the transit was at an end since the goods had passed from the intermediate possession of the carrier to the possession of the agent of the buyer. 3.4 EQUITABLE REMEDIES As seen above apart from damages, equitable remedies may be available for breach of contract in suitable cases. As Indian law makes no distinction between legal and equitable rules, many of the principles of equity are found embedded in various statutes including the Indian Contract Act, 1872. So also the equitable remedies in contract are found in the Specific Relief Act, 1963 (replacing the Act of 1877). Among the remedies are the Specific Performance of the contract, the remedy of Injunction, the Rectification and Cancellation of Instruments and Rescission of contracts. (i) Specific Performance Specific performance is an equitable relief which may be given by the court in suitable cases of breach of contract by a judgement that the defendant is to actually perform the contract or a part of the contract according to terms and stipulations. When Specific Performance May Be Enforced S.10 of the Specific Relief Act states the cases in which specific performance may be enforced.
According to S.10, in the discretion of the court, and except as otherwise provided, specific performance may be enforced(a) where there is no standard for ascertaining the actual damage caused by the non-performance, or (b) When compensation in money for the non-performance would not afford adequate relief. S.10 also explains that unless and until the contrary is proved, the court shall presume that (1) the breach of a contract to transfer immovable property cannot be adequately compensated in money, and (2) the breach of a contract to transfer movable property can be so compensated except where (a) It is not an ordinary article of commerce, or of special value or interest to the plaintiff or consists of goods which are not easily obtainable in the market, (b) it is held by defendant as the agent or trustee of the plaintiff. For example, B agrees to buy and S agrees to sell a rare painted picture or a rare china vase. B may compel S to specifically peform the contract. Unreasonable delay by the plaintiff in performing his part of the contract operates as a bar to obtaining specific performance provided that (1) time was originally an essential element of the contract, or (2) time was made an essential element by subsequent notice, or (3) the delay has been so long and unreasonable that it amounts to abandonment of the contract. S.11 (1) provides another case in which specific performance may be enforced. According to S.11(1), except as otherwise provided, in the discretion of the court, specific performance may be enforced, when the act is in the performance wholly or partly of a trust. Any person having an interest under a contract which relates to a trust may specifically enforce its performance. Such contract may be specifically enforced at the instance of the beneficiaries or trustees. S.11(2) however provides that a contract made by a trustee (a) in excess of powers, or (b) in breach of trust, cannot be specifically enforced. The first is ulra-vires. The second is unlawful. S.12 provides for specific performance of part of a contract. According to S.12(1), as a general rule a court shall not grant the specific performance of a part of a contract. However S.12(2) to (4) provide certain exceptions to this rule, as follows: (1) According to S.12(3) where a party to a contract is unable to peform the whole of his part and the part of a contract left unperformed either (a) forms a considerable part of the whole, though admitting compensation in money, or 201 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
(b)
(i)
(ii)
does not admit compensation in money, the court, at the suit of either party, may direct the party in default to specifically perform so much of his part of the contract as he can perform, if the other party in a case falling under clause ‘a’, pays or has paid the agreed consideration for the whole contract reduced by the consideration for the part which must be left unperformed, and in a case falling under clause ‘b’, the consideration for the whole contract without any abatement, and in either case, relinquished all claims to the performance of the remaining part and all right to compensation either for the deficiency, or loss or damage.
The party in default is not entitled to obtain a decree for specific performance against the other party. (2) According to S.12(4) when a part of a contract which, taken by itself can and ought to be specifically performed stands on a separate and independant footing from another part of the same contract which cannot or ought not to be specifically performed, the court may direct specific performance of the former part. (3) According to S.12(2) where a party to a contract is unable to perform the whole of his part, but the part unperformed bears only a small proportion to the whole in value and admits compensation in money, the court at the suit of either party, may direct the specific performance of so much as can be performed, and award the compensation in money for the deficiency. The Explanation to S.12 states that a party to a contract shall be deemed unable to perform the whole of his part if a portion of its subject matter existing at the date of the contract has ceased to exist at the time of performance. According to S.13, when there is a contract for the sale or lease of immovable property but the seller is found having no title or imperfect title, the buyer or lessee may compel the seller or lessor to specifically perform the contract when he is subsequently in a position to do so in certain circumstances. Defences Open to Defendant According to S.9 of the Act, except as provided in Setions 9 to 25, all defences open to a defendant under the law of contract are open to to him where any relief is claimed under Sections 9 to 25 in respect of a contract. This means that matters such as the validity and enforceability of the contract, its uncertainity, incapacity of parties, coercion, undue influence, fraud, misrepresentation, mistake and similar matters under the Contract Act could be grounds of defence against a party sueing for specific performance and other reliefs under Sections 9 to 25. Thus in Mayawanti v. Kausalaya Devi [(1990) 3 SCC 1], the contract was for sale by a principal seller and a co-seller and was in an alternative form. If the co-seller failed to sign the sale deed the principal seller would execute the sale deed of 202 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
her “one of two shares”. Otherwise she had to pay back the advance and compensation in the same amount. The co-seller did not sign. The seller had either to sell her share or pay compensation. Her share was not defined and therefore the promise to sell her share was void for uncertainity and could not be specifically enforced. If she opted for compensation there was no breach and no question of specific performance. The Supreme Court therefore refused to grant the relief of specific performance in this case. When Specific Performance Cannot Be Enforced S.14 of the Act states the contracts which cannot be specifically enforced, namely (1) (a) a contract for non-performance of which compensation in money is an adequate relief, (1) (b) a contract which runs into such minute or numerous details or which is so dependant on the personal qualifications or volition of the parties, or otherwise it is from its nature such that the court cannot enforce specific performance of its material terms, (1) (c) a contract which is in its nature determinable, (1) (d) a contract the performance of which involves the performance of a continuous duty which the court cannot supervise. Thus a contract of marriage, contracts of employment, personal service, artistic skill, literary skill and such cannot be specifically enforced. but an employee wrongfully removed may be reinstated. A contract to publish a piece of music or build a house may be specifically enforced. Building can be decreed if the work is precisely defined, damages will not be adequate and defendant is in possession of the land so that plaintiff cannot get the work done by another builder. Thus in Jeune v. Queens Cross Properties Ltd [(1974) Ch.97], the landlord was ordered to restore a collapsed balcony in performance of a repairing covenant. Regarding a contract of determinable nature, the repealed Act of 1877 provided the following illustration based on the English case Scott v. Rayment [(1868) LR Equ. 1912] : A and B agreed to become partners in a certain business not specifying the duration of the partnership. The contract could not be specifically enforced because, it were ordered, either A or B might at once dissolve the partnership. Regarding a contract whose performance involves constant supervision by the court, courts have refused to specifically enforce contracts to have a porter at a service flat constantly in attendance, to cultivate a farm in a particular manner, for the obligation of a ship owner under a charter party and in Dowty Boulten Paul Ltd v. Walver Rampton Corporation [(1971) WLR 204], a contract to keep an airfield in operation. The above are illustrative examples only of various such instances. According to S.14(2), except as provided by the Arbitration Act, 1940 no contract to refer present or future differences to Arbitration shall be specifically enforced. But if a person has made such a contract (other than an arbitration agreement to which that Act applies) and has refused to perform it, and sues in respect of any subject so contracted to refer, such suit shall be barred by such contract.
Some Exceptional Cases When Specified Performance May Be Enforced According to S.14(3), a court may specifically enforce the following contracts not withstanding S.14(1). (a) (1) a contract to execute a mortgage or furnish any other security for securing the repayment of a loan the borrower is not willing to repay at once, provided where only a part of the loan has been advanced the lender is willing to advance the remaining part under such contract, or (a) (2) a contract to take up and pay for any debentures of a company. (b) (1) to execute a formal deed of a partnership the parties having commenced to carry on the business of the partnership, or (b) (2) the purchase of a share of a partner in a firm, (c) for the construction of any building or the execution of any work on land provided (1) the building or other work is described in the contract sufficiently precisely for the court to determine its exact nature, (2) the plaintiff has a substantial interest in the performance and compensation in money is not an adequate relief, and (3) the defendant has, under the contract obtained possession of the whole or any part of the land on which such work is to be executed. Discretion of Courts to Grant or Refuse Specific Performance S.20 of the Act lays down that the jurisdiction of courts to decree specific performance is discretionary and it is not bound to give such relief merely because it is lawful to do so. But such discretion shall not be exercised arbitrarily. Its exercise should be guided by judicial principles and open to correction by a court of appeal. S.20 lists certain circumstances in which the court in its discretion may refuse specific performance, as follows : (1) where the contract gives an unfair advantage to the plaintiff over the defendant. The unfair conduct may appear from the terms of the contract, from the conduct of the parties when entering into it or other surrounding circumstances. It is not necessary that the contract should be voidable. Thus, in Beyfus v. Lodge [(1925) Ch 350], the seller in a contract to sell a lease hold estate, suppressed information that the landlord had served notice for repair of a dilapidated portion. Specific performance was denied to the seller although the suppression was not sufficient in itself to allow rescission to the buyer. In P.V. Joseph’s son Mathew v. N.Kuruvila’s son [AIR 1987 SC 2328], A purchased rights to property of B. Before the execution of the sale deed B died. A acquiesced in the sale of the property by W, Widow of B, to T another person. Further,
A disposed of his right under the contract to Y yet another person. Y asked for specific performance from W. The Supereme Court did not decree specific performance. It said A had lost or waived his rights by acquiescence to W. Y had no better rights than A. Y can recover only the advance. (2) where the enforcement of the contract would cause unforeseen considerable hardship to the defendant whereas no such hardship would be caused to the plaintiff by nonperformance. Thus, where it involved litigation with uncertain results to enable the defendant to perform [Wroth v. Tyler (1974) Ch.30], and where the cost of performance to the defendant was wholly out of proportion to the benefits to the plaintiff [Morris v. Redland Bricks Ltd (1979) AC 652], specific performance was not granted. Similarly in Denny v. Light [(1857) 26 LJ Ch 459], it was not granted where the buyer of a land for farming purposes found it to be landlocked from all sides without any right of way. Ordinarily, the fact that performance would cause severe hardship to the defendant has to be considered on the basis of facts at the time of the contract. But the explanation to S.20(2) says that where the plaintiff has cuasd the hardship by his subsequent conduct that would also have to be taken into account. (3) where the circumstances of the contract are such that though they do not make the contract voidable, they render the enforcement by specific performance inequitable. For example, a contract may be one sided, an imposition by one upon the other or the parties may not be on equal footing. The repealed Act of 1877 gave the following illustraton : D agrees to buy from the factory of S all the goods of a certain class used by him in his trade. S cannot be granted specific performance by B as B may be ruined if S does not supply him the goods. (4) according to S.20(3), where a party has already substantially performed his part of a contract or suffered losses, the court may properly exercise the discretion to grant specific performance by the other party if the contract is capable of specific performance. (5) according to S.20(4), the court shall not refuse specific performance to a party merely on the ground that the contract is not enforceable at the instance of the other party. It was at one time thought that the court will not order specific performance at the suit of one party unless it could do so at the suit of the other party. The Privy Council in Mir Sarwarjn v. Fakkruddin Mohammad [(1912) 39 Cal. 232 PC], held that a contract to buy land on behalf of a minor was not specifically enforceable at his instance because it could not be enforced against him. There was no mutuality. It was also the English law. But the Privy Council allowed specific performance in suitable cases even where there was no mutuality of remedy starting with the case Srikakulam Subramanyam v. K. Subba Rao [(1948) IA 115]. The doctrine of mutuality ceased to have 203 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
force. S.12 also has taken away the requirements of mutuality. in English law also, as Chitty “On Contracts” says the number and importance of the exceptions to the requirements of mutuality has given rise to a doubt as to its existence. Power of Court to Award Compensation According to S.21, relief of compensation may be claimed either in addition to or in substitution of specific performance. If the court is of opinion that specific performance ought not to be granted, it may award compensation. If the court should find that specific performance by itself would not be sufficient relief, it may in addition award compensation. Compensation would be assessed according to S.73 of the Contract Act. The Act of 1877 gave the following illustration: A sues for specific performance of a resolution passed by the directors of a public company under which he is entitled to have certain shares allotted to him, and for compensation. All the shares have already been allotted to others. The court may award compensation for non-performance. Liquidation of Damages no Bar According to S.23, where the parties have fixed compensation for default, this would be no bar for the relief of specific performance. The court may allow specific performance if the contract did not fix the compensation as an option to the defaulting party for performance. If specific performance is granted, the payment of fixed compensation cannot be ordered in the same decree. Application to Certain Awards According to S.25, the provisions of Sections 9 to 25 apply to awards to which the Arbitration Act does not apply. (ii) Declaratory Decrees Sections 34 and 35, state the law relating to the relief of declaratory decrees. A declaratory decree is one which is declaratory of a legal right to which the plaintiff is entitled provided that he being able to seek a further relief does not ommit to do so. The object of such a decree is to clear the legal character of the plaintiff and maintian it against any person denying or interested to deny his title to such character or right. A declaratory decree is not a matter of right but discretionary by the court. Legal character of a person is the position recognised by law. It may include rights under a contract. A person asking for a declaratory decree need not ask for a further relief. But, where a person being able to seek further relief than a mere declaration of title, ommits to do so, no court shall make any such declaration. This is to avoid multiplicity of suits. Negative declaration will not be allowed. For example, that the plaintiff did not infringe the defendants trade mark. Injunctions Lord Halsbury has defined the equitable remedy of injunction as a judicial process where by a party is ordered to refrain from doing a particular act or thing or to do a particular act or thing. It is a discretionary remedy. It is a remedy which acts only in personam. It does not run with the subject matter or the property. 204 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
An injunction may be issued in favour of a plaintiff against the defendant whether an individual or incorporated body or a public body or even the state. The law of injunctions is the same in India as in English law. But most of the rules have been codified in India in the Specific Relief Act, 1963 (which replaced the Act of 1877), and some rules are found in the Code of Civil Procedure, 1908. Injunctions may be: (a) Temporary, or (b) Perpetual, (a) Preventive, or (b) Mandatory. Injunctions will not be issued where damages are the appropriate remedy and where the contract cannot be specifically enforced. S.37(1) defines a temporary injunction as one to continue until a specified time, or until the further order of the court and that may be granted at any stage of a suit (interlocutary injunction) and as regulated by the Code of Civil Procedure, 1908. Under Order XXXIX Rule 2 of the Civil Procedure, in a suit for restraining the defendant from committing a breach of contract or other injury of any kind, whether any compensation is claimed in the suit or not, the plaintiff may, at any time after the commencement of the suit, and either before or after judgement, apply to the court for a temporary injunction to restrain the defendant from committing the breach of contract or injury complained of or any breach of contract or injury of a like kind arising out of the same contract or relating to the same property or right. S.36 of the Act states that preventive relief is granted at the discretion of the court by temporary or perpectual injunctions. The English case Lumley v. Wagner [(1852) 5 De GM & G 604], is considered illustrative of the remedy of injunction against breach of contract, in that where a court may not be able to compel a person to do a promised thing, but if there is also a term not to do something which will go against the promisee the court may restrain him from doing such a thing, in the hope that it may induce him to do the promised thing. The facts were: W agreed to sing at L’s theatre and to sing nowhere else during a certain period. But afterwards W entered into a contract with Z to sing at another theatre and refused to perform the contract with L. The court restrained W by an injunction from singing for Z. In Warner Brothers v. Mrs Nelson [(1937) 1 KB 209[, Mrs. Nelson (whose professional name was Bettie Davies) a film actress, agreed to act in films exclusively for Warner Brothers for a year and for no one else. But during the year she entered into a contract to act for Z. The Court restrained her from acting for Z by an injunction. Thus injunction may be issued in breach of contract to enforce a negative term which has the effect of leaving the party without any diversion from carrying out the positive term. But there may be limits even to such an injunction. In Warren v. Mendy [(1989) 3 AER 103 CA], there was a contract for the
services of a boxer to a manager as a performer. The boxer was bound by both positive and negative obligations. He was not to enter into any agreement with any other master or manager. The facts showed the contract of service contained obligations of mutual trust and confidence between performer and manager. The facts also showed that the boxer had lost the mutual trust and confidence in the master or manager genuinely. A third party, another manager induced the boxer to leave the service and join him. The master or manager sought a long term injunction against the boxer and the other manager. The court thought that enforcement of the negative term would bring compulsion psychologically and materially on the servant and performer to fulfil the positive term. It should not be also always assumed that damages were an inadequate alternative remedy for injunction. The court refused to grant injunction in this case. The Court may order such injuction on such terms including duration as the court thinks fit. Disobedience will entail attachment of property or civil prison and sale of property and compensation from the proceed to the other party. An injunction was issued to restrain breach of confidence in Attorney General v. Barker [(1990) 3 AER 257 CA]. The first defendant was employed in the British royal house hold between 1980 and 1983. The contract of service included undertakings not to disclose, publish or reveal any incident concerning any member of the royal family or any visitor or guest which come to his knowledge during his employment. The undertaking was perpectual and worldwide. The second defendant a Canadian Company controlled by the first defendant planned to publish in the United Kingdom a book written by him about his service in the royal household. The Attorney General applied for worldwide injunction against the first and second defendants restraining publication of the book. The Court of Appeal held that the negative covenant in the contract which was not limited in territory or time was enforceable provided it was not illegal or against public policy as a restraint of trade, which it was not. The balance of justice required that an interlocutory injuction having extra territorial effect should be issued against both the defendants. S.37(2) defines a Perpetual injunction as one which can only be granted by the decree made at the hearing upon the merits of the suit, enjoining the defendant perpetually from the assertion of the right, or from the commission of an act which would be contrary to the rights of plaintiff. In other words a permanent injuction can be prayed for only a regular suit in which the rights in issue would be heard on merits and finally decided and such injunction may be granted by means of decree. S.38 states the circumstances in which a permanent injunction can be granted. It provides that subject to the other provisions in this regard, a perpetual injunction may be granted to the plaintiff to prevent the breach of an obligation existing in his favour whether expressly or by implication, and when such
obligation arises from contract, the court shall be guided by the rules and provisions contained in Sections 9 to 25 of the Act. S.38 is based on S.54 of the Original Act of 1877. S.54 of that Act carried, inter alia, the following Illustrations (slightly adapted) : (c) the directors of a public company are about to pay dividend out of capital or borrowed money. Any share holder may sue for an injunction to restrain them. (d) the directors of a fire insurance company are about to engage in marine insurance. Any share holder may sue for an injunction to restrain them. (1) A,B and C are partners in a partnership at will. A threaten to do an act of destruction of some partnership property. B and C may sue for an injunction to restrain him. (u) A infringes B’s patent. B may obtain an injunction to restrain the infringement if the court is satisfied that the patent is valid and has been infringed. (v) A pirates B’s copyright. B may obtain an injunction to restrain such piracy unless the work for which the copyright is claimed is libellous or obscene. (w) A improperly uses the trade mark of B. B may obtain an injunction to restrain the user. (x) A, a businessman, holds out B as his partner against his wish and without his authority, B may sue for an injunction to restrain A from doing so. When Perpetual Injunction may be refused According to S.41, Perpetual injunction will be refused by the court in the following circumstances, inter-alia : (e) to prevent the breach of contract the performance of which would not be specifically enforced, (g) to prevent a continuing breach in which the plaintiff has acquiesced, (h) when equally efficacious relief can certainly be obtained by any other usual mode of proceeding except in case of trust, (i) where the conduct of the plaintiff or his agent has been such as to disentitle him to the assistance of the court, (he who comes to equity must come with clean hands is the principle in this clause). According to S.42, where a contract comprises a positive agreement to do a certain act coupled with a negative agreement not to do a certain act, whether expressly or impliedly, the fact that the positive part is not capable of specific performance will not preclude the court from enforcng the negative part of the agreement by means of injunction provided the plaintiff performs his part of the contract [see the cases Lumley v. Wagner and Warner Brothers v. Mrs. Nelson]. An injunction which commands the defendants to do something (positive) is called a mandatory injunction. According to Salmond, a mandatory injunction is an order requiring the 205 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
defendant to do a positive act for the purpose of putting an end to a wrongful state of things created by him, or otherwise in fulfilment of his legal obligations. For example, an order to pull down a building which the defendant has erected in obstruction of rights of the plaintiff.
(3) where the balance of convenience is in favour of the defendant. (4) where a mandatory injunction instead of restoring status quo would create a new state of things.
S.39 of the Act defines a mandatory injunction as follows : “when to prevent the breach of an obligation it is necessary to compel the performance of certain acts which the court is capable of enforcing, the court may in its discretion grant an injunction to prevent the breach complained of, and also to compel performance of the requisite acts “.
According to S.40 of the Act, in a suit for perpetual injunction under S.38, or mandatory injunction under S.39, the plaintiff may claim damages either in addition to, or in substitution for, such injunction and the court may, if it thinks fit, award such damages.
S.55 of the old Act carried, inter alia, the following Illustration: (g) the court can order the destruction of books produced by infringement of another person’s copyright, documents consisting infringement of a trade mark or patent and communications made in professional confidence when there is a threat to misuse them. Mandatory injunction will not be granted in the following cases: (1) where compensation in terms of money would be an adequate relief to the plaintiff, (2) where the plaintiff has shown acquiescence in the wrongful acts of the defendant,
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Damages in lieu of or in addition to injunction
Damages may be awarded in lieu of injunction even where the injury is threatened though not yet caused. In Leads Industrial Co-operative Society Ltd v. Black [(1924) AC 851], the House of Lords allowed damages to a person whose tenement was sure to suffer loss of right to light when a planned building structure came up. In an Indian case,Tilok Chand v. Dhundiraj [AIR 1957 Nag 2] , a person happened to raise his building to encroach on the land of his neighbours up to three inches. The court allowed the neighbour compensation instead of an order for demolition of the building.
4. CASE LAW HOPKINS V. NORCROSS PLC [(1993) L ALL ER 565] The plaintiff was employed by the defendant company for 27 years and was the Chairman of one of its divisions when he was wrongfully dismissed on 12th September 1989 at the age of 58. The plaintiff was a member of the company’s pension scheme, not having opted out when employees became entitled in 1986 to make provision for their pensions in schemes other than those run by their employers. Under the terms of the scheme the plaintiff was entitled on leaving employment for whatever reason over the age of 50 and before the age of 60 to an immediate pension calculated as a proportion of the pension that he would have been entitled to had he retired on his 60th birthday. There were no provisions in the scheme modifying the plaintiff’s absolute entitlement to the pension and since he was unable to find any alternative employment the benefits he received by way of pension were equivalent to the loss of his salary for the period between the date of his dismissal and the date of his 60th birthday. In an action by the plaintiff for wrongful dismissal the defendants admitted liability and damages were assessed as being the loss of salary for the period between the date of dismissal and the date of normal retirement. The question arose whether the pension arising out of the termination of employment should be set off against the damages to which the plaintiff was entitled for wrongful dismissal. The defendants contended that, since it was a basic principle in the assessment of damages for breach of contract that the plaintiff was to be placed in the same position as if the contract had been performed, failure to take into account the pension money would provide the plaintiff with double the amount to which he was entitled under his contract of employment because if he had not been dismissed he would have continued to earn his salary up to 1st October 1991 and since he had received precisely the same sum by way of pension, which would not have been payable but for the termination, he had lost nothing. Held - In a claim for damages for wrongful dismissal pension benefits received by a plaintiff as a result of that dismissal were not, in the absence of any term in the contract of employment or pension rules expressly prohibiting payment in such circumstances, to be set off against the damages to which the plaintiff was entitled, because there was no relevant distinction between damages for lost earnings arising out of a claim in contract for wrongful dismissal and damages arising out of a claim in tort for lost earning capacity as a results of injury, where it was established law that money payable under a pension, be it a disability or retirement pension, was not deductible, and it would not be satisfactory if the answer to the question whether a pension was to be deducted depended on the way in which the claim was formulated. Furthermore, since the plaintiff could have opted out of the company pension in 1986 but chose not to, and since it was accepted that any pension that he would have received as a result would not have been deductible, it would be unjust for there to be different result merely because the pension was provided by the employer. It followed that the
pension payments received by the plaintiff were not deductible from the figure which had been agreed as the damages for wrongful dismissal. Jagdish Singh v Natthu Singh AIR (1992)1 SCC 647 The respondent sold two plots of land to the appellant for a consideration of Rs.15,000/-. On the same day another agreement was entered into between the parties whereunder appellant agreed to re-convey the said properties to the respondent against payment of Rs. 15,000/- within two years. Well within the stipulated period of two years respondent instituted the suit for specific performance alleging that despite offer of performance and tendering the price, appellant, with the dishonest intention of appropriating the properties to himself refused re-conveyance. The appellant contested the suit principally on the ground that respondent was never ready and willing to perform the contract and that respondent himself was in breach. The trial court dismissed the suit finding that the respondent was not ready and willing to perform the contract. Respondents first appeal was also dismissed. However the High Court in the second appeal reversed the findings of the two courts below and allowing the appeal held that the respondentplaintiff was ready & willing to perform the contract; that the appellant was party in breach; and that, therefore, respondent was entitled to a decree. The decree was available before the Supreme Court. It had also happened that during the pendency of second appeal the State had initiated acquisition proceedings against the suit lands making specific performance impossible. Modifying the decree the Supreme Court held; When the plaintiff by his option has made specific performance, impossible, section 21 does not entitled him to seek damages. The position is common to both English Law and Indian Law. But in Indian Law where the contract for no fault of the plaintiff becomes impossible of performance, section 21 of the Specific Relief Act, 1963 enables award of compensation in lieu of substitution of performance. Lal Chand and another v Chandigarh Administration [AIR Punjab and Haryana 194] In this petition under Articles 226 and 227 of the Constitution, the point involved is very short, that is, as to whether the Chandigarh Administration can cancel the allotment of a site if the allottee has failed to abide by the terms and conditions of allotment and there being no clause in the agreement empowering the authorities to forfeit the earnest money deposited by the allottee, can the earnest money be forfeited as a consequence of cancellation of allotment and resumption of site. Briefly stated, the Notified Area Committee, Manimajra, in the Union Territory, Chandigarh, allotted two Shop-cum-Flats bearing nos. 24 and 26 (commercial sites), on free-hold basis in the Motor Market and Commercial Complex at Manimajra, in 1977 in favour of the petitioners. The petitioners had already deposited a sum of Rs.2,000/- each as earnest money along 207 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
with the application for allotment. But instead of paying the balance, they approached this Court in 1977 by way of C.W.P. No. 3553 of 1977 and got stay of recovery of further instalments beyond 25 per cent. In the said writ petition, the petitioners had pleaded that as the respondent-Notified Area Committee, Manimajra, had failed to develop the area, the petitioners were not obliged to take possession of the sites in dispute and complete construction thereon within the stipulated period. In reply thereto, the respondents had stated that the Motor Market and Commercial Complex had been fully developed and roads had been constructed, water pipes had been laid and sewerage and drainage had been provided. Consequently, the writ petition was dismissed by S.S. Sandhawalia, C.J., as his Lordship then was, on 13th July, 1979. However, his Lordship taking a compassionate view of the matter, granted a period of one year from the date of the judgment to the petitioners to complete the construction. Thereafter, the Notified Area Committee, Manimajra, issued a number of notices to the petitioners requiring them to deposit the instalments within the stipulated period failing which the allotment of sites would be canceled and plots resumed, besides forfeiting the amount already deposited. Despite this nothing was done by the petitioners and ultimately on 24th October, 1979, the allotment of the sites in dispute was cancelled in accordance with the terms and conditions of allotment as the petitioners failed to comply with the terms of the notice served on them on 5th September, 1979, and the earnest money deposited earlier was forfeited. Aggrieved against this order, the petitioners have approached this Court by way of the present writ petition challenging the cancellation of allotment and resumption of plots as also forfeiture of the earnest money deposited by them, mainly on the ground that the respondents had no jurisdiction to cancel allotment and resume the plots, much less to forfeit the earnest money, for breach of the terms and conditions of the allotment. In reply, the respondents have pleaded that the principle of constructive res judicata was attracted in the case and otherwise also the matter in dispute being purely contractual, the writ petition under Art.226 of the Constitution was not maintainable. After hearing the learned counsel for the parties and having gone through material on the record, I am of the view assuming for the sake of argument that the writ petition was maintainable and was not barred by the principle of constructive re judicata, still the respondents were well within their rights to cancel the allotment of plots, resume the sites and forfeit the earnest money already deposited by the petitioners, as they had clearly violated the terms and conditions of allotment. In this regard, C1.7 of the terms and conditions of the allotment attached to the application for allotment (Annexure P.6), is reproduced below:“In case any installment is not paid by the allottee by the 10th of the month following the month in which it falls due, a notice shall be served on the allottee calling upon him to pay the instalment within a month together with a sum not exceeding such amount as may be determined by the President by way of penalty for delayed payment. If the payment is not made within the said period or such extended period as may be allowed by 208 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
the President, not exceeding three months in all, from the date on which the instalment was originally due, the President may proceed to cancel the allotment and resume the plot. The notice shall be served on the allottee either personally or by affixation on a prominent part of the site or building erected thereon or by beat of drum.” From a bare look on the aforesaid clause, it would be evident that violation of the terms and conditions of allotment would certainly entail cancellation of allotment and resumption of plot, necessarily followed by forfeiture of the earnest money. In any case, if the petitioners are only interested in refund of the amount, the request could be considered had the petitioners approached the respondents for that purpose. This having not been done, I do not find any merit in the writ petition. Consequently, this writ petition is dismissed with no order as to costs. Shaukat Ali Khan v. Babu Khan, AIR 1991 Del 190 In this case one of the parties to the contract was a foreign resident. None of the parties to the contract was aware of the fact that the agreement would be void. Later on when one of the parties filed suit for the recovery of his share money and profits, it was noticed for the first time that the agreement executed was void for the want of approval of the Reserve Bank of India, under the provisions of Foreign Exchange Regulation Act. Thus the agreement was attracted by the section 85 of the Contract Act (1872) as the invalidity was discovered at the later stage in the court. So the plaintiff was entitled to the compensation with interest. The court said that there is nothing to show that the plaintiff or even the defendant were aware and thus, it has to be held that the Contract has been discovered to be void only when this suit has been filed. If that is so, the plaintiff becomes entitled to be compensated for the amount given to the defendant by virtue of the contract which has been discovered to be void later on. So the plaintiff is entitled to have a decree for recovery of the amount in suit from the defendant. Surrey Country Council and another v. Bredero Homes Ltd [(1992) 3 All ER 302] The two plaintiff councils were the respective registered freehold owners of two adjoining parcels of land totalling 12.33 acres in area which had been acquired originally for road purposes. By 1980 the land was no longer required for those purposes and the councils, acting together, decided to offer the entire site for development as a housing estate. The councils subsequently accepted an offer by the defendant development company which in the councils’ view represented the best balance of the amount offered and development scheme submitted. By a contract in writing dated 28th November 1980 the councils agreed to sell the entire site to the defendant for Pound 1.52m, subject to the defendant obtaining planning permission for the development of the site in accordance with the councils’ development brief and the scheme for the development of the site. The defendant duly obtained the necessary planning permission and by transfers dated 22 January 1981 the councils transferred the
land to it. Under Cl.2 of each transfer the defendant covenanted with each council that it would carry out the development of the housing estate in accordance with the terms of the planning permission and the approved scheme. The defendant subsequently obtained fresh planning permission which enabled it to build more houses on the site than the number specified in the approved scheme and it completed the development covenants. The development was thus more profitable than that originally authorised. The councils, although aware of the breach of the covenants in the transfers, did not seek an injunction or specific performance to compel the defendant to develop the housing estate in accordance with the development covenants. However, after the defendant had disposed of all the houses on the estate, the councils brought proceedings against it for damages for breach of the covenants equal to the payment that might have been extracted from the defendant in return for agreed modifications to the covenants so as to authorise the more profitable development which had in fact been carried out. The defendant accepted that it was in breach of the covenants, but denied that the councils were entitled to recover anything more than nominal damages, contending that the correct measure of damages for the breach was the aim of money which would restore the councils to the position in which they would have been if the covenants had been performed, with the result that the court was concerned only with the councils’ loss and not with any profit made by the defendant by reason of the breach of the covenants and that the councils had not suffered any loss and were not entitled to recover substantial damages.
Held - Where a party sustained loss by reason of a breach of contract he was, so far as money could do so, to be placed in the same position as he would have been in if the contract had been performed in full. Accordingly, in assessing damages for a breach of covenant the court was only concerned with the extent of that party’s loss and would not award him a share of the profit which the other party had made as a result of not performing the covenant. There was no justification for the assessment of damages on an alternative basis by reference to such sum of money as might reasonably have been demanded by the party affected by the breach of covenant in return for relaxing the terms of the covenant because an injunction could no longer be granted. When the position of the plaintiff councils was considered by reference to what their position would have been if the development covenants had been performed it was clear that the councils had not suffered any loss, since none of their property had been diminished in value and it could not be said that the defendant’s breach had destroyed the value of the covenants obtained by the councils, and if the value of the covenants had been diminished that loss had occurred because of a deliberate decision by the councils not to seek equitable relief and did not in itself result from the defendant’s breach of covenant. It followed that, although the defendant was liable to each council for breach of covenant, the councils were only entitled to recover nominal, as distinct from substantial, damages at common law. Moreover, since there were no grounds on which the court could grant an injunction or specific performance in respect of the housing estate development it had no jurisdiction to award damages in equity in substitution for such relief.
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5. PROBLEMS 1. C chartered a ship of O for three years. One of the terms was that if she was requisitioned by the Government under any emergency hire would not be payable for that period. She was requisitioned by the Government in the second year for six months to carry food supplies to an African country for famine relief. O sold the ship away during that period. At the end of the six months, C sued O for damages for breach of the charter party. Analyse and decide with reasons. 2. Southern Railway ordered 300 platform ticket issue machines from Southern Automatic Machinery Ltd. Price and specified dates and numbers of delivery were fixed in the contract. The company had delivered 175 machines. There was no complaint of quality of performance. The General Manager wrote to the company that no more machines would be required. Advise the Company for legal action with grounds. 3. An air conditioning firm entered into a contract to instal air conditioning system for P’s house at Madras for a certain amount. The system was installed but it worked very inefficiently. P refused to pay anything. The firm sued P. Decide with correct reasons as to what kind of breach had taken place with what result. 4. P, a hotel, agreed with D that a film a week should be supplied by D for screening at the hotel auditorium for Rs.1,000/- a week for one year. Films were supplied for six weeks and payments made. An advance of Rs.6000 was paid. But no film was supplied. After two weeks P wrote to D that on account of the delay there was a breach of contract and further dealings were stopped. D accepted the repudiation. P sued D for refund of Rs.6000. Decide on the proper grounds. 5. P, a big fruit merchant at Cochin chartered a ship “Hamsa” of D to carry a cargo of mangoes from Kakinada to Cochin. The ship deviated to Visakha patnam and delayed the delivery of the cargo at Cochin by four days. The monsoon had broken out a day before and the mango market came down and P incurred a loss of Rs.8,000/-. P sued D for damages. D contended he had no special knowledge that onset of monsoon would slump the mango market. Give your decision on correct grounds. 6. A firm of film producers signed on a famous actress to play heroine in a new film called “Shangri La Again” to be shot
in the Himalayan region. They got the script written, hired players, arranged locations and made other arragements. At the last minute, the leading lady repudiated the contract. As a proper replacement could not be made the project was abandoned. They calculated they would have lost Rupees Three Lakhs initial profits and had incurred Rupees One Lakh Twenty Five Thousand actual expenses of preparation. Advise them on what to sue the actress for and why. 7. A businessman from Hyderabad booked a cargo of crackers by road from Sivakasi to be delivered one week before Deepavali and informed the carriers that the cargo was required for Deepavali sales. The cargo carriers delayed the transit and the crackers were delivered one week after Deepavali. What rights of suit has the businessman against the carriers ? Explain the grounds. 8. B agreed to buy a house from S for Rs.3 lakhs. B paid Rs.10,000 as earnest money. B paid Rs.75,000 on being put in possession. B also agreed that if he did not pay the balance before six months and get registration a sum of Rs.85,000 would be forfeited. B defaulted. S forfeited Rs.85,000 and sued for possession and compensation. The fair rental value of the house was assessed at Rs.3000 per month. By the time the Court gave judgment it was one year. what is the correct decree the Court has to give and why ? 9. Sothebys, London had entered into contract with a Bangalore art dealer to buy an original Roerich canvas which was lawfully his property. But he later refused to part with it and offered a suitable amount as compensation. But Sothebys wished to auction the canvas at London. What can they do ? Explain the grounds. 10. T was making and selling ‘Mexican Balm’ as a remedy of rare medical efficacy. R, a rival trader started selling a balm under the same name. T moved the court for a permanent injunction against R. The court found on evidence that the ‘Mexican Balm’ sold by T did not contain any special medicinal properties. The court gave the injunction. R goes on appeal on a point of law to vacate the injunction. Would you as appellate judge confirm or vacate the injunction? What would be the grounds for your decision?
[Note: Specify your Name, I.D. No., and Address while sending answer papers]
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SUPPLEMENTARY READINGS 1. 2. 3. 4. 5. 6. 7. 8. 9.
Avtar Singh, Law of Contract, (1994), Eastern Book Company, Lucknow. Anson, Law of Contract, (1986), English Language Book Society and Oxford Press, London. Beale,N.G., Bishop, W.D., Furmston,M.P.,Contract Cases and materials, (1990), Butterworths, London, Edinburgh. Chitty, On Contracts, (Vol-II, 1983), Sweet and Maxwell, London. Cheshire and Fiefoot, Law of Contract, (1986), Butterworths, London. Iyer, Venkatesh, The Law of Contracts, (1987), Asia Law House, Hyderabad. Joga Rao, S.V., Contract Law - General Principles, (1991), NLSIU, Bangalore. Puri and Ponuswamy, cases and material on contract, (1974), Eastern Book Co., Lucknow. Trietal, G.K., Law of Contract, (1966), Steven & Sons, London.
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Master in Business Laws Law of Contracts Course No: IV Module No: VII
REPRESENTATIVE CONTRACTS
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 212 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
Materials Prepared by: Prof. P.C. Bedwa Ms. Archana Kaul Ms. Srividya Materials Checked by: Ms. Sudha Peri, Materials Edited by: Prof. N. L. Mitra, Prof. T. Devidas
© National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.
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Instructions Mercantile agents are the key players in the trade and commerce today. A general agent does everything for his principal starting from procuring of birth certificate to arranging for the cremation of dead bodies. There is nothing under the sun which a general agent does not do. As such it is necessary for everybody in the trade and commerce to understand the philosophical and legal basis of functioning of agents. Though 'agency' is a very age-old practice for a person to get things done for and on his/her behalf, the principle of agency came very handy in the success of mass production and disposition of grades and series in industrial civilization. An industry requires a very wide market for selling its articles at the same time and at various markets. So it can be done only through agents. As a matter of fact anyone can multiply his/her personal rights and duties through appointing agents. The general principle in agency is that done one who does something through another does it oneself.' In ancient Indian Law he was called "pratinidhi' (or representative). Agency is a creation of a contract. The principal enters into a contract with an agent in order to empower the later to act on his/her behalf. In doing so the agent has to work within the stipulated terms and conditions as laid down in the contract. But an agent also has the power to breach these terms and conditions acting bona fide for the protection of the Principal's interest. It is necessary for us to critically look at the law and practice in order to appreciate the needs of the business community. There are several types of agents based upon the need of trade and commerce. While you go through this module try to prepare a check-lists of every issue, like, how to appoint an agent, what are his function, what points does he have, in what situation is he liable to whom for what and other matters. In India, a big section of our trading activities are done by partnership. Partnership form of business is also based upon the principle of agency. As such a section of partnership law and practice is also included in this chapter. You can try and understand the basic similarity and dissimilarity between these two forms of authority i.e., agency authority and partnership authority. A good understanding of theory and practice of agency will enable you to properly appreciate the functions of many other authorities like, company management, public officials and administrative authorities of other forms of business and commerce. It is very easy for you to understand this module because most of you are directly or indirectly involved with some form of agency work or the other. A good understanding of the subject will be beneficial even in your personal life.
N. L. Mitra Course Co-ordinator
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Representative Contracts
TOPICS A) Agency 1.
Introduction ....................................................................................................................
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Creation of Agency .........................................................................................................
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Authority of an Agent ....................................................................................................
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Duties of Agent ...............................................................................................................
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Rights of Agent ...............................................................................................................
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Undisclosed Principal ....................................................................................................
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Termination of Agency...................................................................................................
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B) Partnership 8.
Agency Principle in Partnership ...................................................................................
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Minor Partner ................................................................................................................
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Authority of a Partner ...................................................................................................
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Rights and Liabilities of a Partner ...............................................................................
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Relevant Sections of the Bare Act .................................................................................
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Case Law .........................................................................................................................
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Problems..........................................................................................................................
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Supplementary Readings ...............................................................................................
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1. INTRODUCTION SUB-TOPICS 1.1. Agency & Authority: Definitional Delimitation 1.2. Agent vis-a-vis other offerers 1.3. Classification of agents 1.4. Who can be an agent 1.1 AGENCY & AUTHORITY: DEFINITIONAL DELIMITATION The principle of agency is based upon a contractual relation between two parties through which one delegates some authority to another on which the other acting on behalf of the first person can lawfully bind him. This principle is very old both in Eastern and Western jurisprudence. Roman Law Justinian Code contains the basic principle of appointment of an agent by any person. According to the rule, ‘qua facit per alium facit per se’, i.e., one who does something through another does it oneself. In Hindu Law Prothinidhi is also almost an identical principle. Of course, in course of time, the principle gathered all moral and legal support. The appointment of prothinidhi has always been a well accepted principle in all walks of life. With the industrial revolution setting in motion in the seventeenth century the appointment of an agent through the delegation of authority has become very handy in market development for commodities produced in large quantities in industries. Over the years the definitional approach changed. In Common Law agency is taken as employing a person for creating legal relations between the employer and third party. 'American Re-statement' has given a technical definition ‘as an agreement to represent another in an act’. Bowstead defined agency and authority on the basis of Restatement (1,7 & 8) thus (1) Agency is the relationship which exists between two persons, one of whom expressly or impliedly consents that the other should represent him or act on his behalf and the other of whom similarly consents to represent the former and to so act. The one who is to be represented or on whose behalf the act is to be done is called the principal. The one who is to represent or act is called the agent. Any person other than the principal and the agent may be referred to as a third party. (2) In respect of the acts which the principal expressly or impliedly consents that he shall do, the agent is said to have authority to act, and this authority constitutes a power to affect the principal’s legal relations with third parties. (3) Where the agent’s authority results from a manifestation of consent that he should represent or act for the principal expressly or impliedly made by the principal to the agent himself, the authority is called actual authority, express or implied [Bowstead, p.1]. According to Prof. Friedman, agency is the relationship that exists between two persons when one, called the agent is 216 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
considered in law to represent the other, called the principal in such a way as to be able to affect the principal’s legal position in respect of strangers to the relationship by the making of contracts or the disposition of property [Fridman, p.8]. There are several advantages derived out of the system of agency. Through the appointment of agents, a person, called the principal can engage himself in entering into several contracts and bind himself at the same time with different persons at different places. Efficiency in operation of scale can be enjoyed only because the principal can appoint agents of various types suitable for various specified tasks. Agents are not servants because agent can take policy decisions and act on behalf of the principal as if he is the principal himself, but a servant can only do an act as directed by the principal. According to section 182 an 'agent' is a person employed to do any act for another or to represent another, in dealings with third person. The person for whom such act is done or who is so represented is called the ‘principal’. So the agent has the authority to do an act on behalf of the principal binding the principal personally for the work. 1.2 AGENT VIS-A-VIS OTHER OFFERERS There are several distinctive features of contract of agency which become clear if the institution of agency is distinguished from some other types of contracts. These distinguishing features are given below on the basis of relative assessment. (a) Agent and servant: The Supreme Court has tried to distinguish an agent from a servant in Laxmi Narain Ram Gopal and Sons v. Hyderabad Government (AIR 1954 sc 364). 1. The agent can act on behalf of the principal for creating contractual obligations for third party which a servant cannot. 2. The servant acts under the direct supervision and control of master and must conform to all reasonable orders.. But an agent is not subject to direct control and supervision of the principal though he exercises his authority in accordance with the lawful instructions. 3. A servant has to be remunerated with salary or wages which must conform to all laws made by the state in that context but there is no consideration required for an agent. An agent is generally remunerated with a commission as agreed between the parties. 4. A principal is liable for the wrong committed by an agent within the scope of the authority. If the wrong committed is on matters ultra-vires, the principal is not responsible. A master is liable for the wrongful act of the servant in the course of employment even if such act be outside the parameter of the job for which the servant is employed.
5.
6.
An agent may serve different principals at the same time whereas a servant cannot serve more than one master at a time. An agent is not a servant, but a servant or an employee may be deemed to be an agent of the master, eg., A has appointed B to work in his shop on a monthly remuneration of Rs.500/-. B while selling the commodity to C represents his master in the contractual relation between the master and customer. Often servants get this type of authority while serving the master.
(b) Agent and Independent Contractor: In modern times independent contractors are appointed in many turn key mega construction contracts. In such cases a contractor is appointed to accomplish whole or a part of the whole contract, eg., in building contracts the main contractor may appoint a sub-contractor for electricity installations or for plumbing work. A sub-contractor generally is appointed with a contract which contains job specifications and contract amount. A sub-contractor is not under the control and management of his principal contractor. He is not remunerated on the basis of any specific job. For any wrong committed by sub-contractor the principal contractor is not bound. The sub-contractor or the independent contractor does not take the direction from the principal contractor for his day to day work nor is he accountable for that. (c) Agent and Trustee: Institution of agency and trusteeship both are the creation of equity and as such there are some converging characters. Maitland suggested that law of trusts and law of agency have a common origin in the early doctrine of usages (Maitland, p.226). Both agency and trust create legal relations between principal or beneficiary on the one hand and third party on the other, eg., agent selling goods on behalf of his principal can also transfer the ownership. Similarly a trustee selling the property to a third party may also transfer the title. But in spite of resemblances there are important distinctions. Agency is creation of a contract with the consent of both the parties but an institution of trust may not be the creation of a contract. It also does not require the consent of beneficiary. A trustee can never be said to be a representative of beneficiary, for the act of the trustee the beneficiary is not responsible but on the other hand agent is the representative of the principal and for all his acts the principal is responsible. In Kalipada v. Haridasi Dasi [AIR 1938 Cal 673], the Court pointed out that there is a well marked distinction between the relation in agency and that of trusts. But in many cases the agent is involved in a relation of trust and confidence. (d) Agent and Bailee: A bailee is an independent contractor for service. An agent though in possession of his principal’s goods is not a bailee because he is not required to do any service or act on those goods before returning them to the principal, as in case of bailment. He has to dispose those
off on behalf of the principal. The bailee has no power to make contracts on behalf of the bailor nor can he make bailor liable by his acts or omissions. 1.3 CLASSIFICATION OF AGENTS Ramachandran has given a comprehensive classification of agents as follows: i) Public Agents (attributed to servants of the Crown or State). ii) Private Agents (representing individuals or companies) iii) Home Agents (inside country) iv) Foreign agents (outside country) v) General Agents (on all matters pertaining to a trade or profession) vi) Special Agents (to act in a particular transaction) vii) Mercantile Agents or Commercial Agents, e.g. Brokers, Factors, Auctioneers, Del Credere Agents and Insurance Agents. viii)Non Commercial Agents, e.g. Commission Agents, Estate Agents, House Agents, Law Agents. ix) Co-Agents (to act along with an agent) x) Sub Agents (employed by and acting under the control of an Agent). 1. Public Agents: Public officials in discharging their public duties function as an agent of the chief executive. Therefore, while discharging the duties, a public official is generally immune from personal liability. Of course, the extent of this immunity is subjected to many other principles of administrative law. 2. Private Agents: Agents appointed by any person including the corpa juris fall under this category. These agents may be concerned with commercial and industrial activities or noncommercial and individual affairs. As for example a jobber or a broker is an example of a commercial agent but a person may be representing another person in all private affairs simply with the authority given by a power of attorney. He is a private agent. 3. Home Agents: Home agents are those who are authorized to operate within the home country of the principal. As such their authority does not extend beyond the territory of home country. As for eg., a clearing agent operates in the port of the home country of the importer. 4. Foreign Agents: Foreign agents are those who operate in a foreign country outside the country of the principal. As for eg., shipping agents operating in ports of foreign countries are foreign agents of the importer. 5. General Agent: General agents are very common in the commercial sector specially in wholesale and retail trading. These agents are authorized to represent the principal in all transactions relating to the trade, commerce and industry. General agents have unlimited power, of course within the nature 217 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
of the trade business and commerce. In Jacobs v. Moris [(1902)1 Ch. 816]; it was stated that: “A general agent has the full apparent authority due to his employment or position and the principal will be bound by his acts within that authority though he may have imposed special restrictive limits which are not known to the other contracting party”. An individual can also appoint a general agent to represent him in all events either under a general power of attorney or with implied authority exercised by a person on behalf of another. 6. Special Agents: A special agent is generally appointed by a person for a specific purpose. The authority is strictly confined to specified limits. The agent cannot exceed that limit and bind the principal. If X has appointed Y for the specific job of selling his Delhi property, the agent cannot bind the principal with a contract entered into for the sale of his principal’s Bangalore property. 7. Mercantile Agents: There are various types of mercantile agents based upon nature of work. In the capital market agents are known as jobbers and share brokers. In commodity market there are factors and brokers. In trade and commerce there are del credre agents. A broker functions as a middleman between the seller and the buyer either as an agent of the seller or of the buyer and sometimes of both. A broker does not generally do any business on his own account. A broker in a share market is prevented from entering into any contract on his own account, though he is not compelled to disclose the identity of the principal at the very beginning of the contract. A jobber, on the other hand, sells or buys stocks in his own account. An equivalent agent in commodity market is known as factor. A factor in the commodity market [in mandis] can enter into a contract on his account. In Bombay these types of agents are known as pacca adatia who act like a principal. A kaccha adatia on the other hand is a person who exclusively functions like an agent on behalf of a Mofusil (rural) principal. A pacca adatia is also a del credre agent. A del cedre agent is one who not only sells the commodity in cash and credit but also takes the responsibility of realizing the credit against a special commission known as del credre commission, and unless an agent has a special contract to deal with the credit, he does not have any responsibility for realization of the credit in case he sells the commodity on credit. Therefore, if he sells in cash and credit the commodities of his principal, he is responsible to pay the entire amount to the principal even if the part of the debt becomes bad provided the agent has a del credre contract. Auctioneers: Auctioneers are market agents taking the responsibility of realizing money from public auction. Auctioneers are generally not mercantile agents. They are agent for public auction specifically responsible for selling of asset through public auction. The auctioneer has a lien over the goods on which his charges are not yet paid. Auctioneer's lien is a particular lien, thus until the auctioner is paid, he can retain the goods which he has auctioned on behalf of his principal. An auctioneer can become a public auctioneer if he is notified as such under the law to which he is subject. 218 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
Other commercial agents: In transportation, carriage and international trade, several types of agents work on the basis of commission, for example, wharfinger, collection agents, clearing agents, bonded warehouse owners, etc., who are the agents for importers and exporters of goods. Some work on the movement of commodities from a point to a point, or loading and unloading of the goods, upkeep of the goods in transit and in warehouse, clearing the goods from port authorities after paying due charges and duties, transporting those goods to the principal. These are specialized agents for specific jobs and one does not undertake the work of other, i.e., a wharfinger will not undertake the job of a clearing agent or vice-versa. Amongst the other specialised commercial agents’ in the insurance business there are insurance agents who secure insurance business for and on behalf of the Insurance Companies. Similarly there are commission agents in industries and trade who are ready to do anything lawful for the principal on commission. Commission agents do all multifarious activities on behalf of the principal for which they charge a commission. Recently real estate has become an important field of commerce. Of course, in the advanced countries there is a booming business in land. The transactions in land are generally conducted through real estate agent who facilitate a contract between the buyer and the seller and charge a commission. They also do other business like leasing of properties. Similarly in building contracts there are several types of agents who operate and whose work is different from that of the independent contractors. These agents like labour contractor or plumber, work under the supervision and control of the principal contractor and do not work for profit but for commission. Two distinctions are to be remembered between the agents operating in building and other construction works with the independent contractors working in the same field. Firstly, agents work for commission and not for profit. Secondly, an agent is not responsible for the work done as in the case of independent contractor. 8. Non-commercial Agents: Operation through an agent is a very old practice in every walk of life. Therefore it is needless to show that in every aspect of our life a person depends upon another person who works as his/her agent. Sometimes this power of agency originate by status, as for example the wife is the agent of her husband. Any one can appoint another person for a specific work or for any work in general. Any agency under the Transfer of Property Act is entered through power of attorney. In service sector the best example of a professional agent is a Solicitor and a Chartered Accountant Firm who undertake agency functions through offering services. 9. Co-agents: When a principal appoints two agents for discharging the same job or one agent to discharge the job along with the principal, the agents are called co-agents. In big commercial projects instances of co-agents are many. In bridge contracts, agents may be appointed for the approach road on both the sides jointly with the bridge contractors due to their expertise in various fields, or in structure building many agents may be appointed on account of their speciality in one or the other type of services. These are all co-agents.
10. Sub-agents: Generally speaking an agent cannot delegate his work further, delegatus non-potest delegare i.e., once delegated can not be further delegated. But in the commercial world unless it is prohibited, sub-delegation is quite normal. Of course when a specific agent is appointed for a specific personal service that cannot be further delegated. A broker can appoint a sub-broker or a clearing house may appoint a subagent to do a specific job. Therefore sub-agents are those who are assigned a task by the agent against commission. In so far as the principal is concerned the sub-agent also becomes an agent for all practical purposes. 1.4 WHO CAN BE AN AGENT According to Section 184 of the Indian Contract Act any person can be appointed as an agent at the risk of the principal. Agency is an outcome of a contract, therefore, as per section 10 of the Contract Act a person can enter into a contract if he has attained the age of majority under the law to which he is subject and is not a lunatic or of unsound mind at the time of entering into a contract, or is not otherwise incapacitated under any other law to which he is subjected. Position of Minor: Section 184 apparently contradicts with the provisions of sections 10 and 11 of the Contract Act. If one reads section 10 and 11 together it becomes clear that a minor is incompetent to enter into a contract in India unlike U.K. In England a minor can enter into a contract for services. This is not possible in India as per the clear provision in section 11. Section 184 allows a minor to be appointed as an agent on a stipulation that he is not responsible to the principal for anything i.e., that a principal cannot attach any liability to the minor. Presumably the position can be explained according to British law where appointment of an agent is a contract of service. Therefore in England a minor can be appointed as an agent without attaching a personal liability. In India, there is no distinction made between any type of agreements in so far as minor is concerned. All agreements made by him are void ab initio. According to section 184 the contract of agency made
with a minor appointing him as an agent is valid in law without any detriment to minor. The contradiction is apparent but since there is no litigation on the issue a clear judicial opinion is not available. But in some of the cases judiciary has indirectly reconciled to the position, eg., in Gopimal Durga Das v. Jain Bank of India Ltd. [AIR 1918 Lah 269], the court held that a minor purchasing share for the firm he represents can bind the firm to pay for it. An analogy of this case with a British Judgement is Gudi v. Harison [(1821), 5B & ALD 147] which held that an infant partner can bind the firm by his act' is unfounded because in India a minor cannot be a partner as he cannot accept any agreement of service or appointment. But even with the Law Commission suggestion, the contradiction still exists. 13th Report of the Law Commission observed in para 133 as follows: “Section 184 permits a minor (as well as a person of unsound mind) to become an agent as between the principal and third persons without being responsible to his principal. There may be cases where an agent may incur a personal liability upon the contract towards third persons. But in our opinion an agent who is a minor or a person of unsound mind should be exonerated from such liability. According to Bowstead, the personal liability of the agent upon the contract of agency and upon any contract entered into by him with any third person is dependent on his capacity to contract on his own behalf. We agree with this view and recommend that Section 184 should be modified accordingly.” The Commission suggested redrafting of Section 184 as follows:“184. Who may be an agent: As between the principal and third persons any person may become an agent, but no person who is not of the age of majority and of sound mind can become an agent a) so as to be responsible to his principal, or b) so as to be personally bound to third persons in respect of contracts entered into by him on behalf of his principal, according to the provisions in that behalf here in contained.”
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2. CREATION OF AGENCY SUB-TOPICS 2.1. Agency by agreement 2.2. Agency by ratification 2.3. Agency by operation of law 2.4. Agency by estoppel 2.5. Agency by holding out 2.1 AGENCY BY AGREEMENT Agents are generally appointed by contract. The principal appoints the agent under express terms and conditions to which the agent is required to give his consent. This is the most common method of appointing an agent in the commercial as well as non-commercial world. This type of contracts generally outline the authority delegated, the task to be accomplished, and the terms and conditions relating to the principal and agent determining their rights and duties. It was held in Freeman & Lockyer v. Buckhurst Park Properties Ltd. [(1964)2Q.B.480] that “an actual authority is a legal relationship between principal and agent created by a consensus agreement to which they alone are parties. Its scope is to be ascertained by applying ordinary principles of construction of contracts including any proper implications from the express words used, the usage of the trade or the course of business between the parties”. Express Agreement: In the non-commercial field a person is appointed as an agent by the letter of authority or a power of attorney which specifically stipulates the extent of authority delegated,the task to be completed and the terms and conditions between the parties. Agents are appointed in the commercial sector through letter of appointment which is also subjected to trade and commercial practices. The terms and conditions are often determined by communications over a period of time. In order to determine who is the offeror and who is the acceptor one has to examine the whole correspondence. Generally speaking, appointment of agency is a service contract. Therefore, the principal makes the offer through his letter of appointment to which the agent gives his consent either by factually resuming the work or by communicating a consent letter or by both. Implied Agreement: Very often the relation between a principal and his agent is required to be ascertained from the fact situation because most of the things are not in writing. It was rightly observed in Branwhite v. Worcestor Works Finance Ltd. [(1969) 1 AC 552] that while agency must ultimately be derived from consent, the consent need not necessarily be expressed in writing, but may be gathered from facts and circumstances of the case. If A is a partner of B, A has the implied authority of representing B in all activities of the partnership firm. In general trade and commerce, agents are very often seen to exercise implied authority even where there is a written agreement. Status has a very important role in agency functioning, both in 220 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
the case of public agents as well as in the case of private agents. Even in family life wife acts as the agent of the husband having implied authority to do so, and vice-versa . 2.2 AGENCY BY RATIFICATION The general principle for agency by ratification in common law is based upon the Roman Law principle of Omino Ratihabitio Retrorahitur et manditio aquiparatur apriori, an ‘act when ratified takes effect as if it was a mandate from the very beginning’. It generally means that if a person does a work on behalf of another but without having any authority to do it, he may be justified in doing it and binding the other provided the other ratifies the action after the work is done. In such a case, in the eye of law, it shall be treated as if he has done the act with prior authority. It means that there is no discrimination so far as legal effect is concerned between an act done with prior authority or subsequent authority excepting that in case of subsequent authority the principal is required to be fully informed before he exercises the power of ratification. The ratification can be made subject to the following conditions:1. Ratificattion only of acts which principal is capable of doing: An act can be ratified only when the principal can himself do it A minor or a lunatic cannot ratify an act done on their behalf when they were minor or lunatic after attaining majority or lucidity. It is because when the act is done the principal himself was incapable of doing the same. Similarly a company which is yet to be registered cannot formally appoint any authorized agent for doing promotional work on its behalf nor can it ratify such promotional activities undertaken by the promoters before the company is registered. In Surendro and Co. v. The Liquidator, Punjab Tannery Co. [AIR 1923, Lah. 100] it was held and rightly so, that a company can not ratify, or adopt a contract which was entered into by the promoters on its behalf before its incorporation. 2. Ratification can be made only with full knowledge of acts done: It has already been stated that ratification can bind the principal only when he is fully aware of the material circumstances in which the act is done. If A ratifies an act of B, it shall be presumed that A has all material information communicated by B. Therefore, if A can subsequently prove that the ratification was made without having material information or some material information has been withheld the ratification shall be ineffective. But the principal will be liable on ratification even though he has no knowledge of the legal effect of the act ratified or of collateral matters affecting the nature of work. 3. The ratifier must be competent to ratify: No one can ratify an act done by another on his behalf unless he can do it himself. So a minor cannot ratify an act done on his behalf. An act done by a de facto guardian is required to be done again by the minor after he attains the age of majority in order to bind himself. [Tukaram v. Madras Row (AIR 1948 Nag. 293)].
4. Act should be done on behalf of ratifier: A contract can only be ratified by a person on whose behalf it was purportedly made [Chitty, Vol.2 p.8]. If a person acts in his own name and makes no allusion to agency his act cannot be ratified by another. This principle is laid down in the famous case of Keighley Maxeted & Co. v. Durant [(1901) AC 240]. In this case K.M. & Co. authorized their agent to buy Karachi wheat at specified rates on their joint account. Wheat was not obtainable at those rates. He brought wheat from Durant at a higher rate. He did so in the hope and confidence that his act would be adopted by the principals but he never mentioned their name while contracting and contracted in his own name. The principals approved the purchase, but when the price of wheat fell, refused to take delivery. Durant sued the agent and principals for breach of contract. But the principals were not held liable. The court held that the agent having contracted in his own name, his act was not open to anybody’s ratification and therefore, the purported ratification was ineffective. The rationale of the judgments is succinctly summarized by Lord Macnaghten’s remark that “civil obligations are not to be created by or founded upon undisclosed intentions”. Lord James said : “To establish that a man’s thoughts unexpressed and unrecorded can form the basis of a contract so as to bind other persons and make them liable on a contract they never made with persons they never heard of seems a somewhat difficult task”. 5. Ratification must be made within a reasonable time: It is essential that the person who ratifies the act of another does it within a reasonable time. It may be noted that in commercial contracts time is often a very significant factor. In Prince v. Clark [(1823) 1 B & C 186], this principle has been explained as that the principal has no right to pause and wait for the fluctuation of the market, in order to ascertain whether the purchase is likely to be beneficial. Similarly in Madhura Municipality Case [AIR 1931 Mad 957] it was held that “an option of ratification could be held to be capable of being exercised within a reasonable time of the act purported to be ratified and not after the expiry of the period for which the option was open.” 6.No illegal or void act can be ratified: As for example, dividend cannot be declared out of capital. Even if it is done with all the shareholders approval, it can not be ratified. A lease by a minor cannot be ratified. An act done by a director outside the parameter of the memorandum of the company cannot be ratified. No criminal act can be ratified. In Premila Devi v. Peoples Bank, Northern India Ltd. [AIR 1938 PC 284], the Privy Council explained the rule thus; “there can be in truth no ratification without an intention to ratify and there can be no intention to ratify an illegal act without knowledge of illegality. A voidable contract can of course be ratified subsequently. 7. Ratification must be communicated: Ratification is required to be communicated to the agent. Unless he communicates the
same he cannot derive the benefit of the agents act or be liable for the same. Ratification may of course be expressed or implied. Effect of Ratification It has already been stated that ratification takes retrospective effect as if the authority has been vested in the agent from the very beginning. In Surendranath v. Kedar Nath Bose [AIR 1936 Cal 87] the Court held that by the very nature of the act of ratification the thing ratified has a clearly retrospective effect. In Wilson v. Tunman [Man. 9. 36] Chief Justice Tindal observed: “an act done, for another, by a person, not assuming to act for himself, but for such other person, though without any precedent authority whatever, becomes the act of the principal if subsequently ratified by him...In that case the principal is bound by the act whether it be for his detriment or his advantage and whether it be founded on a test or a contract, to the same effect as by, and with all consequences which follow from the same act done by his previous authority.” According to section 196 and 199 of the Indian Contract Act an act done by one person on behalf of another but without his knowledge or authority may be ratified by that other, and if that other so elects the same effect will follow as if the act was performed by that other. According to section 195 the following are the basic requirements of ratification and general implications: 1) A person acts on behalf of another; 2) Without the latter’s knowledge and authority; 3) The other may elect to ratify or disown and 4) Once it is ratified it shall be deemed to be have been done with principal’s prior authority. 2.3 AGENCY BY OPERATION OF LAW Status Most of the personal laws provide special status between spouses as long as they live together. It is true that business laws are presently codified and secularized but the religious texts dealing with personal laws still bear a very important role in so far as the interspouse relationship and power of agency. According to Christian law there is identity of interest. Therefore, husband and wife can mutually represent each other specially in contracts relating to household. Any spouse has a general power of representation on all matters of common interest in the household. Of course, this power is not extended to any one of their individual status created by a contract with any other party as for example, wife does not have an automatic power of representation in the business affairs of the husband or the husband does not have any authority to represent the wife in her service contract with others. In so far as the family and household interest is concerned husband and wife are considered having identity of interest and mutual right of representation. In Hindu law, of course, the situation is slightly 221 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
different. A wife can represent the husband in all family proprietary interest of the husband she is taken as a general agent of the husband. But the husband does not have any automatic power of agency in dealing with the Stridhan of the wife. In Islamic law, the position is not much different excepting that the wife by way of status has a limited power of agency in comparison to the husband’s power. A guardian can represent the interest of the minor. Here, though the power is analogous to the power of an agent, the guardian is really not an agent. In tax laws the guardian is himself the assessee and can be individually punished for non payment of tax as the guardian of the minor. Generally speaking an agent is never personally liable for any act done on behalf of the principal. There are many similarities in the rights and obligations of a guardian dealing with the properties of a minor and that of an agent dealing with the properties of his principal. A guardian simply represents the interest of a minor and in that broad sense is an agent. A corporate being cannot function itself. Therefore, some people represent the corporate identity. They are generally called directors. Directors working through the board represent the company. In section 291 of the Companies Act this general power of the board for representing the company is stated. According to this section the board of directors of the company shall be entitled to exercise all such powers, and to do all such acts and things, as the company is authorised to exercise and do. The restrictions to this general power are: (1) exclusive statutory or constitutional power given to the general meeting, (2) restriction imposed by general meeting through a resolution. Chakraborti in Taxman’s Company Law has rightly held that for ‘considering the validity or otherwise of the acts of a director in many a situation, the law of agency in so far dealing with the question of the principal being bound by the acts of his agent...would apply [Chakraborti, p.8]. This general principal of agency is not only applicable against the directors but also applicable against all officers of the company. The Court applies the principle with a larger coverage as for e.g., in Freeman and Lockyer v. Buckhurst Park Properties [Mangal Ltd. [(1964) 2 QBD 480], the Court held that an act done by a director does not become invalid on account of mere fact that there is a defect in the appointment of the director. The company is bound by the act. In partnership the partners have an implied authority to represent the firm and other partners. By mere fact that A is a partner of B, A can do an act binding both the partnership firm and other partners. Of course he has to be within the frame work of the business. There are certain restrictions on the implied authority of a partner which is also statutarily prescribed by the Section 19 of the Partnership Act. Necessity A person may be held responsible as a principal or as an agent due to an act of necessity. There are innumerable instances of such type of agency in case of necessity. Marine adventure in order to tackle unforeseen emergencies is one such example. 222 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
The master of the ship is given certain powers he may sell the goods in order to save the goods from destruction. In Hawtayne v. Bourne [(1841)7 M & W 595], Baron Parke gave two instances where agency of necessity could clearly be said to arise, Viz: (1) where a bill of exchange was accepted for the honour of the drawee by some one not already liable on the bill. The person so accepting is then subrogated to the rights of the holder, as regards the person for the sake of whose honour he accepts and pays. (2) The case of the master of a ship, who has wide powers in relation to the ship or its cargo if either is in danger. If the cargo is in danger of perishing, or the ship needs repairs or is otherwise incapable of being used on the voyage then the master may sell or otherwise deal with the cargo, or the ship itself, and the acts of the master, though not expressly authorized will bind the owner as his principal. But there must be some urgent necessity, caused by accident or otherwise, for this form of agency to arise. In the absence of necessity there is no such agency. The agency in case of necessity is a power that arises out of need of circumstances, as for eg., in Sims & Co. v. Midland Railway Co. [(1913) 1 K.B. 103]. The railway was carrying perishable goods. As a result of strike there was delay in delivery of the goods and as a consequence the commodity started deteriorating. The railway sold them to avoid further loss. It was held that the railway was not liable for breach of contract. It only discharged its agency functions in case of necessity. In Prager v.Blatspiel Stamp and Heacock Ltd. [(1924) K.B, 566], it was decided that the doctrine of necessity in case of agency is capable of extending to cover any new situations provided that the requirements of the doctrine are fulfilled. Necessity here is always looked from the point of compulsiveness of a person to treat the goods he is charged with as if they were his own. 2.4 AGENCY BY ESTOPPEL AND HOLDING OUT a) Estoppel In law of evidence, an equitable principle has been included as one of the cardinal principle of proof. The principle is generally laid down in section 115 of the Evidence Act. It stipulates that any one inducing another to believe by his act, mission or conduct, that a fact is true, though it is not true, he is held responsible as if the fact is true. He is estopped from denying the truth of the fact. This concept gives rise to two types of agency i.e., authority arising out of a positive or negative assertion. As for e.g., if a person allows another to believe that he is an agent of somebody or a principal of another he can be estopped from denying his liability as an agent or the principal as the case may be. In Mac-Fisheries v. Harrisen [(1924) 93 JKB 811] Lord Halsbury explained the principle of estoppel thus: “estoppel arises where you are precluded from denying
the truth of anything which you have represented as a fact although it is not a fact. The situation may arise (a) on account of the agent acting ultra-vires but ostensibly for the benefit of the principal and the principal enjoys the benefit with knowledge or knowingly the principal does not prevent the agent to operate beyond the jurisdiction. (b) there is no agency relationship between the two but one gets the authority due to the behaviour of the other. As for e.g., A a friend of B often comes to his shop and help B over the selling counter. In the absence of B oneday, A sells goods on credit to C. It shall be deemed in law that B has a power of agency because A is estopped to deny the authority.
given to a person; (b) the representation is made to a person who relies upon it and acts accordingly, (c) the representation may be made intentionally or negligently; (d) the representation must be the proximate cause leading the other party to commit mistake. (b) Holding out
The requirements for agency by estoppel were summed up by Slade, J., in Rama Corporation Ltd v.Proved Tin and General Investments ltd. [(1952) 1 All E.R. 554]. He says that there had to be : (i) a representation; (ii) a reliance on a representation and (iii) an alteration of a party’s position resulting from such reliance.
The principle of holding out is just an extension of the principle of estoppel. Estoppel is applied to the detriment of the principal by way of withholding his right to come out with truth that there is no right of representation. It really validates the act of the agent as if he had the right of representation though in reality there is no authority of representation given to the person. Holding out on the other hand is holding a person liable as if he is the principal. In effect both are same, though in application of the rule one arises out of a negative action whereas the other arises out of the positive assertion of the law. A allows his wife B to manage his property and to mortgage it, A is bound by the act of his wife [Maung R. Sein v. Ma Myit AIR 1933 Rang. 361].
Such an authority therefore, may arise if (a) there is a representation in the normal course of events to another person to believe that express or implied authority of representation is
A has allowed his servant to collect amount against credit sale. Debtors are discharged by paying the amount to the servant. He is estopped to deny the authority of the servant.
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3. AUTHORITY OF AN AGENT SUB TOPICS 3.1 Introduction: extent and authority 3.2 Express and implied authority 3.3 Customary authority 3.4 Apparent and presumed authority 3.5 Sub-delegation 3.1 INTRODUCTION; EXTENT AND AUTHORITY The nature, extent and quantum of authority of an agent depends upon various internal and external factors. According to section 188 the extent of an agent’s authority has been made coextensive with principal himself. It is provided that an agent, having an authority to do an act, has authority to do every lawful thing which is necessary in order to do such act. Similarly an agent having an authority to carry on a business, has authority to do every lawful thing necessary for the purpose, usually done in the course of conducting such business. In case of emergency the authority is further extended by section 189. According to the section, an agent has authority, in an emergency to do all such acts for the purpose of protecting his principal from loss as could be done by a person of ordinary prudence, in his own case under similar circumstances. Justice Shah, explained the extent of agent’s authority in Kucawar Lime and Stone Company v. Dehri Rahtas Light Railway and Company Limited [AIR 1969 SC 1993]. According to him “normally the liability for payment for demurrage charges lies upon the consignee for whose convenience the wagon is detained.” The same is the principle laid down in Halsbury’s, Laws of England “the party primarily liable to pay the demurrage is the party for whose convenience the wagons are detained.” In the said case coal was consigned to the appellant company by the colliery, under the Colliery Control Order 1955 by the order of the Coal Commissioner. As the company refused to take delivery, the railway company sold the coal and sued the company for demurrage. It was held in this case that under section 56 of the Railways Act, a railway could sell the consignment after serving notice on the owner. The position of the railway becomes that of a bailee qua the company and therefore it was bound to minimize the loss. It could not unnecessarily detain the wagons and claim demurrage. It could have unloaded the coal and put the wagons to use. In that case the consignee would be liable only for the wharfage. An agent can do every lawful thing but cannot exercise his power beyond reasonability and act arbitrarily. As for example, if A is employed by B, in London, to recover at Bombay a debt due to B, A may adopt any legal process necessary for the purpose of recovering the debt and may give a valid discharge on the receipt of debt amount. In trade and commerce often the extent of this authority comes to debate. It differs from trade to trade on the basis of business practice. Therefore the extent of agents authority depends upon: (i) nature of the act or business, (ii) things incidental to the business that are usually carried out, and (iii) usual trade, custom 224 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
and practice. The agent has authority to do all lawful acts to achieve this purpose which according to him is necessary to do to perform his job. The extent of this authority is therefore based upon bonafide exercise of the power. 3.2 EXPRESS AND IMPLIED AUTHORITY Agent’s authority may be express or implied. According to section 187 an authority is said to be express where it is given by words spoken or written. An authority is said to be implied where it is to be inferred from the circumstances of the case. It is express according to Fridman when it is given by express words, such as when a board of directors passed a resolution which authorized two of their members to sign cheques [HalyHutchinson v. Brayhead Ltd. Co. (1967)3 All ER 48]. A power of attorney is a formal grant of power with express and clear terms. In such case the strict rule of interpretation is applicable and if the agent does an act holding it within the authority, though not-covered under express terms, he has to prove necessary implication so that he can claim power. As for example, authority given “to demand and receive all moneys due to the principal on any account whatsoever and to use all means for the recovery thereof, to appoint attorneys to bring action and to revoke such appointments, and to all other business, was held to mean all other business necessary for the recovery of money and was not-authority to endorse a bill of exchange [(Harpar v. Godsell (1870) L.R. 5 QB 422,]”. Implied authority is what is necessary for or incidental to the effective execution of express authority. As for example, A is authorized to receive and sell certain goods and to pay himself a debt out of the proceeds. He has an implied authority to bring an action against a third person wrongfully withholding possession of the goods [Bowstead, p.80]. Implied authority extends to doing of any act in an emergent situation to protect the principal’s interest. 3.3 CUSTOMARY AUTHORITY Customary authority is based upon trade practices. In Bayliffe v. Butterworth [(1987)1 Ex 425] the principal authorised his broker to sell shares for him. The broker sold them to X who was another broker, but could not deliver the shares at the time of the settlement of the account. X bought same quantity of the share of the said company at the market price for his client and claimed the difference from the broker. Amongst the Liverpool brokers there was a custom to pay such differences in case one failed to settle the accounts at the time of execution. The broker paid the difference and demanded the money from the principal. It was held in this case that “if there is, at a particular place, an established usage in the matter of dealing and making contracts, a person who is employed to deal or make a contract there has an implied authority to act in the usual way.”
The custom of course is required to be reasonable and lawful and be known to the principal. Sometimes customs in maritime trade is expressly written in the contract because of variation of trade practices in different countries. Some of the trade customs are interesting to note. A factor is entitled to sell the goods entrusted to him in his own name unless he has been specifically instructed to sell the goods in the name of the principal. An auctioneer has an implied authority to sign a contract on behalf of both the vendor and the purchaser, but of course he does not warrant the goods he sells as a factor does. A shipmaster has number of implied authorities. He can do all necessary things for the due and proper progress of the voyage. He may pledge the goods or may even throw the goods in the ocean if safe return of the ship to the shore does require it. Similarly an estate agent has implied authority to receive deposit from the prospective purchaser [(Ryan v. Pilkington [(1959)1 All E.R. 676]. Solicitors may receive payment on the debt for the clients. 3.4 APPARENT AND PRESUMED AUTHORITY Apparent authority is usually that which is actually given to the agent by his principal expressly or by necessary implication. More often it is the authority which is actually not given to an agent, though a third party presumes that he has it. This is also known as ostensible authority. In Hely Hutchinson v. Brayhead Ltd. [(1967)3 All E.R. 98], Lord Denning explained the apparent authority of an agent in the following words: “Ostensible or apparent authority is the authority of an agent as it appears to others. It often coincides with actual authority. Thus, when the board (of directors) appoints one of their members to be a Managing Director they invest him not only with implied authority but also with ostensible authority to do all such things as fall within the usual scope of that office. Other people who see him acting as Managing Director are entitled to assume that he has the usual authority of a Managing Director.” In the Freeman case [(1964)1 All E.R. 630], Diplock L.J., went on to explain that an “apparent” or “ostensible” authority was “a legal relationship between the principal and the contractor created by a representation, made by the principal to the contractor, intended to be and in fact acted on by the contractor, that the agent has authority to enter on behalf of the principal into a contract of a kind within the scope of the ‘apparent’ authority, so as to render the principal liable to perform any obligations imposed on him by such contract.” An apparent authority is generally an authority delegated by the principal. This authority is either actual or ostensible. As for e.g., a hotel manager buying cigar on credits from the suppliers was supposed to have ostensible authority and the principal was bound to pay for the same. [Watteu v. Fenwick (1893)1 Q.B. 346)]. Similarly in Ishaq v. Madan Lal [AIR 1965 All. 34], the Court held that in a case in which an agent is authorized by his principal to go to another place and take delivery of and to sell goods there at any price which he chooses, the agent would have implied authority to accept the price either
wholly in terms of ready cash or part of it in terms of cash together with abandonment for a claim for remaining money by the principal against the purchaser. Apparent authority once created continues to exist until notice is served to the third parties about termination. Presumed authority is one which is not an outcome of express consent. Given the facts and circumstances the third party can presume that there is the authority of the agent to do the act. Such authority does not come from any positive representation but arises on account of situations. As for e.g., A sends his servant to the local shop to buy goods on his behalf on credit and pays for them on several occasions. A’s behaviour now induces the shopkeeper to believe that the servant has authority to buy on credit for the master. This is presumed on the basis of the behaviour of the master. Such type of presumptions are induced by act or omission of the principal, and as such the principal is estopped to deny the authority of the servant. Presumed authority may not always be created by estoppel as in the above case. As for example, A makes B his agent to carry his business of a furniture manufacturer, B will have power to purchase timber and other materials, hire workmen and carpenters, to manufacture the furniture. 3.5 SUB-DELEGATION The general principle is ‘delegatus non potest delegare’ i.e., once delegated cannot be further delegated. A person who receives an authority by virtue of delegation of authority by another cannot sub delegate it to yet another person and get it done by him. According to section 190 such a sub delegation is possible only ifthere is an ordinary custom of trade to that effect, or from the nature of agency a sub-agent can be employed. In the commercial world appointment of sub-agents in ordinary business contract is generally allowed. Even in service contract a concern entering into a contract with a person to provide services can get it done by any one unless the contract specifically mentions otherwise. In the following situations a sub-contract is held to be quite valid: 1. Where the job to be performed is purely ministerial and does not require any discretional judgement. 2. Where the principal knows that the work to be done would require appointment of sub-agents. For example, in building contracts principal knows that the contractor shall appoint several types of sub-agents for plumbing, electrical, mosaic laying sub-contracts and the like. 3. Where it is a business custom and practice to appoint subagents, i.e., wholesalers to retailers, to market the commodities belonging to the principal. 4. Where the authority conferred is such that experts from different fields are necessary to execute the program. 5. Where the personal services of the agents is not required to execute the work. According to section 190 exceptions are only two, namely:1. nature of the agency demands or permits sub-agents, and 2. ordinary custom of trade allows appointment of sub-agents. 225 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
1. Nature of agency demanding sub-agents: Where the owner of a house appointed a bank to be its agent to lease his house, it was held that the bank was not expected to search for the tenant. It could certainly appoint a sub-agent for the work [Mohindar Das v. Mohan Lal, AIR 1939 All 188]. In building contracts as has already been said or in turnkey projects the nature of the work is such that several specialized agencies are required to execute the project. Therefore appointing of other agents is natural. 2. Commercial practices: In the commercial world sub-agency has become essential part of the game excepting in such cases where the customer demands personal services like services of a lawyer or a doctor.
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Relation between sub-agent, agent and the principal A sub-agent is a person employed by and acting under the control of the original agent in the business of agency. A sub agent must not be confused with a substitute agent. Where an agent holding an authority named another person to act for the principal, he is not a sub-agent. He becomes an agent of the principal by substituting the first agent. The agent is responsible to the principal for the acts of the sub-agents. But the principal is responsible to the third party for the acts of the sub-agent as if he is the agent of the principal.
4. DUTIES OF AN AGENT SUB-TOPICS 4.1 Introduction 4.2 Duty to follow instructions 4.3 Duty to follow trade customs 4.4 Duty to communicate 4.5 Duty to exercise care and skill 4.6 Duty to render accounts 4.7 Duty to remit money 4.8 Duty not to delegate 4.9 Conflicting interests 4.10 Confidentiality 4.1 INTRODUCTION Though sections 211 to 221 of the Contract Act are stipulated to prescribe duties of an agent, yet the duties are not exhaustively covered by those sections. Often the courts have to refer to Common Law in order to settle issues in the matter. Section 211 provides the basic code in this matter. Section 211 postulates the essential functions of an agent to be: (i) to conduct the business of the principal according to his directions; (ii) where there are no such directions to act according to the custom that prevails in doing business of the same kind at the place where the agent conducts the business. (iii) if agent acts contrary he is liable to the principal for the loss sustained; and (iv) the agent must account for the profits, if any, to the principal. All other duties generally evolve out of this basic code. 4.2 DUTY TO FOLLOW INSTRUCTIONS As to the agent’s duty to obey principal’s instructions, Chitty observes :“If the agency contract is for consideration the agent must do what he has undertaken to do; he must, in performance of his duties, carry out any express instructions given to him by the principal even though he may reasonably believe that in departing from them he would be promoting his principals interests. If, however, his instructions are susceptible of two meanings he incurs no liability by interpreting them in the sense not intended by the principal. An agent who fails, whether deliberately or negligently to carry out his orders, has no right to remuneration or indemnity. But where the act which the agent is employed to perform is one which by law is void (such as the making of a wagering contract) the principal cannot recover damages for the failure to perform it." It is the duty of the agent to use all reasonable diligence in communicating with his principal and to obtaining his instructions. So agents duty involved in this regard are firstly
to observe the principal’s instructions and secondly to seek instruction where they are not given at the earliest opportunity. In so far as obeying the instructions of the principal, he has to be diligent. In Lilly v. Double Day [(1881) 7 QBD 510] the principal instructed the agent to keep his goods in A’s warehouse. The agent kept the goods in B’s warehouse which was equally good but cheaper. B’s warehouse was destroyed by fire. It was held that the agent was to compensate the principal for not following his instructions. In this case, the agent did act diligently and in the interest of the principal with a view to reduce the warehousing cost, therefore a rigid interpretation of the instructions perhaps cannot be made. In such a case therefore the decision ought to be different. The instructions of the principal has to be clear, unambiguous and lawful. The British courts in most of the cases interpreted the agents duty to follow the instructions most rigidly. That is why it has been held in number of cases that agent’s duty is only to follow instructions and not customs otherwise he is liable to compensate the principal. Indian courts have sometimes emphasized on the principle of diligence. As for example, where an agent is entrusted with the duty of investing principal’s money, he has a clear duty to invest in a security only after proper valuation of the assets in which he is investing. Therefore if the agent acts on his own general valuation, he runs the risk of being liable to the principal [William v. Frederick AIR 1932 P. C. 94]. Similarly, where ‘A’ engaged ‘B’ to sell gas cylinders with instructions to return the empty cylinders to ‘A’, ‘A’ was entitled to a decree for the value of these cylinders from ‘B’, because ‘B’ did not follow the instructions [Fraunjee Shaparjee v. M. S. Karan Devi (1966) I C 446]. 4.3 DUTY TO FOLLOW TRADE CUSTOMS An agent has to discharge his duties according to the terms of the contract with his principal. In case the instructions are not given in detail the agent has to adhere to the commercial customs and trade practices. If the principal stipulates anything contrary to commercial practice it is preferable for him to get back to the principal and inform him that the commercial practice was different from his instructions, but an agent cannot defy the instructions in order to go for the customary practices on his own. Of course, where there is neither any custom nor any instructions to follow, the agent can exercise his own honest judgement to protect the principal’s interest. In Soloman v. Broker [(1862) 2 F&F 726] the broker was entrusted to sell goods which he did at an inadequate price without previously estimating the value in accordance with the custom of the particular trade. It was held that the agent had to compensate the principal. 4.4 DUTY TO EXERCISE CARE AND SKILL An agent is bound to display such care and skill in discharging his duties as if he is managing his own affairs. (Avery v. Salie [(1972)25 DLR 495]). A professional agent is required to take 227 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
highest degree of care and skill as is required from such a professional person. An insurance broker is required to use his professional skill to protect the interest of his principal (Claude R. Ogden & Co v. Reliance Fire Sprinkler Ltd [(1975)1 Lloyds Rep. 52]. According to sec. 212 of the Contract Act an agent is bound to conduct the business of the agency with as much skill as is generally possessed by persons engaged in similar business unless the principal has notice of his want of skill. The agent is always bound to act with reasonable diligence and to use such skill as he possesses; and to make compensation to his principal in respect of the direct consequences of his own neglect, want of skill or misconduct, but not in respect of loss or damage which are indirectly or only remotely caused by such neglect, want of skill or misconduct. ‘A’, a merchant in England directs ‘B’, his agent in Bombay to send 100 bales of cotton by certain ship. B having it in his power to send the cotton omits to do so. Here B is negligent. Therefore B has to compensate ‘A’ by making good the loss sustained by ‘A’ soon after the arrival of the ship in England. This can be easily calculated on the basis of the price of the cotton in England when the ship reaches. The degree of skill and care required by the principal is based upon the circumstances of the case. In some cases requisite skill attracts implied warranties. In Story’s Treatise of an Agency, the author made it clear that where a skilled labourer, an artisan or an artist is employed there is on his part an implied warranty that he has a skill to reasonably undertake the work or art as the case may be. The principal can always expect a high skill and care from a professionally competent person. As for example, a Solicitor instituting a suit in a court which does not have jurisdiction has to compensate the principal. Section 211 obligates the agent to exercise reasonable and expected skill. The phrase in the section ‘unless the principal has notice of want of his skill’ stipulates that the principal expects from the agent his natural skill but if the principal is aware about the lack of skill of the agent, he can only blame himself. If the principal wants his agent to buy some goods, the agent is bound to use reasonable care to buy goods worth buying in view of quality. But where a broker is asked to buy scrap iron, he is not required to choose between scraps. He can chose between the prices. [Lambret v. Hath 15 MNW 486]. If the agent fails to exercise reasonable diligence and fails to use skills he in fact possesses, he is liable to compensate the principal [Narain Deo v. Hanumantha, AIR 1950 Orissa 241]. If inspite of the instructions of the consignor, the consignee does not take insurance cover for the goods and the goods are destroyed by fire against which consignee recovers half the worth the goods, the consignee must compensate the consignor full value of it [Panna Lal Janki Dass v. Mohanlal, AIR 1951 SC 144]. 4.5 DUTY TO COMMUNICATE According to sec. 214, an agent is required to use all diligence in communicating with his principal in case of a difficulty, and obtaining his instructions. Whenever there is some doubt or 228 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
difficulty, the agent has to act according to his principals wishes, rather than do whatever he feels like. Though, under sec. 189, he can act in a manner which would minimize the loss accruing to his principal and may in some exceptional cases even disregard the instuctions of the principal, yet as far as possible he should get in touch with the principal and follow his instructions as far as practicable. In case he fails to do so, the principal may repudiate the unauthorized act of the agent and hold him liable for neglect of duty. An agent can act according to his own discretion only when he feels either that it is practically impossible for him to seek instructions from the principal or that it would result in immeasurable loss to the principal if he delayed the taking of action any further, but in all such cases the action taken should be proportional to the needs of the situation. 4.6 DUTY TO RENDER ACCOUNTS According to section 213 an agent is bound to render proper accounts to his principal on demand. According to the normal equitable principle an agent is bound to keep his principal’s money separate from his own and also maintain an up-to-date and correct account on the principal’s behalf. In K. Chetty v. R. Chetty [AIR 1927 Mad 478] an agent lent some money to a third party out of the money of the principal without any necessity or authority. It was held that principal can sue on an ordinary money accounts for the recovery of the money lent by the agent. 4.7 DUTY TO REMIT MONEY It has already been said that the agent has a duty to give details of the accounts of transactions entered into by the agent on behalf of the principal. An agent is not bound to realize the credit in the event of his selling the goods on credit on behalf of the consignor unless the agent is also a del credre agent. According to section 218 an agent is bound to pay all sums received by him on behalf of the principal, of course subject to such deductions as the agent is entitled to. This obligation subsists in common law even if the money received is for void or illegal agreement. If any money is received wrongfully the amount can be recovered from the agent if and only if the agent has not repatriated the money to the principal. The agent is not liable to repay the money on the plea that the principal cannot be sued for realizing the money as he is a foreign sovereign [Rahimtulla v. Nizam of Hyderabad, AIR 1958 SC 379]. But if the agent represents himself as a principal, he is personally liable for refunding the money. In such a case there is no value of the proof that he has already transmitted the money or accounted for it to another [Baylis v. Bishop of London, (1913) 1 Ch 127]. If the liability arises subsequently, say, on the ground of breach of contract, the principal is the proper person to demand the money back, even though the amount is still with the agent. In Burt v. Claude Cousins & Co Ltd [(1971) 2 QB 426] the court held that where the agent acts as pre or post contract stake
holder, the agent would be personally liable for failure to comply with his delegations. In case of post-contract situation the principal is also liable. Some times personal privilege granted to a party, like an export licence or quota could be unlawfully transferred to another party through an agent though such privilege could not be alienated. The agreement is opposed to public policy and therefore the principal cannot realize the amount from the agent (following the rule of exturpi causa). 4.8 DUTY NOT TO DELEGATE An agent cannot sub-delegate his authority unless he is so permitted by the specific contract with the principal or by established trade practice. The principle is explained under delegatus non potest delgare. In the commercial world however there are established sub-agency system. The agent is fully liable to the principal for the acts of the sub-agents. Sub-agent must not be confused with substitute agents as has already been mentioned. 4.9 CONFLICTING INTERESTS In common law the agent has a fiduciary relation with the principal which compels him not to involve himself in a position where his duty to the principal can conflict with his own interest or the duty to any other principal. Suppose that a managing director of a company approaches a land dealer to acquire a plot of land adjacent to its factory. Realizing that the offer is extremely beneficial he leaves the company’s job and purchases the land himself. Here though apparently the rule is not violated but if one pokes deeper into the incident one realizes that the information received as a agent for and on behalf of the company is itself a bargaining situation. As such the bargain is against the principle of fiduciary relation. An agent who deals with different principals having conflicting business interests may
be placed in a similar situation because he is trading in goods of competing firms. In such a case a clear waiver is necessary to save the agent against the violation of the principal. So where a large trading company carrying on a state agency and building business was employed to sell property and was subsequently authorized to inspect the drains on behalf of the purchaser it was held that the company committed a breach of duty by accepting agency of adversarial parties. While functioning as an agent, an agent is bound to disclose his interest in the transaction entered into on behalf of the principal. According to sec. 299 of the Companies Act, Directors are bound to disclose their personal interests in the transaction entered into on behalf of the company. A further consequence of the fiduciary relation is that the agent cannot make a secret profits for himself while acting as an agent or using principal’s property or through confidential information received as an agent [Schering Chemicals Ltd v. Falkman (1982) QB 1]. In Reading v. Attorney General (1951) AC 507] an army surgeon was held accountable to the crown for an amount which he allegedly made in Egyptian black market by using his rank and uniform to ensure that lorries on which he was travelling were not searched by military police. An agent’s duty not to misuse his position or property or information of his principal may extend beyond the period of agency on the basis of contract or in special situations. 4.10 CONFIDENTIALITY An agent is required to be trustworthy on the basis of his specific duty of confidentiality. He can not use any confidential information for any other purpose except for which the information was passed. If he uses the information otherwise, he has to return the profits so improperly made [Brown v. I RC (1965) AC 244]. The agent has also an additional duty not to set up adverse title.
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5. RIGHTS OF AN AGENT SUB TOPICS 5. 1. Introduction 5. 2. Rights against principal 5. 3. Rights against property 5. 1 INTRODUCTION Actually speaking, the Contract Act itself does not deal with an agent’s rights separately, in much detail but mentions only two specific rights, i.e., ‘right to retainer’ and ‘right of lien’. But the general presumption which applies to the law of agency is that the ‘duties of a principal are the rights of an agent and vice-versa’. Thus apart from the above mentioned specific rights, we would also deal with those rights of an agent which are actually in the nature of duties owed by the principal towards the agent. Further, these rights can be sub-divided into two categories, those which an agent has against the principal personally and those which he has against the property of the principal. The following flow chart will give an idea of the various rights of an agent. Rights of an Agent Against the Principal
Against the Property Right to Lien
Right to Right to remuneration retainer
Right to indemnity
Right to compensation
General Lien
Specific or Particular Lien
We will now deal with each of these rights. 5. 2 RIGHTS AGAINST PRINCIPAL A] Right to remuneration A contract of agency does not need any consideration to support it, i.e., a principal need not pay any remuneration to the agent for the work executed by him, unless there is an express or implied contract to the contrary. Thus, whether an agent is entitled to payment or not depends on the facts and circumstances of each case. Once it is ascertained that an agent is entitled to a remuneration, then the question arises - when does such remuneration become due ? Section 219 of the Act states that, remuneration of an agent becomes due to him on completion of the task assigned to him. This again is subject to a contract to the contrary, i.e., though in general an agent is entitled to payment only on completion of a job, the principal may agree to make an advance 230 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
payment or to make the payment in installments. Thus, in Saraswati Devi v. Motilal [AIR 1982 Raj 108], the plaintiff being an estate agent was engaged by the defendant to find a customer for his house - the condition being that if such a customer could be found, the plaintiff would become entitled to a commission. The plaintiff found a person who was willing to purchase the house and also paid Rs.30,000/- as advance purchase price. Later, the defendant refused to sell the house to this person and consequently refused to pay the agent a commission since no sale had taken place. The agent filed a suit. It was held that, ‘according to the nature of this agreement the remuneration was payable to the plaintiff when he found a purchaser who was ready, willing and able to purchase the property and since he had done that he was entitled to his commission. But if a contract has come into being without any effort on the agent’s part, then he does not become entitled to remuneration [G.T.Hodges and Sons v. H.P.Residential Hotel Ltd., (1939)4 All ER 347]. It is equally not necessary that every time a remuneration is fixed, an agent becomes entitled to it. Under section 220 of the Act, whenever an agent misconducts himself, or is not true to the principal or acts in breach of his duties etc., then he ceases to be entitled to remuneration. Misconduct of an agent thus includes the omission to perform any act/duty specified under sections 211-216. This particular principle can be better understood in the words of Lord Alverstone, in ‘Andrew’s v. Ramsay and Co.’ [(1903)2 KB 635]: “A principal is entitled to have an honest agent and it is only the honest agent who is entitled to any commission. In my opinion, if an agent directly or indirectly colludes with the other side, and so acts in the opposition to the interests of his principal, he is not entitled to any commission.” B] Right to retainer The right to retainer given under section 217 is similar to a parallel right given to a bailee under sections 170-171. If the agent has in his possession any amount belonging to the principal, then, before returning the money he can retain out of it - (a) any sum due to him in respect of advances made or expenses incurred during the course of agency, and (b) any sum due to him as remuneration. An agent can retain money only for expenses incurred during the transaction in question - he cannot retain any money for his past/previous dues. Similarly, an agent’s right of retainer does not affect the full right of the principal over that amount, who can still exercise control over it subject to the agent’s rights over it. If the agent returns the entire amount to the principal, then he loses his right of retainer - as this right is a ‘possessory right’ and is available only so long as possession remains with the agent. C) Right to compensation Section 225 of the Act provides that, the principal is liable to compensate an agent in respect of any injury caused to him either because of the principal’s neglect or want of skill. For
example, A employs B to whitewash his house and puts up the scaffolding himself. The scaffolding is unskilfully/negligently put, and moment B climbs on it it breaks and falls to the ground. As a consequence B is injured. A must compensate B. Such compensation can be claimed under Tort Law rather than under Contracts. If the agent himself is guilty of contributory negligence, then he cannot claim compensation or if the court feels it just then it may apportion the compensation between the agent and the principal, i.e., if an agent would have been entitled to Rs.5000/- as compensation if no blame attached to him, then he will receive only Rs.2500/- or Rs.3000/- when he is guilty of contributory negligence. D] Right to indemnity Section 222 of the Act embodies the principle of indemnity as, “the employer of an agent is bound to indemnify him against the consequences of all lawful acts done by such agent in exercise of the authority conferred upon him.” For the application of this section, two conditions are necessary, namely: a) The agent should act lawfully. b) The act should be done in the course of agency business. If both these conditions are fulfilled, then he is entitled to be indemnified by the principle for all consequences which may flow from such an act. In Thacker v. Harday [(1874)4 QBD 685], it was held, “An agent is entitled to indemnity from his principal against liabilities incurred by the agent in executing the orders of his principal unless these orders are illegal or unless the liabilities are incurred in respect of some illegal conduct of the agent himself or by reason of his default.” This provision of an agent not being entitled to indemnity for any criminal or wrongful act has been incorporated in section 224 wherein it is stated that, “where one person employs another to do an act which is criminal, the employer is not liable to the agent, either upon an express or an implied promise, to indemnify him against the consequences of that act.” The right to be indemnified extends not only to consequences following from lawful acts, but also to acts done in good faith by him even if such act results in an injury to a third person [section 223]. For example, B at A’s request sells some horses in possession of A but which A had no right to sell. B unaware of A’s not having this right, sells the horses and hands over the proceeds to A. Later, C the true owner of the horses files a suit against B for the value of horses and costs. A is liable to indemnify B for any amount which he has been compelled to pay to C alongwith any legitimate expenses incurred by B in the process. But, where an agent willfully and with full knowledge commits an unlawful act, he cannot claim an indemnity from the principal. If A asks B to burn C’s house, and B is caught in the process and is made to compensate C for the damage suffered by him he cannot ask A to indemnify him for the amount which he is compelled to pay to C.
5.3 RIGHTS AGAINST PROPERTY Apart from the rights which an agent has as against the principal personally, he has a ‘right of lien’ under section 221 over any property belonging to the principal which is in his possession. Right of lien is a right of retainer exercisable over movable property or goods (not being money) for legitimate expenses incurred over those goods. Lien is generally of two kinds, viz: a) General Lien - This is provided for under section 171 of the Act and provides that a person may retain all goods belonging to another for a general balancing of accounts. This type of lien is available to bankers, factors, attorneys, wharfingers etc. For example, suppose a person takes a loan from bank against security of some gold ornaments. The bank is entitled to retain those ornaments not only till the said loan is returned but also till all other amounts due from him to the bank are also paid up by him. b) Particular Lien - This is a lien which is available to bailees and agents in general. In this lien, a person can retain goods belonging to another for all expenses incurred by him in respect of those goods. For example, a tailor may retain the dresses made by him till his tailoring charges against those dresses are paid to him. But he cannot retain those dresses for any amount due to him from the customer for some dresses he had made in the past. In Pestonji Bhicaji v. Raviji Javerchand [AIR 1933 Sind 235] the essential conditions of a valid lien under this section were laid down as follows: a) The agent should be in a lawful possession of the goods; b) His right to exercise lien over them should not be inconsistent or in contravention of any arrangement or agreement between him and the principal; c) As far as the agent knows the property should be that of the principal (i.e., an agent cannot exercise lien over goods not belonging to the principal); d) He should have received the goods as an agent during lawful transaction of agency business; and e) He should be holding the goods expressly/impliedly on behalf of his principal and not for or on account of some third party. The extent of lien has been well stated by Khan,J., in Gopaldas v. Thakurdas [AIR 1957 MB 22] as follows: “The agent’s lien does not give unrestricted authority to the agent to deal with the property in any manner the agent may like. The right is limited in nature. It enables the agent to retain the property till his dues are paid. But this confers no authority on the agent to sell or otherwise dispose of the property without the consent of the owner.” Extinction of Lien An agent’s right to lien is lost in the following situations, viz: 1] by the principal paying him his dues; 2] by the agent’s entering into an agreement or acting in a manner inconsistent with the exercise of lien (for example, 231 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
his returning the goods back to the principal unconditionally); 3] by waiver, i.e., by the agent giving up his right of lien; Lien being a possessory right cannot be exercised once the possession of the goods is lost by the agent, unless the manner of his losing possession is consistent with his ritht i.e., though he loses possession the loss is temporary and he intends to get the possession back (for example, a tailor wanting to exercise his right of lien can still give the dress for trial - since his intention is to regain possession of the dress and then retain it till his dues are paid).
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Sub-agent’s right to lien Wherever an agent has an authority to appoint a sub-agent, such sub-agent also acquires a right of lien over the principal’s goods (section 221). But where the agent has no authority to make such appointment, the sub-agent does not acquire any right of lien even for his dues. The reason for this differentiation is simple - lien is a right granted to a person for recovery of lawful dues. An unauthorized act cannot result in lawful dues, and so right of lien cannot be granted for their recovery.
6. UNDISCLOSED PRINCIPAL SUB TOPICS 6.1. Kinds of principals 6.2. Doctrine of undisclosed principal a) Rights of undisclosed principal b) Rights of a third party 6.1 KINDS OF PRINCIPALS As seen earlier a principal is the person who appoints an agent to act on his behalf. There are four kinds of principals generally recognized, viz: i) Named Principal - He is one whose identity (i.e., name) has been revealed to the third party by the agent. In these cases, the third party knows that the agent is acting on behalf of some person ‘X’ and not on his own behalf. ii) Unnamed/Disclosed Principal - Sometimes an agent may inform the third party that he is acting on behalf of someone, but does not reveal the identity of the person. Such principal whose existence is known to the third party but not his identity is known as unnamed or disclosed principal. iii) Undisclosed Principal - In certain situations, an agent portrays himself to be the contracting party, i.e., he does not reveal either the existence or the identity of the principal to the third party. The third party in these cases are absolutely unaware that the agent is acting on behalf of someone else and take him (i.e., the agent) to be the contracting person. iv) Foreign Principal - As the name itself suggests, this is a person who is an alien and appoints an agent (usually a native of the country where he wants to do business) to execute some job for him in his country. Thus, if a Pakistani national appoints an Indian to look after his business interests in India, then such Pakistani national would be deemed to be a foreign principal. Unless otherwise stated, as far as the third parties are concerned, they are entitled to treat the agent as the principal and ignore the existence of a foreign principal. This is because, if a dispute arose, such third party would find it very difficult to file a suit/ enforce a contract against such foreign nationals. Hence, for the sake of convenience, they can file a suit against the agent who can claim an indemnity from his (foreign) principal. 6.2 DOCTRINE OF UNDISCLOSED PRINCIPAL Under law a person is not really required to disclose whether he is acting on his own or on someone else’s behalf. So also, a third party is not required to make inquiries as to whether the person contracting with him is an agent or a principal. The entire doctrine of ‘undisclosed principal’ is thus based on this principle of ‘no need to know or inform’. Thus, any person entering into a contract has to take the risk that the person before
him may in all probability be acting on behalf of an undisclosed principal, and he has contracted not with a person ‘A’ but with some person ‘B’ of whose existence also he was unaware. As the agent in these situations the agent contracts in his own name, he is personally liable on the contract and can sue and be sued in his own name. This raises an interesting question - can a undisclosed principal sue the third party in such cases ? The answer to this lies in the rights available to an undisclosed principal with which we will now deal. (a) Rights of an Undisclosed Principal Though an agent in such cases contracts in his own name, the agent is personally aware of the fact that he is acting on someone else’s behalf, irrespective of the third party’s ignorance of the fact. This existence of agency relation gives the principal the right to interfere at any time of the contract and disclose himself to the third party (section 231). After so disclosing himself, he can continue with the performance of the contract, and can sue or be sued in his own name. But, this right of an undisclosed principal to abruptly take over the reigns from his agent are subject to certain restrictions or qualifications, which we will discuss later. (b) Rights of a Third Party The sudden disclosure of an undisclosed principal may come as a rude shock to the third party, who in all innocence has continued with the contract thinking that the agent was acting on his own behalf. To compensate the third party for any inconvenience which may be caused to him due to such disclosure, sections 231 and 232 provide certain rights to the third party which act as a qualification to an undisclosed principal’s right to disclose himself with a view to participating personally in the concerned transactions. These qualifications are as follows: i)
The third party can claim against the principal the same rights and privileges which he had against the agent. For example, suppose A acting as an agent of an undisclosed principal P, lends Rs.5000/- to T. After some time A borrows for his personal use Rs.1000 from T. Now T has a right of set-off against A i.e., when time to return the loan comes T needs to pay only Rs.4000/- to A instead of Rs.5000/-. If now P discloses himself and compels T to return the money to him instead of to A, T can insist on paying only Rs.4000/- to P i.e., the amount he would have to pay if A was the principal. When such set off is claimed, the principal can recover the deficit amount from his agent but can under no circumstances deny the right of set off to the third party.
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also has the right to avoid the contract if he can conclusively show that he would never have entered into the contract if1) he had known who the principal was; or 2) he had known that the person contracting with him was an agent acting on behalf of someone 3) Once the principal discloses himself, the third party has a right to sue either the principal, or the agent or both of them together. If he opts to sue only one of them (i.e.,
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either the principal or the agent) he is deemed to have waived his right against the other. For application of section 231 and 232, it is essential that the third party actually believes the agent to be the principal i.e., he has no suspicion of the existence of an undisclosed principle. This position is different from the one in England, where mere belief/suspicion of the third party that the agent is the principal is sufficient for him to exercise his rights against the principal.
7. TERMINATION OF AGENCY SUB-TOPICS 7.1. Classification 7.2. Termination by act of parties 7.3. Termination by operation of law 7.4. Effects of termination 7.5. Agent’s duty on termination
7.1 CLASSIFICATION ‘Termination’ as the word implies means ‘coming to an end’. There are various situations under which an agency comes to an end. Some of these situations arise because of the act of the parties and others due to the operation of law. The following flow chart gives a classification at a glance of the various forms of termination of agency. Termination
By act of parties
Revocation
Efflux of time
Death of P or A
By Operation of Law
Renunciation
Insanity of P or A
Agreement
Insolvency of P or A
Performance
Destruction of subject matter
Agency business becoming unlawful
termination of agents authority
Note: P - Principal A - Agent We would now deal with each of these in detail. 7.2 TERMINATION BY ACT OF PARTIES
Limitations on the Right
a) Revocation by Principal
Though the principal has been given a general power of revocation, this right is subject to certain qualifications, i.e., there are certain situations in which an agent’s authority cannot be revoked. These situations are as follows: i) Where authority is partly exercised - When the agent has partly exercised his authority, i.e., he has done some work on behalf of his principal, then his authority cannot be revoked so as to effect obligations incurred through acts already done (section 204). Thus a principal’s right to fully revoke an agent’s authority, exists only so long as the agent has not exercised. Once he has - the principal can revoke the authority only with prospective effect i.e., for acts to be done in future. Such power cannot have a retrospective effect. The reason for this qualification was explained in Read v. Anderson [(1884)13 QBD 779} as, ‘where an agent has incurred a personal liability vis-a-vis third parties, the agency becomes irrevocable, as the principal cannot be permitted to withdraw exposing the agent to the risk of liability incurred’.
‘An authority once given can be revoked at any time’. A principal can revoke the authority of his agent any time he wants by giving an express or implied notice (section 203). Express notice is when the principal either in writing or orally informs the agent ‘that his services will no longer be needed’. Implied notice is when from the conduct of the principal the only logical inference which follows is that ‘he has revoked the authority of the agent’. For example, if a principal appoints a person to look for a tenant for his house, but later lets out the house himself - the authority of the agent is automatically (though impliedly) revoked. Under section 206 the principal/agent (as the case may be) is required to give a reasonable notice of termination, else he would be liable for damages for unjust termination to the other party. Whether a particular notice period is reasonable or not depends on the facts and circumstances of each case, though normally a month’s notice would be deemed sufficient.
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(ii) Agency coupled with interest - If by the terms of the agency agreement, an agent has a personal interest coupled with the agency, then his authority cannot be revoked, unless there is a contract to the contrary (section 202). For example, P owes some money to A. He appoints A as his agent for the purpose of selling his (i.e., P’s) house, and tells him that A can retain the amount due to him from the sale proceeds of the house. Here, P cannot revoke A’s authority. In Smart v. Sanders [(1848)5 C.B. 895] the rule was laid down as, “where an agreement is entered into on a sufficient consideration, whereby an authority is given for the purpose of securing some benefit to the donee of the authority, such an authority is irrevocable.This is what is usually meant by agency coupled with interest.” This section comes into play only when, the interest of the agent existed at the time of creation of agency. In the words of Wilde, C.J., in the Sander’s case “.....This doctrine applies only to cases where the authority is given for the purpose of being a security, or...as a part of the security; not to cases where the authority is given independently, and the interest of the donee of the authority arises afterwards, and incidentally only.” Further, if the basic intention of agency is to secure/recover something for the principal, and the agent’s rights also are incidentally protected through such act, then that agency is revocable. Thus, the mere fact that an agent’s salary or commission is to be paid out of the proceeds of the (agency) transaction, will not make it ‘an agency coupled with interest’. But once it is ascertained that an agency is irrevocable because of this factor, death, insanity or insolvency of the principal cannot effect the irrevocability. b) Renunciation by Agent Just as the principal can revoke an agent’s authority by giving a notice so also the agent can give up his authority by giving a reasonable notice to the principal, except in cases where the agency is itself for a fixed or definite duration. A notice by an agent may be either express or implied. Implied notice is presumed when from the conduct of the agent it is apparent that he no longer wants to continue with the agency, as for example, when he ceases to transact agency business or he sets up an adverse title to that of the principal etc. When an agent renounces his agency he makes himself liable for paying a compensation to the principal if: i. the agency is for a fixed duration, and he ends it prematurely; or ii. the renunciation is without a just and reasonable cause and has resulted in an injury to the principal (section 205); or iii. he fails to give a reasonable notice of his intention to renounce (Section 206). In the following cases he can renounce without incurring any liability, viz: a) the principal expects him to perform an illegal or unlawful act; or b) the conduct of the principal is such that it justifies renunciation; or 236 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
c) the principal refuses to pay remuneration to the agent without a reasonable cause; or d) the principal refuses to indemnify the agent from the consequences of all or any lawful act(s) done by him during the course of agency; or e) the principal makes it difficult or impossible for the agent to continue with his work under the agency agreement. c) Agreement An agency comes into force through an agreement and can be brought to an end by an agreement. If both the principal and the agent agree to end the agency, then the agency will cease to exist from the date of agreement or such other future date on which they may agree upon. d) Performance by the Agent If the agency is for a specific purpose, and the agent has performed the job entrusted to him, the agency comes to an end, as the agent becomes a ‘functus officio’ unless there is a contract to the contrary. In Khil Dhish v. Moolchand [(1969)3 SCC 411] the Supreme Court observed that, whether an agency is terminated or not in a question of fact and has to be determined from the facts and circumstances of each case. 7.3 TERMINATION BY OPERATION OF LAW a) By efflux of time Whenever an agency is for a fixed duration, it comes to an end the moment that duration is over, regardless of whether the agency business has been completed or not. But, under certain cases an agency may continue beyond the specified time period, as for example, in cases where there is a contract to the contrary or there is an agency by holding out etc. b) Death of the parties Unless a contrary intention appears from the circumstances of the particular case, the general rule of law is that on the death of either the agent or the principal the agency comes to an end. If there are joint principals or joint agents, then, death of one of them does not result in the termination of agency, unless there is a contract to the contrary. Unless such an intention clearly appears, death of one of the joint-parties results only in the termination of the agreement so far as the deceased is concerned. Thus, in Bhagirath v. Premchand [17 CLJ 201] it was observed, “If the agency is strictly a joint agency, that is, if it is the intention of the parties that the work of the agency must be done jointly by all the agents acting together and not individually, the work must be done by all of them jointly and consequently upon the death of one of such agents, as the agency can no longer be carried on the manner intended by the parties, it must be presumed to have terminated.” c) Insanity of the parties Where either the principal or the agent become insane, the agency comes to an end as between them, but such termination does not effect the rights and obligations of the third parties,
who remain unaffected by it unless they had notice of the insanity of the principal. Since an agent has the authority to bind the principal in a legal relation, the principal has to be always of a sound mind (as defined in section 12 of the Contract Act) because a person of unsound mind cannot enter into a contract. But by a liberal interpretation of section 184 even an insane person can be an agent but he will not be responsible to the principal for his acts although the principal himself would be bound by such an (insane) agents acts. Hence, it is in the interests of the principal to have as an agent only a person who is a major and of sound mind - and to terminate the agency if the agent becomes of unsound mind. According to Story, ‘there can be no doubt that if the agent is insane, the agency gets a closure for it is the fundamental reliance of the principal on the agent’s skill, intelligence and trust worthiness [Ramchandran, p.342]. d) Insolvency of the parties If the principal is declared an insolvent under the relevant laws the agency is automatically terminated, though formal/routine acts done in completion of a transaction before he became insolvent, can be completed by the agent. Acts done by the agent bona fide and in good faith before he had notice of his principal’s insolvency are valid and for this reason an agent’s authority is deemed to be subsisting till he receives notice. So far as insolvency of an agent is concerned a similar interpretation as above [i.e., as in case of insolvent agent] can be given, but under the English Law, an agency is terminated on an agent’s insolvency. e) Destruction of subject-matter, etc. In case, there is a substantial destruction of the subject matter for which the agency was constituted, the agency would come to an end. For example, if P appoints A to sell his house. The house is totally destroyed in a fire. The agency is terminated. Similarly, if the principal looses his interest in the subject matter in question, the agency is terminated. For example, P appoints A to collect rents from his tenants in his building. Later P sells off the building to T. The agency is terminated. f) Agency business becoming unlawful If after the creation of an agency, a subsequent law or executive order is passed making the relevant business unlawful, the agency comes to an end. For example, a person P in Bangalore, employs A, resident of Hyderabad as a distributor for his liquor company. Due to the prohibition laws in Andhra Pradesh, distribution or sale of liquor is unlawful in that state. The agency automatically comes to an end. g) By termination of agent’s authority If the agent has appointed a sub-agent, then the agency between the agent and sub-agent comes to an end, the moment the primary agency between the principal and agent comes to an end for any of the above reasons.
The 13th Law Commission Report in 1958 (p.66) made the following recommendations regarding the termination of agency, namely: “157. There is conflict of authority on the question as to when the business of the agency of sale of goods is completed i.e. whether on payment to the principal of the price released by the agent, or on completion of the sale and receipt of the price of the agent. The Allahabad and Calcutta High Courts take the former view while the Madras High Court has taken the latter view. We are of opinion that the view of the Madras High Court represents the law correctly and we consider that agency is determined when the agent ceases to represent the principal, though his liability in respect of acts done by him or by his agent continues. Under the English law the agent becomes functus officio on the completion of the contract of sale. That this was the intention of the Legislature appears to us to be clear from the heading of the sub-chapter in which the section occurs which is ‘revocation of authority’. We do not, accordingly, consider any legislative change necessary. 158. This section is not, however, exhaustive of the cases when the authority of an agent is determined and the agency is terminated. The following should also be included in the section as circumstance in which the authority of agent is determined: 1. Destruction of the subject-matter of the agency. 2. The happening of any event rendering the agency unlawful or upon the happening of which it is agreed between the principal and agent that the authority shall determine. 3. Insolvency of agent. 4. Dissolution of the firm, corporation or company where the principal is a firm, corporation or registered company. There are good reasons for providing for termination of agency on the agent becoming an insolvent. The credit in the market of a person who is adjudicated insolvent is affected and in many cases such an agent is not in a position to fulfill the object of the contract of agency. Under the Insolvency Law where a commission agent has sold the goods and realized the money, such money, on his adjudication as insolvent, is not treated as trust money and it goes to the Official Assignee or Receiver. Section 201 - For section 201 of the principal Act, the following shall be substituted, namely:“201 Termination of agency - An agency is terminated a) by the principal revoking his authority; b) by the agent renouncing the business of the agency;..... c) by the business of the agency being completed;..... d) by either the principal or agent dying or becoming of unsound mind;...... e) by either the principal or agent dying or becoming of unsound mind;...... f)
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g) by the destruction of a material part of the subject-matter of the agency; h) by the happening of any event which renders the agency unlawful or upon the happening of which it is agreed between the principal and the agent that the authority shall determine; or i) by dissolution of the principal, where the principal is a firm or a company or other corporation”. The above amendments are salutary but we submit they are not exhaustive yet. We may add the following: j) by impossibility occasioned by: i) death or loss of capacity of the third party with whom the agent has to deal; ii) cessation of principal’s interest in the subject-matter of the agency; iii) by agency being rendered unlawful i) by change of law, ii) by war, iii) by change in status of principal and agent. Agent’s disloyalty may be good reason for revocation but that should be proved. It can be preceded by notice of revocation. If the term of the contract is that the agency shall last till the happening of a contingency, the happening of that contingency will also terminate the agency. This again may be solved by implementing the term of the contract itself. It appears proper to protect the principal and third parties from an insolvent agent’s machinations. Section 201 speaks only of insolvency of the principal. It may be even appropriate if the insolvency of the agent is also included. The recommendations haven’t been legislatively incorporated in the relevant sections, though the judiciary has taken note of these recommendations under suitable circumstances. 7.4 EFFECT OF TERMINATION Once an agent’s authority is revoked, an agency comes to an end, and he can no longer represent his principal in any matter. The question that arises is - when does an termination of agency take effect. Section 208 of the Act provides that, revocation of agent’s authority takes effect as follows: i) Vis-a-vis the agent - Termination is effective, the moment he has a notice of it. The notice may be actual or constructive. Thus for example, an agent is appointed to sell certain goods. The principal sends a letter to him revoking his authority. After the letter is sent but before it is received by the agent, he sells the goods. The sale is binding on the principal, and the agent is entitled to a commission. ii) Vis-a-vis the third parties - Termination is effective with regard to third parties, when they come to know of it. If a
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third party enters into a contract with an agent whose authority has been revoked but which fact is not known to such third party, the contract is binding on the principal. His only recourse in such cases (if he suffers a loss) is to make the agent personally liable. For example, P appoints A to sell his horse but by a later letter revokes the authority. A sells the horse to C despite the second letter. C knowing that A is the agent of P, in good faith pays the money to A, who absconds with the money. The sale is binding on P, who can only recover the money and interest etc., from A. Thus the general rule seems to be that revocation of authority takes effect only when it is brought to the notice of the concerned person (be it the agent or the third party). Acts entered into by such concerned party before notice of such revocation are binding on the principal. As Williston puts it: “In order to free the principal from possible liability to third persons for further acts of the agent, within the apparent continuing scope of his original authority, notice must be given to such third persons either of the remuneration or of revocation in order that the principal may not be bound by the agent in accordance with his continuing power. [Ramachandran, Pp.396-397]. 7.5 AGENT’S DUTY ON TERMINATION Section 209 states that, “when an agency is terminated by the principal dying or becoming of unsound mind, the agent is bound to take, on behalf of the representatives of his late principal, all reasonable steps for the protection and preservation of the interests entrusted to him.” It is clear from this section that an agent’s duty or liability towards his principal does not cease immediately on the death or insanity of his principal. He is still required to take all possible steps to protect the interests of his principal (or in certain cases of his legal representatives). This power of the agent continues till his authority is revoked by the legal heirs of the principal. Section 109 does not create a new agency as such but merely imposes a duty on the agent, But in case of death of the principal, an agent cannot act in any matter not covered under section 209 without a fresh power of attorney, i.e., an agent is only required to take all possible steps for a successful winding up of the business originally entrusted to him but he cannot undertake any fresh work etc., on behalf of such deceased or insane principal unless expressly authorized to do so by the legal representatives of the principal. Since this section only speaks of agent’s duty in case of death or insanity of the principal, by implication it would mean that the provisions of this section will not apply in other kinds of termination, unless the special circumstances of the cases require the agent to wind up the business in hand in the best possible manner.
8. AGENCY PRINCIPLE IN PARTNERSHIP SUB-TOPICS 8.1. Partner as agent 8.2. Binding nature of partner’s authority 8.3. Factum of being partner and burden of proof 8.4. Partner’s authority in trading firm 8.5. Single partner appearing in a suit 8.6. Who may question the act of a partner 8.7. Relation between partners. 8.8 Minor partners 8.1 PARTNER AS AGENT ‘Partnership’ has been defined in sec. 4 of the Indian Partnership Act, 1932, as "the relation between persons who have agreed to share the profits of the business carried on by all or any of them acting for all". From this definition it appears that words “acting for all” have been inserted to emphasize that partners are agents, and not merely principals. One essential element of partnership, as is shown in the definition , is that there should be agency. One partner can always bind another partner in any matter which falls within the scope of the partnership business, subject to any limitation under the Act (eg. sec.20), and if the relationship construed between parties in respect of a particular matter does not expressly or by necessary implication involve the right of one party to pledge the other as an agent, then there is no partnership [Chimanram v. Jayantilal, AIR 1939 Bom 410]. Hence the doctrine of partnership necessarily involves mutual agency between the partners. It is worth noticing that while the relation between the partners are governed by the fundamental norm of good faith, their relations to the outside world are governed by the rules and principles of agency. The law of partnership has often been described as nothing but an extension of the law of agency. A maximum use has been made of this concept in regulating the relations of the partners with persons dealing with them. This is what has been specifically laid down in section 18 of the Act thus : “Subject to the provisions of this Act, a partner is the agent of the firm for the purpose of the business of the firm”. The principle of agency has been enunciated in the section in such general terms that it becomes almost as a natural legal incidence of the very creation of a firm that every partner becomes vested with the position of an agent for the business purposes of the firm. The very act of forming a partnership with certain persons is a declaration to the world that the partners are the agents for implementation of the projected business of the firm. The Calcutta High Court in Chandi Charan Dutt v. Eduljee Cowasji [(1981)8 Cal. 678] after holding that the authority of a partner as an agent of the firm can be terminated in the same manner as that of an ordinary agent, namely, by due notification, observed:
“The law which regulates the liability of the partners for the acts of their co-partners is a branch of the law of agency; and in the absence of any specific rule upon the subject under the head of partnership, we must look to the law of agency for the solution for our present question. Each partner is the agent of his co-partners for the purpose of contracting debts and obligation in the usual course of partnership business.” Thus every partner is an accredited or acknowledged agent of the firm and all other partners. Consequently he binds all the other partners by his acts in all matters which are within the scope and objects of the partnership [V.Perumal v. A. Muhammad, AIR 1958 Ker. 257]. Each individual partner makes the others his agents for the purpose of entering into all contracts for him within the scope of partnership concern, and consequently is liable to the performance of all such contracts in the same manner as if entered into personally by himself. [Fox v. Cliffton (1830) 31 RR 544]. This position of agency is occupied by the partners in reference to the outsiders, but not as between themselves. This is what has been explained in Hoshiar Singh v. Udai Ram Singh (AIR 1929 All. 542). Here: “The plaintiff was one of the several partners in the firm. Two of the members of the firm executed a promissory note in plaintiff’s favour agreeing to pay him a certain amount as being the amount due to the plaintiff on taking partnership accounts. The plaintiff sued not only the executants of the promissory note, but the other partners. The question before the court below was whether the promissory note given by two of the five partners bound the other two defendant partners. The court below has answered the question in the negative and we are of the opinion that the court below was right. The learned council for the plaintiff appellant had taken his stand on section 249, 251, 263, Contract Act (old Act). They do not lay down that one of the partners, as between themselves,can bind another partner where the dealing is not with a third party. The authority which a partner holds on behalf of other partners to deal with third persons is the subject matter of legislation in those sections. “But as between the partners and the outside world (whatever may be their private relations between themselves) every partner is the unlimited agent of every other in everything connected with the partnership.....” While partners are the agents of the firm for business purposes, they are not agents outside there purposes nor of their copartners in any personal and individual capacity. The result, for example, is where payment is made to an acting partner for a sum of money due to the firm, it is a good discharge to the payer. But when payment is made to a partner for a personal debt due to one of his co-partners, it will not be a good discharge 239 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
to the party paying. “Payment to one of two joint creditors is a good discharge of a joint debt. A partner has no implied authority to receive payment of a debt due to a co-partner in individual capacity. {Powell v.Brodhursta, (1901)2 Ch.160]. But a payment to one of several partners is a perfect answer to an action by all; and if one partner sues and recovers the verdict in that action would be a legitimate ground of defence in any subsequent action by the firm for the same demand [Cowan v. Dast, (1848)10 LT 466; Mathura Nath v. Bangeswari Rani, AIR 1928 Cal. 56]. 8.2 BINDING NATURE OF PARTNER’S AUTHORITY The authority which a partner holds on behalf of other partners to deal with third persons is the subject matter of the legislation. So any representation by one of the partners will not bind the other partners. A firm always operates through one or more of its partners. Each partner is the agent of the firm. Therefore each partner has got the authority to do all acts which are necessary for the benefit of the partnership firm, in particular to keep its business running [Sarabhai Hathisingh Firm v. Shah Ratilal Nathalal, AIR 19799 Guj. 110]. The authority of a partner in a mercantile firm to draw and accept bills on behalf of the firm is well recognised. In Banarsee Dass v. Ghulam Hossein [(1869) M.I.A.,358] the principles affecting the matters were stated in the following terms: “Everyone of the partner in a mercantile firm of ordinary trading partnership is liable upon a bill drawn by a partner in the recognised trading name of the firm, for a transaction incident to the business of the firm, although his name does not appear upon the face of the instrument and although he be a sleeping and secret partner”. “In order to take a case out of these principles of the general law, it must be shown that the holder of the bill knew at the time he received it that the transaction was the private affair of a single partner”. A third party who in respect of a private debt of a partner accepts from him any paper of his firm with knowledge that the partner himself is negotiating the same takes it at his own peril and will not be able to hold the firm liable unless he rebuts the prima facie inference or presumption that the proceeding was irregular and unauthorised [Sundredas Sobhraj v. Liberty Pictures, AIR 1956 Bom. 618. If the two partners of a firm are brothers they are equally entitled to participate in the management of the business of that firm and it is in the fitness of things that either of them may at all opportune times attend to the business and, do all that is needful. In Gulam Muhammad v. Sohanmal [AIR 1927 Lah.325] the firm had to realize the decretal debt and it was the business of the firm and of nobody else to realise it. it is obvious that one of the two brothers must have received payment of money rendered by the judgment - debtors, and in doing so no liability was incurred, that is to say, the firm was not placed under any 240 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
obligation. The debt was realized on behalf the firm and if the brothers had not fallen out subsequently, another partner could not have taken any objection to the act of the partner who had received payment of the money on behalf of the firm, appeared in the executing court and certified that he had done so. The executing court having recorded the payment and recognized it the decree stood satisfied. Therefore it was held that he was an agent of his partner. The general rule is that, each partner is an agent only in and for the business of the firm and, therefore, his acts beyond the business will not bind the firm. Lord Justice James said: “as between the partners and the outside world, whatever may be their private arrangements between themselves each partner is the unlimited agent of every other in every matter which is partnership business or which he represents as partnership business and not being in its nature beyond the scope of the partnership." 8.3 FACTUM OF BEING PARTNER AND BURDEN OF PROOF Section 109, Evidence Act provided that when the question is whether persons are partners, landlord and tenant or principal and agent and it had been shown that they have been acting as such, the burden of proving that they do not stand or have ceased to stand each other in these relationships respectively is on the person who affirms it. There is no doubt that in the first instance it is for the plaintiff to prove either (1) that the defendant is partner in the said firm , or (2) that the defendant has been acting as such [Bharat Spinning & Weaving Co. v. Manilal Lallubhai, AIR 1935 P.C. 175 at pp. 179-180]. 8.4 PARTNER’S AUTHORITY IN TRADING FIRM The Privy Council's decision in Bank of Australia v. Breill'at [(1847) Moore, (P.C.) 152] is an authority for the proposition that any partner in a trading firm has an implied authority to borrow money for the purposes of the business on the credit of the firm. But the firm must be a trading firm. A firm would be a trading firm if its business consists in buying and selling. Where, however, the business is not of a commercial nature, e.g. where it is a professional business, or even the business of a farmer, or a quarry worker, where there is no buying and selling of goods, or any auction, no partner can borrow or pledge the partnership property, so as to bind his co-partners. Where a firm is a trading firm, one partner can borrow money for the purpose of the business on the credit of the firm, no duty is cast on the person advancing the money to make any further inquiries. 8.5 SINGLE PARTNER APPEARING IN A SUIT When a firm is sued, the partners appear individually in their own names according to the provisions of Order XXX, rule 6 of Civil Procedure Code and under the provisions, after appearance all steps in the suit must be in the name of the firm. Moreover, it is clear that though the appearance in such
circumstances is individual by each partner, that appearance is an appearance on behalf of the firm. But if a suit is not brought in the name of a firm all partners must be impleaded [Ghisulal v. Gumbhirmull, AIR 1938 Cal. 377; Tikkaram v. Durga Parshad, AIR 1934 Lah. 459]. 8.6 WHO MAY QUESTION THE ACT OF A PARTNER Each partner is an agent of the others. How far a transaction entered into by one partner on behalf of the firm binds the other partners is a question which can properly be raised by other partners. If they by their acts and conduct assent to the transaction the third party who himself enters into the transaction cannot question it. The law must be taken to be as stated in Lindley, on partnership at p.345 that “In an action against a firm.... one partner has no authority to bind the firm by consenting to an order for judgement against it.” The statement suggests that it will apply where the judgement is called in question by the other partners. For example, in Ram Bharose v. Kallu Mal [(1900)22 All 135] it was held that the partner has no authority to bind the firm by a submission to arbitration, and in Ram Niwas v. Diwan Chand [AIR 1931 Lah. 618], the question was raised in a proceedings under Order XXIII, rule 3, C.P.C. in which a compromise said to have been effected on behalf of a firm by one of its partners was repudiated by another partner and it was held that the compromise in order to be lawful within the meaning of Order XXIII, rule 3 must be assented to by all the partners. 8.7 RELATION BETWEEN PARTNERS In Bank of Australia v. Breillat [(1847)6 Moore (P.C.) 152] on the relation between partners it was observed: “Every partner is, in contemplation of law, the general and accredited agent of the partnership, or, as it is sometimes expressed, each partner is praepositus negotiis societatis,
and may, consequently, bind all the other partners by his acts, in all matters which are within the scope and objects of the partnership. Hence, if the partnership be of a general commercial nature, he may pledge or sell the partnership property; he may buy goods on account of the partnership, he may borrow money, contact debts, and pay debts on account of the partnership, he may draw, make, sing , endorse, accept, transfer, negotiate, and procure to be discounted, promissory notes, bills of exchange, cheques and other negotiable paper in the name and on account of the partnership.” The above observation has been followed in the Saremal Punanchand v. Punamchand [AIR 1924 Bom. 260] and was held that a firm would be a trading firm if its business consists of buying and selling and that in a trading firm any partner has an implied authority to borrow money for the purpose of the business on the credit of the firm and the other partners also are liable for the amount so borrowed by him. To sum up, the conception of mutual agency lies at the root of partnership. The law laid down in section 18 of the Act simply states the general proposition that a partner is agent of the firm for purposes of the firm's business, but prefaces it with the words “subject to the provision of the Act”. As observed by Garth, C.J., in Chunder Churn Dutt v. Eduljee [(1882)8 Cal. 678], the law which regulates the liability of partners for the acts of their co-partners is a breach of the law of agency. The partner embraces the character of both a principal and agent. In other words, a partner transacts business for himself as principal, and also as an agent for the other partners even though any of the partners is a sleeping partner. The principle of mutual agency in partnership, therefore, is that if two or more agree that they should carry on, trade, and share the profits of it, each is a principal, and each is an agent for the other, and each is bound by the other’s contract in carrying on the trade, as much as a single principal would be by the act of an agent, who was to give the whole of the profits to his employer.
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9. MINOR PARTNER SUB-TOPICS 9.1. Minor’s Legal Position 9.2. Rights of Minor 9.3. Liabilities of Minor 9.1 MINOR’S LEGAL POSITION Section 30(1) of the Law of Partnership (hereinafter the Act), 1932 reads“A person who is a minor according to the law to which he is subject may not be a partner in a firm, but, with the consent of all the partners for the time being, may be admitted to the benefits of partnership”. This clearly indicates that a person under the age of majority cannot be a partner by contract and he cannot be one of that group of persons called firm. Obviously neither there can be a partnership of minors, as they cannot enter into a contract nor of one adult and all other minors. A minor is incompetent to contract and, therefore, a contract of partnership cannot be entered into with a minor [Lachmi Narain v. Beni Ram, AIR 1931 All 327]. A minor even cannot become a full fledged partner in an existing firm. He is not a partner even if he is so described in the partnership agreement. A partnership deed that tries to make a minor a full fledged partner is invalid to that extent [Income-Tax Commissioner v. Shah Mohandas, AIR 1966 SC 15]. The only concession that section 30(1) gives to the minor is that he may be admitted to the benefits of partnership and that too with the consent of all the partners for the time being. Under this sub-section minor can be admitted to the benefits of partnership if the firm is in existence, as section 4 of the Act specifically lays down that there must be an agreement between two or more adults before a partnership comes into being. The proposition enunciated in section 30(1) that a minor may be admitted to the benefits of a partnership presupposes the existence or coming into existence of a partnership apart from the minor for the simple reason that he cannot enter into a partnership with another and thereby form a partnership. That is why he can be admitted to the benefits of a partnership when there are atleast two major partners who constitute a firm already or are going to form a partnership. To sum up the section applies only where a minor is admitted to the benefits of a subsisting partnership, and is not in terms applicable to a case in which a person is the sole proprietor of a business. So where A and B were partners in equal shares of a confectionery business, B died leaving a minor son. After B’s death, A carried on business under the old name with the partnership funds which be retained in his hands. The minor son alleged that after his father’s death, he be admitted to the benefits of the partnership. It was held that though A was bound to render account of profit of the partnership to the minor son for employing the partnership capital since the death of B, the minor son could not be admitted to the benefits of partnership 242 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
as no partnership existed after B’s death nor could the plaintiff being a minor enter into a contract with A to form partnership [Lachmi Narain v. Beniram , AIR 1931 All. 327]. There must be at least two partners before a minor can be admitted to the benefits of the partnership. [A.A. Khan v. Amer Karium, AIR 1952 Mys. 131]. 9.2
RIGHTS OF MINOR
Section 30(2) of the Act reads: “Such minor has a right to such share of the property and of the profits of the firm as may be agreed upon, and he may have access to and inspect and copy any of the accounts of the firm.” Thus this indicates that when a minor is admitted to the benefits of the partnership, he acquires a quasi contractual right to enjoy benefits. If he has the right, a court of equity would afford him the remedy to enforce the right. He enjoys all the normal rights of a partner, for example, he has a right to his agreed share of profit and property and also access to books of account of the firm and to inspect them and make copies. However his right has been curtailed in two respects. Firstly his rights to have access to books is confined to books of account only. It means that he has no right of access to other books of the firms which do not contain matter of accounts. Account books of a business are in a way public documents for they have to be filed in public offices, like income tax and sales tax departments and therefore they can be shown to minors too. But other books of the firm containing business secrets may not be desirable to trust children with as it cannot be ruled out that they may disclose the business secrets of the firm which may harm the firm. The second curtailment is to be found in the provisions of sub-section (4) which reads : “Such minor may not sue the partners for an account or payment of his share of the property or profits of the firm, save when severing his connection with the firm, and in such case the amount of his share shall be determined by a valuation made as far as possible in accordance with the rules contained in Section 48.” This section contains rules for the final settlement of accounts upon the dissolution of a firm. Thus a minor’s suit for accounts and share is likely to involve acts which are usual to a dissolution. That is why the provisio to the sub section says that either all the partners acting together or any partner who is entitled to dissolve the firm by notice, may elect, upon the minor’s suit to dissolve the firm. The court has then to proceed with the suit as though it were a suit for dissolution and final settlement of accounts between the partners, and the amount of the minor’s share will naturally be determined along with the shares of partners. Thus a minor cannot sue merely for a rendition of accounts. His suit will inevitably involve his severance with the firm and, if the other partners so decide, dissolution of the firm also. But the minor has the right to sue
only for accounts and his share and not for dissolution. Decision in Tulsidas v. Gangaram [AIR 1925 Sund. 272] explains the rationale behind this rule thus: “The Contract Act deals not only with contractual obligations but also with quasi-contractual obligations. Section 68 permits a party supplying necessaries to a minor to enforce his claim against the property of the minor . Sections 247 and 248 [now section 30(1), (3) and (5) of the Act], on the other hand, are intended to provide for the quasi-contractual rights and obbligations of a minor admitted to the benefits of partnership. Section 247 [now 30(1), and (3)] declares that minor may be admitted to the benefits of partnership. When so admitted, he acquires a quasi-contractual right to enjoy such benefit. If he has the right, the court of equity would afford him the remedy to enforce. If an extreme instance be taken, where a scientist seventeen years old is promised a share in a concern which yields considerable profit in consequence of his scientific skill and labour, it is difficult to see how the defendants can avoid liability to account to him for his promised share of the profits on the plea of minority. In passing it may be observed that section 247 [now 30(1) and (3)] refers to the benefits of the partnership and may fairly be interpreted to mean benefits which the minor would have enjoyed by being made a partner if he were sui juris” [Avtar Singh, pp. 290-91]." Where an agreement of partnership provides for arbitration in reference to all the affairs of the firm, including dissolution, the position of a minor under such an agreement was explained by the Allahabad High Court in Satya Narain v. Juggal Kishore [AIR 1958 All 312]. The court said that where the firm is dissolved, as was done in this case, by all the partners acting together, the amount of the share of the minor shall be determined along with the share of the partners. Accordingly, the minor would be as much a necessary party to the arbitration as the partners themselves. Thus, in brief, the rights of minor in a firm under section 30(1), (2), (4) and (8) are : (1) May be admitted to the benefits of partnership with the consent of all the partners for the time being [sec. 30(1)]. (2) Has a right to such share of the property and of the profits of the firm as agreed upon and has a right to inspect and copy any of the accounts of the firm [sec.30(2)]. (3) Has a right, on severance, to sue for accounts [sec.30(4)]. (4) On attaining majority may elect to become partner, and he will be entitled to the share to which he was entitled as a minor [sec. 30(5)] (5) On attaining majority may elect not to become partner, in which case his share is not liable for any acts of the firm done after the date of the public notice that he has elected not to become a partner [sec.30(8)].
9.3 MINOR’S LIABILITIES Liabilities of minor in a firm have been set in section 30(3), (5), (7)(a) and (9) of the Act and these read : 30(3). "Such minor’s share is liable for the acts of the firm but the minor is not personally liable”. 30(5). "At any time within six months of his attaining majority, or of his obtaining knowledge that he had been admitted to the benefits of partnership whichever date is later, such person may give public notice that he has elected to become or that he has elected not to become a partner in the firm and such notice shall determine his position as regards the firm. Provided that if he fails to give such notice, he shall become a partner in the firm on the expiry of the said six months.” 30(7)(a). "Where such person becomes a partner, his rights and liabilities as a minor continue up to the date on which he becomes a partner, but he also became personally liable to third parties for all acts of the firm done since he was admitted to the benefits of partnership, and ...........” 30(9). "Nothing in Sub-section (7) and (8) shall affect the provisions of section 28” [Section 28(1) reads : Any one who by words spoken or written or by conduct represents himself, or knowingly permits himself to be represented, to be a partner in the firm, is liable as a partner in that firm to anyone who has on the faith of any such representation given credit to the firm, whether the person representing himself or represented to be a partner does or does not know that the representation has reached the person to give credit........] Hence the liabilities of the minor in a firm are : (1) May have his share in the firm attached for the acts of the firm [sec.30(3)]. (2) Unless with in six months of his attaining majority he elects not to become a partners, he will be liable as a partner [sec.30(5)]. (3) Where a minor on attaining majority has elected to become a partner, he becomes personally liable to third parties for all acts of the firm done since he was admitted to the benefits of partnership [sec. 30(7)(a)]. (4) After attaining majority, he may be liable for holding himself out as a partner [sec. 30(9)]. Under section 30 of the act, the liabilities of minor can be put into two parts i.e. liability during minority and liability after attaining the age of majority. Thus hereunder we may discuss in detail the liability under both the heads: (1) Liability during minority A person who is under the age of majority cannot become a partner by contract. He cannot, therefore, be one of the group of persons who are called the “firm” as defined by section 4, Indian Partnership act, 1932. He may be admitted to the benefits of a firm but cannot be made personally liable for any obligations of the firm. His share in the property of the firm is liable for the 243 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
obligations of the firm [sec. 30(3)]. The liability of the minor is thus confined to what belongs to him as his share in the profits and property of the firm. Neither is he personally liable, nor is his private property. In this regard Andhra Pradesh High Court in Addepally Nageswara Rao v. C.I.T. [(1971) 79 ITR 306] observes: “In case he contributes capital or is entitled to get benefit in the benefit in the profit of the firm, it is to that extent that liability can be fastened on the minor. But in no case the person of the minor or his other property which he has not brought into the assets of the partnership can be held liable. That is the purport and scope of section 30(3) of the Partnership act.” The basic propositions touching this kind of liability were stated in Sanyasi Charan Mandal v. Asutosh Ghose [(1915) 42 Cal. 225], by the Calcutta High Court. The case arose out of an application to have the partners of a firm adjudicated as insolvents. One out of five brothers, who inherited their father's business was still a minor. The question was whether an infant who has been admitted to the benefits of a partnership could be adjudicated as insolvent and his share seized by the receiver. The court dismissed the arguments that a minor in a firm could be adjudicated insolvent as fallacious : “As regards the infant partner, the creditors of the firm are not entitled to proceed against him personally. They are restricted to a special fund, namely, the interest in the property of the firm. If the value of such interest is not sufficient for the satisfaction of the dues of the creditors, it cannot be maintained that the infant is unable to pay his debts which must be the true foundation of all proceedings in insolvency against him. The remedy of creditors is restricted in its scope, and if that remedy is partial, it cannot be maintained that the person against whom the limited remedy is available is liable to be declared insolvent. Indeed, he may have ample funds other than the partnership assets, though such funds cannot be reached by the creditors of the firm, simply because under the law they cannot hold him personally liable to satisfy the obligation’s of the firm. We are of opinion that the law under the Indian Contract Act does not in this respect differ from the English Law on the subject and that here, as in England, an infant partner of a firm cannot, as much be adjudicated an insolvent”. The court also added that even under Hindu Law an infant, on whose behalf a family trade is carried on, is not personally liable for the debts incurred in such a trade, but his share therein is alone liable. To the same effect, in Jafferali v. Standard Bank of South Africa [(1928) 30 Bom. 762], their Lordships of the Privy Council observed : “The profits of the business were divided among all the six sons. The effect was that in accordance with section 247 (now 30(1) and (3) of the Act) of the Contract Act, which is applicable to Zanzibar, the two sons who were minors were admitted to the benefits of the partnership; and as the result of that admission, while they could not before they came of age be made personally liable for the obligations of the firm yet their shares in the partnership property were liable”. 244 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
The share of the minor which, like that of other partners is liable under section 30(3) means the amount which would fall to his share after all its obligations have been paid off [Sanyasi Charan Mandal v. Krishnadhan Banerjee, (1922)49 Cal.560, at p. 570]. In the case of insolvency of the firm, the whole of the property of the firm including minor’s share in it, will vest in the official assignee. If any part of it has gone to the possession of the minor the assignee has the right to recover from him, because his share is liable under a statutory provision. Liability for Torts As the privilege of infancy is only to be used “as a shield and not a sword”, an infant is always liable for tort. An action arising in contract however cannot be changed into an action in tort to fasten a liability on the infant. The rule is that 'if the tort is directly connected with the contract and is the means of effecting it and is a parcel of the same transaction, the minor is not liable in tort' [Dharma Dass Ghose v.Brahmo Dutt (1898)25 Cal.616]. But where the tort is independent of the contract, the mere fact that a contract is also involved, will not absolve the infant from liability. Thus where an infant borrowed a mare for riding only, he was held liable when he lent her to one of his friends who jumped and killed her [Burnard v. Haggis, (1863) 8 LT 328]. To sum up minor’s liability to compensate the injured party for fraud on him is outside the purview of the law of contract. An infant who is guilty of fraud or misrepresentation as to his age, and who thereby acquires an advantage is liable to return the advantage. (2) Liability after attaining Majority Under section 30(5) minor is given six months time to decide whether he should leave the firm or continue in it by becoming a full fledged partner. This is known as ‘minor’s option', namely, the right to opt out of the firm or become a full fledged member. The six month’s period starts running, either from the date of attaining majority, or from the date on which he acquires knowledge that he had been admitted into the firm as a full fledged partner which ever is later. If he knows of his admission then he has six months from the date of majority. If he does not know of his admission, he has six months from the date of knowledge. Burden lies upon him to show that he did not know of his admission. If he fails to prove that, six months will start running from the date of majority. It is clear that if a minor attaining majority elects to continue as a partner, the partnership does not come to an end, the partnership continues, and the minor having become a partner he is entitled to his profits as computed at the end of the year regulated by the partnership deed. On the other hand if the minor elects not to be a partner, it is equally clear that he severes all his connections with the partnership and he becomes entitled to whatever amount is due to him at the date when he makes the election not to become a partner. Therefore, where as in the first case there is no break, in the continuity of the partnership and there is no need to make up any account otherwise than in the ordinary course, in the latter case there is a break in the partnership and accounts have to be made up as of a particular
date because the minor who has become a major has the right to claim a specific amount as due to him on a particular date. Whatever decision the minor takes, he is required to give public notice of it, and then such notice will determine his position as regards the firm. The proviso to section 30(5) adds that where no public notice is given, he will automatically become a partner in the firm on the expiry of six months. It means that if he wants to stay in the fim he needs to make no public announcement. The lapse of six months’ time without notice puts him by operation of law, into the firm as a partner. Public notice is really needed only when he wants to quit the firm. Or we can say public notice is required to terminate the operation of section 30(5) which makes him partner on the expiry of six months. During the period of six months his position remains the same, namely, that of a minor admitted, to benefits but without any personal liability. Where a suit against the firm, which had a minor partner, was instituted during the period of six months, the minor having not yet exercised his option, Kerala High Curt in Kunchachumma v. Chalapuram Bank [AIR 1958 Kel 318] held that the minor was not personally liable and it was immaterial that by the time the suit was decided, six months option period had already expired. Further, there would be no occasion left for the option to be exercised where, before the expiry of the vital six months, the firm comes to be dissolved. The minor would remain what he was, that is, a partner with his share committed to liability, but no personal liability. This appears from the decision of Supreme Court in Shivagouda Ravji Patil v. Chandrakant [AIR 1965 SC 212], where Subba Rao, J, said : But in the present case the partnership was dissolved before the first respondent became major; from the date of the dissolution of the partnership, the firm ceased to exist though under section 45 of the Act, the partners continued to be liable as such to third parties for the acts done by any of them which would have been the acts of the firm if done before the dissolution until public notice was given of the dissolution. Section 45 proprio vigore applies only to partners of the firm. When the partnership itself was dissolved before the first respondent became a major, it is legally impossible to hold that he had become a partner of the dissolved firm by reason of his inaction after he became
a major within the time prescribed by section 30(5). Section 30 presupposes the existence of partnership....It is implicit on the terms of sub section (5) that the partnership is in existence. A minor after attaining majority cannot elect to become a partner of a firm which has ceased to exist. The notice issued by him also determines his position as regards the firm. Sub-section (7) which describes the rights and liabilities of a person who exercises his option under subsection (5) to become a partner also indicates that he is inducted from that date as a partner of an existing firm with co-equal rights and liabilities along with other partners. The entire scheme of section 30 posits the existence of a firm and negatives any theory of its application to a stage when the firm ceased to exist. One cannot become or remain a partner of a firm that does not exist.” Section 30(7) gives the two effects of the minor becoming a partner. Firstly, his rights and liabilities will remain the same as they were during minority and up to the date on which he becomes a partner, but, in addition, he becomes personally liable for all acts of the firm done since he was first admitted to the benefits of partnership. The effect of the provision is that personal liability commences not from the date of majority, but right from the date of admission to the benefits of the firm. The election to become a partner is, as it were, an automatic ratification by the minor of all the acts of the firm done since his admission. He can get rid of liability for such acts only by electing not to become a partner. Liability under the applications of doctrine of 'holding out' Under section 30, if a minor, after attaining majority, does in fant act as a partner before giving public notice, he will be liable to third parties on the principles of holding out [section 28 of the act}. To be precise the rule is that if a minor after attaining majority represents, or allows others to represent him to third parties to be a partner in a firm, he is responsible as a partner according to section 28 of the Act. The essentials for the application of the doctrine of ‘holding out’ are (1) there must be a representation made or suffered to be made by the person ‘holding out’, (2) it must have been relied on by the other person. it is immaterial whether the person making the representation does or does not know that it has reached the person so giving credit, (3) credit must have been given to the partnership on the faith of representation.
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10. AUTHORITY OF A PARTNER SUB-TOPICS 10.1. Implied authority 10.2. Essentials 10.3. Partner’s authority to bind firm 10.4. No authority 10.1
IMPLIED AUTHORITY
The power of a partner as an agent to represent the firm for its business purposes is called his implied authority, so called because it arises by implication of law as a legal incidence of the formation of a firm and need not be expressly conferred. Section 18 of the Act bestows every partner with the authority of an agent and states only that he is an agent for business purposes. Section 19 goes a step further in the same direction and tries to see what those business purposes could be and thus delimits the authority of a partner more specifically. Section 19 reads as under “(1) Subject to the provisions of section 22, the act of a partner which is done to carry on, in the usual way, business of the kind carried on by the firm, binds the firm. The authority of a partner to bind the firm conferred by this section is called his “implied authority”. Section 19 tries to locate the scope of a partner’s implied authority. It also charges the other partners with liability for the acts of the partners if they fall within the scope of authority. The scope of authority is thus linked with the kind or nature of the business and the usual manner of carrying it on. In the words of [Pollock, p. 31] : “The acts of a partner done in the name of a firm will not find the firm merely because they are convenient or prudent, or even necessary for the particular occasion. The question is what is necessary for the usual conduct of the partnership business; that is the limit of each partner’s general authority; he is the general agent of the firm, but he is not more.” 10.2
ESSENTIALS
member of the firm will not bind the firm. The cases of Saville v. Robertson [(1792) 100 ER 1264] and Gouthwaite v. Duckworth [(1810) 104 ER 174] furnish illustrations of this principle. In both these cases goods were ordered by a person who had agreed to become a partner, and were in fact supplied and used for the partnership adventure. But as the order was given before the partnership was formed, no liability could be fixed on the other partners. 2. The act must have been done on behalf of the firm and not on the partner’s own behalf. 3. The act must relate to a matter which is within the scope of the business of the firm. If the matter is outside the business of the firm, it must be proved either (i) that the particular transaction had been authorised, or (ii) that the other partners subsequently ratified it. 4. The act must be done in the firm name. 5. The act must be done to carryon the business in the usual way. On this point, the observations of Lindley on partnership, [p.176] are worth quoting “The question whether a given act can or cannot be said to be done in carrying on a business in the way in which it is usually carried on must evidently be determined by the nature of the business and by the practice of persons engaged in it. Evidence on both these points is therefore readily available....An act which is common in the prosecution of one kind of business in the ordinary way may not be required for carrying on an other business of a different character. Consequently no answer of any value can be given to the abstract question - can one partner bind his firm by such and such act unless, having regard to what is usual in business, it can be predicted of the act in question either that it is one without which no business can be carried on or that it is one which is not necessary for carrying on any business whatever”.
Under section 19(1), in order that a partner’s acts may bind the firm, the following conditions must be satisfied :
10. 3
1. The act must have been done by the partner in his capacity as partner. A member of a firm must enter into a contract with a third party, in relation to a matter which is both within the scope of the partnership business, and within the scope of his actual or implied authority in his character of a partner in order to bind the firm. In case he enters into contract as principal and not as an agent for the firm, in such a case his act would not bind the firm. As observed by Scrutton,L.J. in Underwood v. Bank of Liverpool [(1924) 1 KB 775], “In my view, you cannot rely on the apparent authority of an agent who did not profess in dealing with you to act as agent”. Thus an act done by a partner before he becomes a
The power to do usual acts is called the ‘implied authority’. The implied authority here referred to is one enabling the partner to do certain acts with third parties. In this connection, one great distinction has been drawn by courts between trading and non trading firms, the decisions holding that in the former a partner has a greater extent of right than in the latter. A trading firm has been held to be one whose principal business is that of buying and selling [Higgins v. Beauchamp, (1914)3 K.B. 1192 at p. 1195]. In the latter class of cases it has been held in England that, unless there is usage in the particular trade allowing a partner to draw, accept, make or endorse promissory notes or bills of exchange in the firm name, a partner has no such authority. The following kinds of firms have been held to be
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PARTNER’S AUTHORITY TO BIND FIRM
non-trading firms for this purpose viz. (i) solicitors; (ii) farmers; (iii) mining adventures; (iv) quarry workers; (v) auctioneers; (vi) commission agents; (vii) cinema firms. Even in this class a partner may have all or some of the implied authorities which a partners in a trading firm has, so far as they are necessary or incidental to the main purpose of the firm [Nicholson v. Rickeets, (1860)2 E &E 497]. The position is not different in India. Broadly we may discuss the implied authority of the partner as under : In an ordinary partnership, every partner has the authority to bind the firm by any of the following acts : (1) Authority to purchase and sell Every partner of an ordinary trading partnership has the implied authority to purchase on the credit of the firm goods necessary for carrying on its business in the usual way [Hyatt v. Hare, (1698)90 ER 543]. The case of Bond v. Gibson [(1808) 170 ER 923], in which one member of a partnership of harnessmakers bought a number of bits on the credit of the firm, but pawned them for his private use, and the firm was held liable, is an example of this. This authority to purchase on the credit of the firm is available in case of non trading firms. Likewise any partner is authorised to sell any of the partnership goods [Lambert's case, (1614) 78ER 142]. (2) Power to recover money due to firm Payment of debt to one partner is good as against the other partners. But at the same time it must be noted that a set off of a private debt due from a partner against a debt due to the firm is not valid. Nor can a partner accept in payment of a debt due to the firm, shares in a company, even if fully paid up. [Niemann v. Niemann, (1880)43 Ch.D. 198]. It is within the authority of a partner to release and give a valid receipt for a debt due to the firm, provided there is no fraud on the other partners. This authority extends even after dissolution [Diwan Chand v. Ram Dass, AIR 1931 Lah. 270]. And in the absence of collusion between the partner and the debtor such release will be valid and binding. Similarly a partner can settle an account between the firm and a third person. He may also strike balances in the firm account. [Ram Rattan v. Sobha Ram AIR 1929 Lak. 512]. Similarly he can assign a debt due to the firm [Exparte Wright, (1906)2 KB 209]. (3) Authority to engage servants and lawyers A partner may engage servants for the purposes of the business. The power to appoint includes the power to remove and, therefore, removing a servant in accordance with business exigencies is also within implied authority, though a single partner cannot dismiss a servant against the wishes of the other partners. Partner has also the implied authority to engage lawyers to defend actions against the firm.
(4) Authority to insure firm goods A partner has an implied authority to insure the firm's goods and also goods entrusted to the firm [Hooper v. Luspy, (1814)171 ER 22]. In the case of partnership of a general, commercial or trading nature, any partner may bind the firm by any of the following acts : (a) Borrow money on the credit of the firm The sudden exigencies of commerce render it absolutely necessary that a power to borrow should exist in the members of a trading partnership. This power was recognised as early as in 1692 in Lane v..Williams, [(1692) 23 ER 779] in a English case. But it exists only where the business is of such a kind that it cannot be carried on in the usual way without such a power i.e. the partnership should be a trading partnership. In Higgins v. Beauchamp [(1914) 3 KR 1992], it has been pointed out that a trading business is one which involves the buying and selling of goods, and that it will be too much to say that every business which necessarily involves the expenditure of money is a trading business. In this case A and B were carrying on the business of cinematographic theatre proprietors in partnership. A was a sleeping partner and B managed the business. The partnership deed provided that no partner should contract any debt on account of the partnership without the consent of the other partner except in the usual and regular course of business. B borrowed money from the plaintiff stating that the money was to be used for the partnership business. But he misappropriated it. The lender sued A. He was held to be not liable. Where however, money has been borrowed by a partner without authority, but has been applied to the legitimate business needs of the firm, the firm would become bound by the act of the partner though without authority. The scope of the implied authority of a partner in a business of trading nature has been summed up by Story thus : “If the partnership be of a general commercial nature, he may pledge or sell the partnership property, he may buy goods on accounts of the partnership, he may borrow money, contract debts and pay debts on account of the partnership, he may draw, make, sign, endorse, accept, transfer, negotiate and procure to be discounted, promissory notes, bills of exchange, cheques and other negotiable papers in the name and on account of the partnership. Hence in Bank of Bengal v. Ramanathan Chetty [(1915) 43 Cal. 527], in the case of a money lending firm, authority to borrow was held to be implied. Likewise in Kani Ravutar v. Somasundaram [(1908) 31 Mad. 206], it was held that a managing partner has power of borrowing as incidental to the power of trade. In brief, a trading firm had been held in Higgins case, to be one whose principal business is that of buying and selling. Thus it is obvious that a partner in a trading firm has the implied authority to borrow money on behalf of the firm and no duty is 247 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
cast on the person advancing the money to make any further enquiries and the other partners are liable though the borrowing partner may misappropriate the money. (b) Acknowledgement of debt In the case of a mercantile firm, each partner is as if entrusted by his copartners with general authority to do any act necessary for, or usually done, in carrying on the business of such partnership, a partner’s authority extends to making an acknowledgement of debt so as to bind his partners. So in a running mercantile firm an acknowledgement by one partner would ordinarily bind the other, specially where no circumstances have been shown to the contrary. Hence in the case of mercantile firm, it is presumed that a partner who has the implied authority to borrow will also have the authority to acknowledge liability of the firm. In Ganda Singh v. Bhag Singh Bhagwan Singh [AIR 1926 Lah. 616] it was held that in a going mercantile concern a partner has an implied authority to make an acknowledgement on behalf of the other partners and this is sufficient to save limitation in spite of the provisions of section 20 of the Limitation Act, 1963. In case one of the partners was through out acting on behalf of the firm and made acknowledgements from time to time the acknowledgement by him is sufficient to save limitation. [Gulsaran Das v. Brij Mohan [AIR 1939 Lah. 397 at pp. 397-98]. Similarly in Kuljav Ram v. Wishan Singh [AIR 1932 Lah. 456], where a father and his three sons carried on business as partners and contracted debts for the purpose of business. One of the sons signed an acknowledgement in favour of the creditor for the amount due from his firm. The creditor’s suit would have been barred by time but for the acknowledgement so made. It was held that acknowledgement by the partner would ordinarily bind the others i.e. firm. In Chegamull Suganmull Sowear v. Govindaswami Chetty [AIR 1928 Mad. 972 at p. 975], it has been held that an acknowledgement of a payment by a partner without special authority is binding upon the other partner. Under section 20 of the Limitation Act, a partner ipso facto has no authority to acknowledge or to make a part payment; but if he has general authority to contract debts or make payments he has implied authority to keep the debt alive and it is unnecessary to make out special authority. But where an acknowledgement is made after the firm has ceased to be a going concern would not be affective against the other partners. In Prem Ji Ludha v. Dossa Doongersey [(1886) 10 Bom 358] defendants firm had traded in rice, but at the end of a particular year all active business was stopped, and since that time the partners had been engaged in recovering outstandings and in winding up the affairs of the firm. In the cause of the winding up it became necessary to raise money to meet liabilities, and the suit was brought to recover these moneys, the original loan being time barred, but the bar of limitation being sought to be avoided by an acknowledgement signed by one of the partners within three years of the date of suit. Scott, J held that as the firm had stopped all trading, the business being closed and the partnership at an end for trading purposes, the agency which would be presumed as any ordinary 248 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
rule in a going mercantile concern, did not, exist, and that thus it was necessary to show that in point of fact the partner who signed the acknowledgement was authorised by the other partners to do so. In such cases public notice about dissolutions is necessary. Thus we can say desolution does not bind the old customers until they have the notice and, consequently an acknowledgement made after dissolution and before notice binds the firm. The principle has been applied in number of cases where interest on a loan of the firm had been paid by a partner after the date of dissolution, but before the creditors had notice of it and that was held to be sufficient to extend the period of limitation [Mahadeva Aiyar v. Ramakrishna Reddiar, (1926)30 Mad LJ 67; see also Lalta Prasad v. Balik Prasad, (1910)32 All 51]. (c) Authority to bind by negotiable instruments In the case of partnership of a general, commercial or trading nature, a partner may accept, make and issue bills and other negotiable instruments in the name of the firm. In trading firms every partner has implied authority to bind the firm if there is no agreement to the contrary. However a non trading firm is not bound unless the issue of negotiable instruments by one partner is shown to be necessary or usual in the particular business. In the case of non-trading firm, the implied authority to bind his co-partners depends on the nature of the business of the partners. When a negotiable instrument is regularly drawn by a partner in a trading firm in a transaction incident to the firm’s business, another partner is not the less liable because his name does not appear on the face of the instrument [See Bunarsee Das v. Gholam Hoosein, (1870)13 MIA 358; Chandanlal v. Aurinchand, AIR 1960 Punj. 500; Raghavaveera Sons v. Padmarah, AIR 1978 Mad. 81]. As said earlier, every member of an ordinary trading partnership has implied authority to bind the firm by drawing, accepting or endorsing bills of exchange or by making and endorsing promissory notes in its name and for the purpose of the firm in the ordinary course of business. The liability of the firm on negotiable instruments made by a partner is founded on the principle of agency, and the test to be applied as to the binding character is, as has been well put, the apparent authority of the partner then the actual necessity of the firm. So, a bona fide holder for value, without knowledge of any infirmity, can exercise in full all rights under the instrument. In a Privy Council case, Motilal Monucha v. Unao Commercial Bank [(1930) 59 MLJ 661 (PC)], it was held that in a mercantile trading firm a partner has implied authority to draw and accept bills of exchange or hundis on behalf of the firm and that such authority will be negative only on proof that the holder of the bill knew that it was a private affair of the partner. For the liability of the firm thus the rule is that a bill of exchange or a promissory note will not be binding on a firm unless the name of the firm or names of all its members appear on the instrument. Even where the executant describes himself in the body of the pronote and while signing it as a partner of another, yet the partner would not be liable. Lord Buckmaster, expressed
his views in this regard in Sedasukh Janki Das v. Kishan Pershad [461 A 33 (PC)] thus : “It is not sufficient that the principal’s name should in some way be disclosed; it must be disclosed in such a way that on any fair interpretation of the instrument his name is the real name of the person liable upon the bill.” Where the contract is made by the partnership but the promissory note is signed by a partner in his own name, and not in the name of the partnership, nevertheless, the other partners will be liable. But the partnership would not be liable for a loan by a partner in his personal capacity, though the partnership may have had the benefit of it [Ramchandra v. Kasemkhan, AIR 1925 Cal. 29]. It has been held that where a partner executes a promissory note in his individual capacity and not on behalf of the firm, he alone will be liable on the note. But where one partner borrows money on any promissory note executed by him alone but the money is borrowed for the partnership business, and is used in such business, all the partners will be liable for the debt [Mahendra Chandra v. Labanya Kumar, AIR 1934 Cal. 755]. (d) Authority to pledge and mortgage It was held that a power to pledge or mortgage partnership property is incidental to a authority to borrow for partnership purposes [General Auction Estate etc. v. Sumith (1891) 3 Ch. 432]. The implied authority to pledge is also extended to pledges for antecedent debts. But at the same time it is worth mentioning that a partner having implied authority to pledge or mortgage the properties of the firm must necessarily have the concomitant right of redeeming the same on behalf of the firm [Harper v. Godsell, (1870)5 QB 422]. (e) Authority to hire A partner has the implied authority to hire on the credit of the firm any goods of a kind used in business. A partner hired an elephant to trap wild elephants and one of the terms was that the hirer should pay Rs.5000, if the elephant died during the period of hire. The elephant died and the other partners denied all knowledge about the transaction. Even so it was held that the other partners were bound by that term [Mathura Nath v. Sreejukta Begeshwari, AIR 1928 Cal. 57]. 10.4 NO AUTHORITY Section 19(2) imposes certain restrictions upon the scope of a partner’s implied authority. They are statutory restrictions and are distinguishable from those which can be imposed under section 20 by an agreement of the partners. Statutory restrictions are binding upon all persons dealing with partnership firms. They cannot say that they were not aware of them. It is their duty to know and ignorance is no excuse. For example, one of the restrictions envisaged by the sub section (g) is that a partner cannot transfer any immovable property of the firm. A person who contracts to purchase such property of a partnership firm from a single partner and without the concurrence of his copartners, gets no right over the property. On the other hand where the implied authority is restricted by an agreement of the
partners u/s 20, the restrictions will be ineffective as against a person who contracted with a partner without knowledge of the restriction. Here we may discuss section 19(2) of the Act which reads: “In the absence of any usage or custom of trade to the contrary, the implied authority of a partner does not empower him to (a) submit a dispute relating to the business of the firm to arbitration, (b) open a banking account on behalf of the firm in his own name, (c) compromise or relinquise any claim or portion of a claim by the firm, (d) withdraw a suit or proceeding filed on behalf of the firm, (e) admit any liability in a suit or proceeding against the firm, (f) acquire immovable property on behalf of the firm, (g) transfer immovable property belonging to the firm, or (h) enter into partnership on behalf of the firm. All the above restrictions are subject to the “custom or usage of the trade”. The term “usage of trade” is to be understood as referring to a particular usage to be established by evidence [see section 92(5) of the Indian Evidence Act, 1872]. To prove such a usage, there need not be either the antiquity, the uniformity, or the notoriety of custom in its technical sense; usage may still be in course of growth, and may require evidence for its support in each case. [Jagmohan Ghose v. Manickchand, (1859)7 MIA 263]. “Custom of trade” refers to a general custom of merchants which has been ratified by decision of courts and adopted as settled law [Pathak, p.171]. To be precise the usage or custom in question should be so much an established part of the routine of a business, that it can reasonably be supposed to be within the knowledge of persons carrying on business in that trade. Where the action of a partner falls within the forbidden categories, it does not bind his copartners. But they can take the advantage of the action by ratifying it. For every principal has the power to ratify the unauthorised acts of his agent. One thing must be noted that the restrictions have been imposed for the benefit of and in the interests of the partners and no absolute legal bar has been imposed by the law against the partners in acting contrary to the provisions of sub-section (2) and it is certainly open to the partners to relax or waive the restrictions [S.N. Soni v. Taufiq Farouk, AIR 1976 Delhi 63]. Hence we may discuss in brief the prohibitions laid down in section 19(2) on the implied authority of the partner. Reference to arbitration [sec. 19(2)(a)] One partner has no implied authority to bind his copartners to a submission to arbitration respecting the matters of the partnership. Submission to arbitration by a partner can bind the copartners only upon proof that they have authorised it before hand or have subsequently adopted or ratified it. This has been explained by the Allahabad High Court, in R.B. Thakur v. Thakur Das [AIR 1958 All 522] thus : 249 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
“Partners will only be bound by a submission to arbitration upon proof that they have either expressly authorised it before hand, or have subsequently adopted and ratified it, or unless upon the terms of the submission it can be implied that the arbitration was within the normal scope of the trade or business of the partnership. Such authorisation need not be in writing or otherwise formal, but it must be actual and the authority will only extend to matters to which it relates and will not be construed to covering other questions. In the present case the other partners did not come forward before the court at any stage to repudiate submission that had been made by Kundan Dass (partner) in his application under section 34 of the Arbitration Act. It will therefore be construed that they by their act or conduct or atleast by their acquiscnce have ratified the act of Kundan Dass.....”
not an obvious error in a bill or other document made out on behalf of the firm by its servants or partners. One partner can release a partnership liability is well established [Bishwanath v. Jagannath, AIR 1956 All 11]. The relinquishment by the defendant of his claim would undoubtedly form good consideration for the withdrawal of their claim by the plaintiff.
It has however been held that a submission to arbitration though signed only by a managing member of a partnership firm is valid [Bishamhar v. Ganga, AIR 1923 Lah. 212] and that the special authority to refer to arbitration may be either express or implied from the circumstances of the case.
Therefore it is not possible to laydown a rule which will generally empower all partners to bind the other members of the partnership by a compromise or a rule to prohibit all partners from so binding their fellow partners. The question as the courts take it is in each case whether the act done by a partner is one which is usual or necessary for the business of the partnership, it would be held that actually litigating and managing partners have authority to bind the other partners by settlement.[Mangal Sen v. Firm of Bhagwandas parmanand, AIR 1925 Sind 61]. A partner cannot compromise a claim unless express authority has been given [Chainraj Ramchand v. Narayanaswamy, AIR 1982 Mad. 326].
Opening of Bank Account [S.19(2)(b)]
Withdraw a suit [sec. 19(2)(d)]
A partner under this clause cannot open a account in the bank in his own name. This clause owes its origin to the declaration in Alliance Bank Ltd. v. Keavsley [(1871) 6 CP 433] that in the absence of evidence of usage, a partner has no implied authority by law to bind his copartner by a bank account opened by him in his own separate name, instead of in the name of the firm, although such account be for the purposes of the firm. Where the account is in the firm name, one partner has implied authority to bind the firm by cheques drawn on the bankers of the firm in the partnership name [Laws v. Rand, (1857)140 ER 812]
It would be unreasonable to say that a partner cannot compromise a claim by the firm but that he can withdraw a suit. It is the accepted law that a partner has no implied authority to withdraw a suit filed on behalf of the firm. Where proceedings are launched by a partnership firm, it is quite natural that no single partner can reserve to himself the liberty to nullify such serious act of the firm. Proceedings started by the firm can be withdrawn only with the authority of all the partners or according to the custom or usage of a particular trade. Where a clause in the deed of partnership provides that in all matters majority opinion shall prevail, there a majority can, in good faith, withdraw a suit [House Ltd Agency v. Panits & Lecquess Ltd., AIR 1954 Cal.409].
Compromise or relinquish any claim or portion of a claim [sec.19(2)(c)] An authority to give discharge for debt on payment, does not include power to compromise or settle in any way a partner likes. Similarly acknowledgement of the liability of firm in respect of subsisting debt made by a partner on behalf of the firm cannot amount to compromising or relinquishment a claim or a portion thereof [Sarabhai Hathi Singh v. Shah Ratilal Nathalal, AIR 1979 Guj. 110]. In the ordinary course of business where a firm deals in purchase or sale of goods according to orders of its customers and the goods supply happen to be of an inferior quality or short in weight and the mistake is pointed out by the customer, the partner who is dealing with the matter must necessarily have the power of correcting the mistakes, otherwise the day-to-day business of the firm cannot be carried on. The case contemplated in S.19(2)(c) is a case of a claim made by the firm which was due and realizable by the firm from the debtor. Where a certain amount is validly due to the firm, one partner has no implied authority, unless there is custom or usage to the contrary, to relinquish a portion of that claim by compromise or otherwise. The claim here referred to is a claim which is lawfully due and 250 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
Admit liability against the firm [sec.19(2)(e) The implied authority of a partner does not empower him inter alia to admit any liability in a suit or proceeding against the firm. Similarly acknowledgement of the liability of the firm in respect of subsisting debt made by a partner on behalf of the firm does not amount to admission of any liability in a suit or proceeding as against the firm. [Sarabhai v. Shah Ratilal Share Broker, (1979)20 Guj 484 at p. 489]. Clause (e) ows its origin to the declaration in Hambridge v. Dc. La crouce[(1846)3 CB 742] that one partner has no implied authority to consent to an order for a judgement in an action against himself and his co-partners. Acquisition of immovable property [sec.19(2)(f)] Under this sub-clause (f) one partner has no authority to acquire immovable property on behalf of the firm in the absence of any usage or custom to the contrary, possibly because the liquid capital of the firm will get locked up in permanent immovable property which is not always easily capable of being converted into money, whenever necessary. But if the fim is formed for the purpose of acquiring immovable property with a view to
selling it later on small or big lots, it may be necessary to vest a partner with such a power. Generally, in such cases, such a power would be contained in the articles themselves; if not a partner can have such power according to the section only by usage or custom of the trade. Transfer of immovable property of the firm [sec.19(2)(g)] No partner has authority by himself to transfer any immovable property belonging to the firm under this sub-clause (g). The transfer may be of any kind whether it be by way of sale, mortgage, lease or gift, all fall within the scope of the clause. Such transaction affecting the immovable property of the firm can be made either with the prior authority of all the co-partners or by their conduct of subsequent ratification. Partnership on behalf of the firm [sec.19(2)(h)]
knowledge of all the partners. A partner without the knowledge and consent of his other partners cannot on behalf of the firm enter into a contract with himself. Partners may in any particular case may permit this to be done or acquiesce in it. It is a totally different matter, whenever a partnership is entered into, it is to be deemed that the partnership was entered into between the individual members of the firms as it is the definite policy of the law to validate if possible, the accomplished fact. [Ghisulal v. Smt. Abhey Kanwar, AIR 1956 Ajmer] At the same time it is worth noticing that engaging the firm in a single transaction with another person with a view to sharing its profits is something different from entering into partnership. This was pointed out in Man v. Darey [(1968)1 WLR 893 which has been discussed earlier].
Partnership firms can and at times do enter into contracts with one of the partners but this can may be with the consent and
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11. RIGHTS & LIABILITIES OF PARTNERS SUB TOPICS 11.1
Rights of partners
11.2
Liabilities of Partners
11.1
RIGHTS OF PARTNERS
Mutual rights and liabilities of partners depend upon the provisions of their agreement,the law confers the following rights upon all partners : 1. Right to take part in business [sec.12(a)] Lord Eldon observed in Peacock v. Peacock [(1809) 170 ER 1076] that “good faith of the partners is pledged mutually to each other that business shall be conducted with their actual personal interposition so that each may see that the other is conveying on for their mutual advantage”. This is the basic principal underlying section 12(a) of the Act which confers the right to take part in the management of the business in each partner thus “Every partner has the right to take part in the conduct of business of the firm”. The privilege of participation must be used for promoting the interest of the firm and not for damaging it. In Suresh Kumar v. Amrit Kumar [AIR 1982 Del.131}, Delhi High Court issued an injunction against a partner, who in order only to undermine the position of the Managing partner, wrote to the principals of the firm not to supply motor vehicles and to bankers not to honour cheques. But since the provisions of section 12 operate only subject to an agreement between the partners, it is open to partners to agree that one or more of them shall not participate in the management of the firm. When there is an agreement of this kind, the partners excluded from management cannot complain of it. They are not competent to say that important decisions concerning the business were taken without consulting them. Partnership agreements usually provide for the execution of the right to take part in the management of the business in the case of some partners. In the absence of any agreement if one partner excludes another unjustly from management, the former can be restrained by injunction. 2. Right to express opinion [sec.12(c)] Under section 12(a) every partner has a right to take part in the conduct of the business and it is only where difference arises as to ordinary matters concerning the business of the firm that the same has to be decided by majority of partners under section 12(c) of the act which reads “any difference arising as to ordinary matters connected with the business may be decided by a majority of the partners, and every partner shall have the right to express his opinion before the matter is decided, but no change be made in the nature of the business without the consent of all the partners.” 252 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
However, this statutory scheme is alterable by agreement. Partnership articles may stipulate that all matters whether fundamental or ordinary shall be decided by majority opinion or that they may require the consent of all the partners. Where all matters are left at the disposal of majority, the majority becomes all powerful with in the organisation of partnership. Under section 12(c) distinction must be made between ordinary matters connected with the business and special matters affecting the nature of business. Where difference of opinion arise in regard to ordinary matters, e.g. taking an apprentice or appointment or dismissal of servants, the verdict of the majority will prevail, provided that every partner is previously consulted before the final decision is made and the decision of the majority is arrived at bonafide. ‘In the absence of such consultation, the act of the majority will be invalid. As Lord Eldon said in Const v. Harris [(1824)24 RR 108] : “For a majority of partners to say, we do not care what one partner may say; we being the majority, will do what we please is what a court of equity will not allow” Again, where powers are conferred on a majority present at a meeting of not less than a certain number, unless such meeting is duly convened, and the required number be present, the power cannot be exercised, for there is no majority as contemplated [Suresh Kumar v. Amrit Kumar, AIR 1982 Del 131]. Where in respect of such matters, the partners are equally divided, those who forbid a change will have the say in consonance with the maxim un re communi potior est conditio prohibentis. For example, where one of the two partners had regularly given a week’s notice to a servant to leave the service, but the other authorised him to continue, the latter opinion would prevail. Dismissal of a servant required a partnership decision and partners being equally divided one who opposed removal had his way [Donaldson v. Williams, (1883) 147 ER 432]. As to a matter of fundamental nature the most important among them being the ‘nature of business’, it has all along been held that no new business can be undertaken against the will of even a single partner. The profitability of the new business is not material or relevant factor. But where difference of opinion relates to a matter of fundamental importance, consent of all partners becomes necessary. Fundamental matters include the question of any alteration of, or addition to, the business of the firm and the admission of a new partner. As said earlier the partnership deed may, however, provide that in all matters majority opinion shall prevail. The manner in which majority power should be exercised was explained in Blisset v. Daniel [(1853)90 RR 454]. The plaintiff was working in partnership with certain persons. It was proposed to appoint one of the partner’s son as a co-manager of the firm. The plaintiff objected. The aggrieved father complained to his partners behind the back of the plaintiff and persuaded them to sign and serve upon the plaintiff a notice of expulsion. This was done in the exercise of a power which authorised a majority to expel any partner without
giving any reason. The plaintiff contested the validity of the expulsion and it was set aside. The court pointed out that powers are given to the majority so that in case of need they may be exercised in good faith for the benefit of the firm, it is no doubt for the partners to decide what is in the interest of the firm but they must do so in good faith. Majority powers should not be used for base or unworthy purposes or merely to injure a copartner [Avtar Singh, p.491]. 3. Right to access to books [sec. 12(d)] Section 12(d) provides the right to all partners to inspect and copy the books of the firm thus “Every partner has a right to have access to and to inspect and copy any of the books of the firm”. Every person may either in person or through an unobjectionable agent inspect and copy the books of the firm. Where the inspection is conducted by an agent he may be made to give an undertaking to that effect. The inspection can be made, whatever be the motive, but not for an improper measure [Trego v. Hunt, (1896) AC 7; Deavan v. Webb, (1901)2 CH 39]. Thus all books, accounts and papers of the firm are accessible to all partners or their legal representatives as a matter of right. Even the legal representatives of partners have that right as this right to access the books of the firm, continues even after dissolution of the firm. In this regard the findings in the case Re Martindale ex p. Truman [(1832)1 Dcac & Ch 464] are worth noticing. Ten years after a firm had been dissolved and accounts settled with books left in the custody of a partner, a former partner became bankrupt and the bankruptcy commissioner called for the books to examine the former dealings of the bankrupt. The suit was resisted on the ground that the partner concerned had himself never called for the books for a whole decade. It was held that in respect of the books both partners continued as tenants in common and the length of time did not affect that relationship. Furthermore there is no restriction upon the number of times that a partner can examine books etc. He cannot be told that he should see them only once in a year. At the same time a partner will be bound by an agreement to accept as correct the balance sheet prepared by the other partners. But where an agreement made on dissolution is based on a false account, it may be set aside [Chandler v. Dorsett, (1970)23 ER 225]. An assignee of partner’s share has no right during the continuance of the partnership, to require any accounts of the partnership transaction or to inspect the books of accounts [S.29]. In Goa Petha v. N.H. Moss [(1931)10 Pat 792], the Patna High Court held that the assignee or mortgagee of a partner’s share is not entitled to accounts of the partnership transactions before dissolution or interfere in any way with the management or administration of the partners. A minor who has been admitted to the benefits of the firm has a right to examine the books of account, but not other papers or books. Perhaps the legislation did not think it proper that a minor should come to know any of the business secrets of the firm. He may not be able to digest or retain them.
The right to inspect books/papers, however, does not include the right to carry them without the consent of the other partners, to any other place [Floydd v. Cheney, (1970) Ch. 602]. 4. Right to remuneration [sec. 13(a)] A partner is entitled to nothing extra for any inequality of services rendered by him as compared with that rendered by his co-partners. Unequal services are presumed to have been rendered without expectation of reward. This conclusion flows from the principle that as each partner is clothed with all the powers of the firm, each is burdened with all the duties of it. But this general rule denying any remuneration to a partner for services rendered by him to the partnership firm does not prevail when there is agreement for such compensation. This compensation may be express or fairly implied from the acts of the partners or from the course of business between them, or from the circumstances under which extra services are rendered by a partner for which compensation is claimed. To this right of the partner, the legal position has been summarized in the following passage of Lindley’s Treatise of Partnership, at p.480 thus : “Under the ordinary circumstances the contract of partnership excludes any implied contract for payment of services rendered for the firm by any of its members. Consequently in the absence of an agreement to that effect, one partner cannot charge his co-partners with any sum for compensation, whether in the shape of salary, commission, or otherwise, on account of his own trouble in conducting the partnership business”. The principle propounded above has received statutory recognition in India under section 13(a) of the Act, which makes it clear that if the contract so provides, a partner may receive compensation for taking part in the conduct of the partnership business. Indeed a stipulation that an active partner shall receive a fixed salary is by no means uncommon in partnership agreements. When a partnership agreement recites that one of the partners will receive a salary for the services rendered by him to the partnership business the contract is regarded as a contract of partnership and is not designated as a contract of service. An agreement to share both profit and losses in addition to a salary points to the existence of a partnership and an agreement to share profits only in addition to a salary indicates the relationship of master and servant or principle and agent [Bhagwan Singh v. Commissioner of Income Tax, AIR 1959 Punj.594; V.D. Dhamsvatay v. Commissioner of Income Tax, MP, AIR 1968 SC 683]. It is now well settled proposition of law that partners in the firm stand in the same position as copromisors or co-contractors [Finance Centre v. Ram Parkash, 1977 Kash. LJ 218]. Hence a partner has a right to claim remuneration for taking part in the conduct of business only when there is an agreement to that effect. 5. Right to Profits [sec.13 (b)] Except in firms which earn purely by intellectual work, not requiring any investment of appreciable capital for its work, such as that of solicitors, and also in firms which do merely a 253 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
sort of agency business, like that of brokers, all other firms require some sort of capital, not only to begin their work, but also to conduct it in the first few years of existence. If the firm prospers, further capital would be necessary not only for its extension but also for opening its branches in other places. As regards subscribing either to the original or subsequent additional capital, the partners sought to agree either that each and every one of them should contribute equally or unequally, or that one or some need not contribute any capital at all, but may contribute instead skill and labour. To give an example of the last class, a capitalist may take with him as partner an inventor of a new process, or a new patentee; and the two might agree to work in partnership. In the absence of an express or implied agreement partners with even unequal capital must share the capital, profits and losses only equally and the onus of proving the contrary is on him who sets it up. This is what has been laid down in section 13(b) of the act, which says that partners are entitled to share equally in the profits earned, and shall contribute equally to the losses sustained by the firm. In the absence of any agreement the presumption of equality stands. It is not at all necessary to prove that the partners agreed to share profits and losses equally. An equality in this respect between the partners is taken for granted [Robinson v. Anderson, (1855) 109 RR 362]. In this case two solicitors were jointly retained to defend certain action and there was no satisfactory evidence to show in what proportion they were to divide their remuneration. It was held that they were entitled to share it equally although they had been paid separately and had done unequal amounts of work. The provisions of section 13(b) of the Act are analogous to section 34(1) of the English Partnership Act, 1890 and Lord Lindley stated the law thus “It is not unreasonable to infer, in the absence of evidence to the contrary that the partners have agreed to consider their contribution as of equal value, although they may have brought in unequal sums of money, or be themselves unequal as regards skill, connection or character. Whether, therefore, partners have contributed money equally or unequally, whether they are or are not at par as regards skill, connection or character, whether they have or have not laboured equally for the benefit of the firm, their shares will be considered as equal, unless some agreements to the contrary can be shown to have been entered into.” The same principals apply in India. In Mansa Ram v. Tej Bhan, [AIR 1958 Punj 5], it was argued that because the contribution of one partner in the capital of the firm was little or three times than that of the other partner and that this ratio had been maintained from the very inception of the partnership to its end and that, therefore, an agreement should be deduced that profits would be distributed in the proportion of their capital contribution. The court rejected this contention and held that their shares will be considered as equal, unless some agreement to the contrary could be shown to have been entered into. An agreement to the contrary can be inferred from the circumstances of the case. In Delhi Veopar Mandal v. I.T. Commissioner [AIR 1967 Punj. 255], a partnership was 254 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
constituted with a view to disposing of the plots of land mentioned in the document creating the firm. The duration of the partnership was fixed as “until this plot of land and any other plots of land purchased are disposed of after development”. There was no mention of the way in which profits were to be shared, but the interest of each partner in the partnership property was fixed. This was held to be an evidence of an agreement that the interest of the partners in profits and losses would be the same as their interest in the property. At the same time we should note one thing that where a change occurs in the constitution of a firm and no new agreement is made, the ratio of profits sharing will remain the same to the extent to which it is consistent with the altered composition of the firm. In Dawood Sahib v Sheik Mohiuddin Sahib [AIR 1938 Mad. 5] where two partners of a firm were sharing profits in a certain proportion, one of them died. His son joined the firm and the business was continued on the same lines as before. No new agreement was made as to any thing whatever. The court had that the profits sharing proportion between them must remain the same. The same principle is applicable on the retirement of a partner. If there is no agreement to the contrary between the remaining partners, their profit sharing ratio will remain the same, though there will have to be some numerical adjustments. In Hiralal v. Chaganmal [AIR 1950 MB 56], of the three partners in a firm two were receiving profits to the extent of 5 annas each and the remaining 6 annas belonged to the third. Thus the ratio roughly was 30:30:40. The partner who was receiving six annas retired. It was held that the reallocated share of the remaining would be half each. Both of them also being equal before the retirement. But where a business which was admittedly commenced with unequal shares, on the retirement of one and the death of the other, the value of the shares of remaining partner and the deceased cannot be equal. [Mohammad Abdul Satar Baig v. Hafija Bibi, AIR 1944 Mad. 346]. For example, where A, B and C were partners having profit sharing arrangement in the ration of 50:25:25 respectively, C retires A & B continued business and accumulated more properties . Partnership dissolved due to one’s death and the surviving partner continued business with the total assets. The question is whether the survivor partner’s and the deceased partner’s share would be equal or in the proportion 1:2 as their share was in the old partnership? There share would be in 1:2 ratio. Whereas a partner has a right to profits of the business, at the same time he is also liable to contribute to the losses of the firm. In the absence of any indication to the contrary, where the partners have agreed to share the profits in certain proportions, the presumption is that the losses are also to be shared in the same proportion [M. Govindu & Co. v. C.I.T. (A.P), (1976) 102 ITR 2284]. 6. Right to interest on capital [sec. 13 (c)] Unless otherwise agreed, partners are not entitled to any interest on their contributions to the capital. Even where the partner is
given the right to receive interest on his subscribed capital, such interest shall be payable only out of the profits. Section 13(c) so provides in the following words: “Where a partner is entitled to interest on the capital subscribed by him, such interest shall be payable out of profits.” Noting the effect of this part of the clause, Rajasthan High Court in Bhagchand v. Kaluram [AIR 1966 Raj. 21], refused to allow interest where only losses were shown and said: “Both the lower courts have awarded interest to the plaintiffs on their investments on the ground that there was a stipulation in the partnership deed that this interest was payable irrespective of the fact whether there was profit or less. Unless there is such stipulation, section 13(c) of the Partnership Act comes into play, and interest is payable only out of profits. The deed of partnership provided for payment of interest on the capital to a partner which only means that plaintiff's became entitled to interest on capital subscribed by them but that interest was payable only out of profits, as there was no contract to the contrary.” Ordinarily partners are entitled to simple interest, compound interest can be allowed only when there is an express or implied agreement to that effect or a practice adopted by the partners in keeping their account amounting in effect to the payment of a compound interest. Thus the Madras High Court in Sivagananahammal v. S.V. Nallaperumal [AIR 1935 Mad. 165] allowed compound interest , where the partners were crediting to the capital account the interest due on their capital. Usually the courts allow interest only under exceptional circumstances where, there is an express or implied agreement to that effect. At the same time, it is worth mentioning that it is well established that where interest on capital is payable between the partners, it stops running from the date of dissolution unless otherwise agreed. So, in taking accounts of the partnership, interest after the date of dissolution will not generally be allowed to the partners on their respective capital, though interest is allowed by agreement during the partnership [P. Chandriah Chetti v. Velehi Madhaviah, AIR 1961 Mad. 478 at p. 480]. 7. On advances [sec.13(d)] An amount in fact contributed by a partner as capital does not become an advance merely because under the partnership deed there is no compulsion on the partner to contribute or maintain any capital with the firm. There is a material distinction between capital contribution of a partner and advances made by him to the firm. The distinction is made clear under 13(c) and 13(d) of the act which read : “(c) mentioned earlier (d) a partner making for the purpose of the business any payments or advance beyond the amount of capital he has agreed to subscribe, is entitled to interest thereon at the rate of 6 % per annum.” This implies that though as a general rule interest is not allowed between partners unless there is an agreement or trade custom,
but this rule is subject to an important qualification, viz., that interest is payable to a partner on money paid or advanced by the partner for partnership purposes beyond the capital he has agreed to subscribe. Where the plaintiff did agree to subscribe any capital it is only fair that he should be allowed interest on the sum, which has been utilized by the partnership. In drawing up accounts between partners, the court is not necessarily limited to the limited measure of relief which was claimed by the plaintiff in the plaint. If the equitable right to interest is established there appears to be no reason why interest should not be allowed. In Iqbal Mohammad v. Ralla Ram [AIR 132 Lah 389], the court found an evidence that goods were purchased by the plaintiff with his own money and these goods were supplied by him to the partnership, in addition to his own contribution towards the capital. It was held this sum (price of goods) being in the nature of a loan by the plaintiff to the partnership, there can be no doubt that he is entitled to get interest thereon. The statutory right to interest on advances emphasizes the fact that a partner in a firm can have dual capacity - one as a partner and second as a creditor. Such advances must be treated as advances made by a third party, that is to say, the partner in his other capacity. The Nagpur High Court in Govind v.Thakur Gajraj Singh [AIR 1921 Nag 45 at p. 46] stated the final effect of these words : “He can then as the promisee of the firm exact payment from the partners jointly or severally under the first paragraph of section 43 of the Contract Act. But he fills a dual capacity. He is not only a promisee of the firm, but he is also one of the joint promisors to himself, and under the accord paragraph of section 43 of the Contract Act, he can only call upon each of the joint promisors to contribute equally to the payment to be made to himself as promisee. At the same time it should be noted that while interest on capital account ceases to run on dissolution, the interest on advances keeps running even after dissolution and up to the date of payment [See Swaminatha Chettiar v. Nagalingam, AIR 1952 Mad. 769]. 8. Right to Indemnity [sec. 13(e)] The right to recover indemnity from the firm is provided in section 13(e) of the Act thus : “The firm shall indemnify a partner in respect of payments made and liabilities incurred by him , (i) In the ordinary and proper conduct of business, and (ii) In doing such act, in an emergency, for the purpose of protecting the firm from loss, as would have been done by a person of ordinary prudence in his own case, under similar circumstances”. I) In the ordinary and proper conduct of the business On the principal of mutual agency which underlines the notion of partnership, it would follow that the firm must reimburse a partner as to payments made or liabilities incurred by such partner in the ordinary and proper conduct of the partnership business. For example, where the working partners of a firm 255 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
had taken a lease of certain premises in their own name but for the partnership purposes and one of them having died, the arrears of rent were recovered from his estate, his executors were held entitled to recover contribution from the other partners in respect of the loss [Mathews v. Ruggles Brise, (1911) 1 Ch 194]. And this right to indemnity subsists even though the expense may turn out to have been useless provided the same has been acquiesced in by the other partners. Nor is it lost because the partner who incurred the liability was more to blame than, the other partners. Of course, the indemnity will not extend to cases where the liability is in regard to a matter outside the scope of the business, or where it is incurred fraudulently or by willful neglect to the prejudice of the firm. The "words in the ordinary and proper conduct of the business" have been explained in Thomas v. Atherton [(1877) 10 Ch.D. 185]. T, the managing partner of a colliery, received notice from L, an adjoining owner, that the workings were being carried on beyond the boundry. T insisted that he was entitled to the disputed ground, and carried on his working . The matter having been referred to arbitration, he was held liable to pay £ 6,000 as damages for the trespass. His claim for contribution from his ex-partners failed as the loss was not suffered in the ordinary and proper conduct of the business. It was held that : “He worked beyond the limits of the partnership colliery without proper inquiry as to limits and had acted with gross negligence and recklessness in continuing his working after notice and without consulting his partners, when it was evident that his right to work in the disputed area was extremely doubtful.”
II) In an emergency
Indemnity and Dissolution
All the partners are jointly and severally liable on any contract entered into by any of the partners. While in English law, the liability of partners is a joint liability in the case of contracts, and a joint and several liabiliity in cases of torts. The Indian Partnership Act, following the Indian Contract Act, has made all liability joint and several. So every partner would be liable for the obligation of the firm incurred in the usual course of business of the firm by the other partners. The principle behind section 25 is that a member who does the act is held out to the world as one for whose acts they are responsible [Iyer, p.749]. The position of the partners is that of joint promisors and is therefore to be regulated for the purpose of contract by section 43 of the Contract Act and the section lays down three rules.
The right of indemnity is not lost by the dissolution of the firm and it also does not matter that there is or has been no settlement of accounts. In Sadhu Narayan Aiyangar v. Ramaswami [ILR 32 Mad. 203] it was laid down that a partner who, after the dissolution of partnership, has been compelled to pay a debt due by the partnership, can maintain a suit for contribution against his co-partners, even though a suit for the general account of partnership and share therein is barred by limitation. The defendant, however, will in such a case be entitled to show that in a settlement of accounts he will not be liable, or that his liability would be reduced. Illegal transaction No contribution is allowed to be recovered in respect of transactions which are illegal. If, for example, the money in respect of which contribution is claimed was collected for or applied to an illegal purpose, the court will not help the plaintiff. But where the plaintiff was not aware of the illegal purpose, and his ignorance was in the circumstances, justifiable, he may be allowed to recover. Again, the court can help him in all cases where he can seek recovery without bringing in the illegality of the transaction [Avtar Singh, Law of Contract p.161].
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The second kind of indemnity is recoverable when a partner has done an act involving expenditure in order to protect the firm from a loss threatened by an emergency. It is necessary that the partner concerned should have acted in a manner in which a reasonable person would have acted in his own case. This provision is supplemented by that in section 21 of the Act which says that every partner has authority, in an emergency , to do all such acts for the purpose of protecting the firm from loss as would have been done by a person of ordinary prudence in his own case. 11.2 LIABILITIES OF PARTNERS Every partner is liable, jointly with all the other partners and also severally, for all acts of the firm done while he is a partner [sec.25]. The section declares that every partner is liable jointly with his co-partners as well as individually for any “act of the firm” done while he is a partner. The section does not talk of liability for any act in particular; it rather talks of a general principle of liability and lays stress upon three main points: 1. The liability of the partners is 'joint as well as several'. 2. They are liable only for the 'acts of the firm'. 3. A partner is liable only if lthe act was done 'while he is still a partner'. We may here under discuss these points. Joint and several liability
Firstly, when joint promise is made, and there is no express agreement to the contrary, the promisee may compel any one or more of the joint promisors to perform the whole of the promise [Ram Shankar Singh v. Shyamlata Devi, AIR 1970 SC 716]. In its application to partners, the rule means that if a firm owes a sum of money to a person, the latter may recover the whole of the amount from a single partner, or all of them. Secondly, a joint promisor who has been compelled to perform the whole of the promise, may require his co-promisors to make an equal contribution to the performance of the promise. In its application to partners the rule means that if a single joint promisor has been compelled to pay the whole of the amount
due on a promissory note, he can recover equal contribution from his copartners. Thirdly, if any one of the promisors makes a default in such contribution, the remaining joint promisors must bear the deficiency in equal shares. In its application to partners the rule means that if the whole of the amount has been recovered from a single partner, and he is not able to recover anything from one of the partners because of his insolvency or otherwise, the deficiency will have to be shared by the rest of the partners equally. [Avtar Singh, p. 248]. Section 43 allows an action to be brought against any one of the joint promisors without impleading the others as defendants. In this situation if he fails to recover anything from him can he subsequently sue the others ? According to Allahabad High Court [Mohamed Ashari v. Radhe Ram Singh, (1900)22 All 307] subsequent suit agains the other promisors should be allowed to proceed, but the Calcutta and Bombay High Corts disallowed such action. At the same time where a creditor discharges one of the partners, the latter may not be liable to creditor, but as between partners his liability to make an equal contribution will remain intact. In cases where strangers are partners the members of the family who are not actively engaged in the business have no contractual relation either with the stranger partners or with the cdreditors of the firm and unless they have been admitted to the benefits of the partnership they cannot be made liable [Mangulal v. Mannilal, AIR 1933 All 311]. But where managing partner stands surety in the name of the firm in the manner mentioned in section 22 of the Act, the other partners are liable under section 25 of the Act. [Suwalal Vemichand v. Fazle Hussain, AIR 1939 Nag 31]. Note: Sec.22 - “In order to bind a firm, an act or instrument done or executed by a partner or other person on behalf of the firm shall be done or executed in the firm name, or in any manner expressing or implying an intention to bind the firm”. Acts of the firm The liabilities that the partners incur is only for such acts of the partner as qualify themselves to be the acts of the firm. The expression “act of the firm” is defined in section 2(a) of the Act thus “an act of the firm means any act or omission by all the partners or by any partner or agent of the firm which gives rise to a right enforceable by or against the firm.” In Jatinder Kumar Dass v. Dhirajlal Varajlal Kanakia [AIR 1975 Cal 123] where the partners of the firm were joint tenants of the plaintiff in respect of the godown, the defendant was liable to pay the rent in respect of the said godown as a joint tenant i.e., a joint promisor or partner. The admitted failure of the firm to pay rent to the plaintiff is held to be an act within the meaning of section 25 of the Indian Partnership act read along with section 2(a) there with.
The effect of section 2(a) read with the fourth chapter is that if an act falls within any of the principles of liability stated in section 18 to 30, it will be an act of the firm and it will either create a right in favour of the firm, or a liability against it. Section 18 vests every partner with the position of an agent of the firm for the purposes of business. The expression ‘business purposes’ means, in term of section 19, the requirements of business when it is done in the manner in which that type of business is usually carried on. These two provisions thus lay down the foundation of contracts of the firm. Such authority can be restricted or extended by agreement under section 20 and it is automatically extended under section 21 in cases of emergency. As envisaged under section 22 a contract which is made in the firm name and within the limits of the firm, all partners are then jointly and severally liable under it and are also entitled to enjoy the rights created by it. To refer, for example, to Re Briggs & Co. [(1906) 95 LT 61]. A father and son were the two partners in the firm. A creditor was pressing for payment, but the firm was not able to pay. Son without his father's information consented to an assignment to the creditor of the book debts of the firm in consideration of the creditor giving time to the firm. The deed of assignment was made out by the son in his own name and that of his father. The firm having become bankrupt, the trustee in bankruptcy sought to set aside the deed as having been signed by one partner. But the deed was held to be an instrument binding upon the firm. Act done while still partner A person incurs liability as a partner only for such acts as have been done while he is a partner. It follows that he is not liable for acts done before he joined the firm as a partner or after be ceased to be a partner. This is, however subject to the principle of liability of an incoming and out going partners. The emphasis of section 25 is that the liability should have arisen at a time when the person sought to be charged was a partner. Thus a claim against the partner must fail where the debt was incurred after the firm has ceased to exist. Where the business of the new firm was carried on by a partner under its old name, the retiring partners cannot be made liable for any transaction enter into after the dissolution. In the case of Rahimatulla Ishak v. Jhamatmal Chainrai [(1909)31C 445], it was held that where A & B carried on business as partners under the name and style of AB and B consequently retired from the partnership, but the business was carried on in the old name, did not make B liable for the transactions subsequent to his retirement. Likewise in Mathura Nath Choudhury v. Sreejukta Bageswari Rani [AIR 1928 Cal. 57] where two persons carried on the business of catching wild elephants and it was alleged that one of the partners and his servant hired an elephant for the purpose of employing him in their business, and the elephant died and a suit was brought for the recovery of Rs. 5000/- it was held that the other partner was also liable under the agreements made between the hirer and the partner. 257 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
To sum up, a suit can be maintained against some of the partners for the liability is joint and several. In a suit upon a contract made by a partner on behalf of the partnership the promisee can compel all or any one of such partners to perform the whole of the promise, and that non-joinder of a copromisor is no ground of defence to such a suit. Liability for acts done upto retirement A retired partner remains liable to the creditors of the firm for all the acts of the firm done before and upto the date of retirement. One may retire from the firm but one cannot retire from subsisting liabilities. Partners are joint promisors. These liability is contractual and no one can retire from a contract which he has made. Thus notwithstanding the retirement the existing creditors can still sue, that the retired partner continues to be liable. Even if the retiring partner makes an arrangement with the co-partners under which he is released from liability for outstanding debts, he will remain liable to creditors [Court v. Berlin, (1897)2 QB 396 CA]. The active partner in a firm consisting of himself and two dormant partners retained a solicitor to conduct an action for the recovery of a debt due to the firm. While the action was pending, the partnership was dissolved, and the dormant partners retired from the business. No notice was given to the solicitor. It was, therefore, held that the retiring partners were liable to the solicitor for the costs of the action. In this respect we may refer to section 32(2) which reads: “ A retiring partner may be discharged from any liability to any third party for acts of the firm done before his retirement by an agreement made by him with such third party and the partners of the constituted firm, and such agreement may be implied by a cause of dealing between such third party and the reconstituted firm after he had knowledge of the retirement”. This sub-section is an instance of novation. Where the arrangement is not with the creditor, the creditor’s rights against the retiring partner are unaffected [Sarma v. Phanindranath, (1931) 35 CWN 593]. A retiring partner’s liability continues till giving of notice. In Bhaishankar v. Lakshmi [(1930) Bom. 449] where a person entered into a transaction with a firm after the retirement of one of the partners, but before notice of dissolution, and had never been aware of the retired partner’s membership of the firm, it was held that no liability could attach to the retiring member. But the Calcutta High Court in Pramatha Chandra v. Bhagwandas [(1931) 59 Cal. 40] had held that the rights of third parties to sue a retiring partner upon post dissolution transactions did not depend on the question whether they knew that he was a partner prior to dissolution. The retiring partner, therefore, continues to be liable so long as no public notice of retirement is given as required under section 32(3). Where no public notice of retirement of a partner is given and the retiring partner pleads non-liability on the ground that the plaintiff was apprised of the retirement before the suit, liability was 258 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
contracted, the burden is heavy on the retiring partner to prove and establish the plaintiff’s knowledge. [Kalaram v. Punjab National Bank, (1935)39 CWN 412]. The persons who had ceased to be partners would not be liable to third parties for the acts done by the other partners subsequent to the dissolution of the firm where the third parties had actual notice of the dissolution when the acts were done [Natwarlal Ambalal & Co. v. Chatuerbhai, (1977) 18 Guj. LR 127]. Liability for acts done after dissolution Section 45 of the Act requires that a public notice of the fact of dissolution should be given. An agency cannot be privately terminated, nor can a firm. The fact of dissolution should be publicly announced, so that those who have been dealing with the firm should come to know that the authority of the partners has been terminated. Where this is not done, the authority though it stands determined between the partners publicly continues. Consequently, if a partner contracts in the name of the firm and the contract would have been within the scope of his implied authority, his co-partners would become liable. The effect is that persons dealing with a firm will not be affected by a dissolution of which no public notice has been given, unless they themselves had notice of such dissolution. This rule is made clear by the Calcutta High Court in Jagat Chandra Bhattacharjee v. Gunny Haji [(1926) 53 Cal. 214] thus : “The law which regulates the liability of partners for the acts of their copartners is a branch of the law of agency; and in the absence of any specific rule upon the subject under the head of partnership, we must look to the law of agency for the solution of our present question. Each partner is the agent of his copartners for the purposes of contracting debts and obligations in the usual course of partnership business. And when this agency has once been established, it does not cease as regards third persons, until its termination has become known to them. In the case, therefore, of a dissolution of partnership or of retirement of one of its members, the agency as between the partners themselves would cease from the time of such dissolution or retirement; but as regards third persons the agency would continue until it had been duly notified.” To this rule there are certain exceptions where no public notice is required and the liability of the partner would cease from the moment of dissolution. These are (1) deceased partner, (2) insolvent partner, and (3) dormant partner i.e., one who was not known to be a partner to the person dealing with the firm after dissolution. Liability to share personal profits Section 50 of the Act reads : “Personal profits earned after dissolution: - Subject to contract between the partners, the provisions of clause (a) of section 16 shall apply to transactions by any surviving partner or by the representatives of a deceased partner, undertaken after the firm is dissolved on account of the death of a partner and before its affairs have been completely wound up
"provided that where any partner or his representative has bought the goodwill of the firm, nothing in this section shall affect his right to the firm name”. Where the firm is dissolved on account of the death of a partner and if, before its affairs are completely wound up, any transaction is undertaken by the surviving partner or the representative of the deceased partner, which brings him some advantage at the expense of the firm, he is bound to share it with other partners under the principle of section 16(a). Section 50 clearly says that such a profit would be accountable to the
other partners in the same manner as if it were earned in violation of the duty under section 16(a). This sub-section provides that a profit made by a partner for himself from any transaction of the firm, or from the use of the property or business connection of the firm or the firm name, has to be accounted and paid over to the firm. Where a partner died and the business of the firm was continued by the other partners without paying out the interest of the deceased, his representatives were allowed to claim profits subject only to deduction of an allowance by the managing partners [Manley v. Sartori, (1926) All ER 661].
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12. RELEVANT SECTIONS OF THE ACT 182, “Agency” and “Principal” defined.- An “agent” is a person employed to do any act for another, or to represent another, in dealings with third person. The person for whom such act is done or who is so represented, is called the “principal”. 183. Who may employ agent .- Any person who is of the age of majority according to the law to which he is subject, and who is of sound mind, may employ an agent. 184. Who may be agent.- As between the principal and third persons, any person may become an agent, but no person who is not of the age of majority and of sound mind can become an agent, so as to be responsible to his principal according to the provisions in that behalf if herein contained. 185. Consideration not necessary.- Nor consideration is necessary to create an agency. 186. Agents authority may be expressed or implied.- The authority of an agent may be expressed or implied. 187.Definition as express and implied authority.- An authority is said to be express when it is given by words spoken or written. An authority is said to be implied when it is to be inferred from the circumstances of the case; and things spoken or written, or the ordinary course of dealing, may be accounted circumstances of the case. 188. Extent of agent’s authority.- An agent, having an authority to do an act, has authority to do every lawful thing which is necessary in order to do such act. An agent having an authority to carry on a business, has authority to do every lawful thing necessary for the purpose, usually done in the course of conducting such business. 189. Agent’s authority in an emergency.- An agent has authority, in the emergency, to do all such acts for the purpose of protecting his principal from loss as would be done by a person of ordinary prudence, in his own case, under similar circumstances. 190. When agent cannot delegate.- An agent cannot lawfully employ another to perform acts which he has expressly or impliedly undertaken to perform personally, unless by the ordinary custom of trade a sub-agent may, or, from the nature of the agency, a sub-agent must be employed. 191. “Sub-agent” defined.- A “Sub-agent” is a person employed by, and acting under the control of the original agent in the business of the agency. 192. Representation of principal by sub-agent properly appointed.- Where a sub-agent is properly appointed, the principal is, so far as regards third persons, represented by the sub-agent, originally, and is bound by and responsible for his acts, as if he were an agent originally, appointed by the principal. Agent’s responsibility for sub-agent.- The agent is responsible to the principal for the acts of the sub-agent. 260 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
Sub-agent’s responsibility.- The agent is responsible to the principal for the acts of the sub-agent. 193. Agent’s responsibility for sub-agent appointed without authority.- Where an agent, without having authority to do so, has appointed a person to act as a sub-agent, without having authority to do so, has appointed a person to act as a sub-agent, the agent stands towards such person in the relation of a principal to an agent, and is responsible for his acts both to the principal and to third persons; the principal is not represented, by or responsible for the acts of the person so employed, nor is that person responsible to the principal. 194. Relation between principal and person duly appointed by agent to act in business of agency.- Where an agent, holding an express or implied authority to name another person to act for the principal in the business of the agency, has named another person accordingly, such person is not a sub-agent, but an agent of the principal for such part of the business of the agency as is entrusted to him. 195. Agent’s duty in naming such person.- In selecting such agent for his principal, an agent is bound to exercise the same amount of discretion as a man of ordinary prudence would exercise in his own case; and, if he does this he is not responsible to the principal for the acts or negligence of the agent so selected. 196. Right to person as to acts done for him without his authority.- Effect of ratification.- Where acts are done by one person on behalf of another, but without his knowledge or authority, he may elect to ratify or to disown such acts. If he ratify them, the same effects will follow as if they had been performed by his authority. 197. Ratification may be expressed or implied.- Ratification may be expressed or may be implied in the conduct of the person on whose behalf the acts are done. 198. Knowledge requisite for valid ratification.- No valid ratification can be made by a person whose knowledge of the facts of the case is materially defective. 199. Effect of ratifying unauthorized act forming part of a transaction.- A person ratifying any unauthorized act done on his behalf ratifies whole of the transaction of which such act formed a part. 200. Ratification of unauhtorized act cannot injure third person.- An act done by one person on behalf of another, without such other person’s authority, which, is done with authority would have the effect of subjecting a third person to damages, or of terminating any right or interest of a third person cannot, by ratification, be made to have such effect. 201. Termination of agency.- An agency is terminated by the principal revoking his authority; or by the agent renouncing the business of the agency; or by the business of the agency being completed; or by either the principal or agent dying or becoming of unsound mind; or by the principal being
adjudicated an insolvent under the provisions of any Act for the time being in force of the relief of insolvent debtors. 202. Termination of agency, where agent has an interest in subject matter.- Where the agent has himself an interest in the property which forms the subject matter of the agency, the agency cannot in the absence of an express contract, be terminated to the prejudice of such interest. 203.When principal may revoke agent’s authority.- The principal may, save as is otherwise provided by the last preceding section, revoke the authority given to his agent at any time before the authority has been exercised so as to bind the principal. 204. Revocation where authority has been partly exercised.The principal cannot revoke the authority given to his agent after the authority has been partly exercised, so far as regards such acts and obligation as arise from acts already done in agency. 205. Compensation for revocation by principal, or renunciation by agent.- Where there is an express or implied contract that the agency should be the agent, or the agent to the principal, as the case may be, for any previous revocation of renunciation of the agency without sufficient cause. 206. Notice of revocation or renunciation.- Reasonable notice must be given of such revocation of renunciation; otherwise the damage thereby resulting to the principal or the agent, as the case may be, must be made good to the one by the other. 207. Revocation and renunciation may be expressed or implied.- Revocation and renunciation may be expressed or may be implied in the conduct of the principal or agent respectively. 208. When termination of agent’s authority takes effect as to agent, and as to third persons.- The termination of the authority of an agent does not, so far as regards the agent, take before it becomes known to him, or , so far as regards third persons, before it becomes known to them. 209. Agent’s duty on termination of agency by principal’s death or insanity.- When an agency is terminated by the principal dying or becoming of unsound mind, the agent is bound to take, on behalf of the representative of his late principal, all reasonable steps for the protection and reservation of the interests entrusted to him. 210. Termination of sub-agent’s authority.- The termination of the authority of an agent causes the termination (subject to the rules herein contained regarding the termination of an agent’s authority) of the authority of all sub-agents appointed by him. 211. Agent’s duty in conducting principal’s business.- An agent is bound to conduct the business of his principal according to the directions given by the principal, or incase the absence of any such directions, according to the custom which prevails in doing business of the same kind of the place where the agent
conducts such business. When the agent acts otherwise, if any loss be sustained, he must make it good to his principal, and, if any profit accrues, he must account for it. 212. Skill and diligence required from agent.- An agent is bound to conduct the business of the agency with as much skill as is generally possessed by persons engaged in similar business unless the principal has notice of his want of skill. The agent is always bound to act with reasonable diligence and to use such skill as he possesses; and to make compensation to his principal in respect of the direct consequences of his own neglect, want of skill, or misconduct, but not in respect of loss or damage which are indirectly or remotely caused by such neglect, want of skill, or misconduct. 213. Agent’s accounts.- An agent is bound to render proper accounts to his principal on demand. 214. Agent’s duty to communicate with principal.- It is the duty of an agent, in cases of difficult, to use all reasonable diligence in communicating with his principal, and in seeking to obtain his instructions. 215. Right to principal when agent deals, on his own account, in business of agency without principal’s consent.- If an agent deals on his own account in the business of the agency, without first obtaining the consent of his principal and acquainting him with all material circumstances which have come to his own knowledge on the subject, the principal may repudiate the transaction, if the case shows, either that any material fact has been dishonestly concealed from him by the agent, or that the dealings of the agent have been disadvantageous to him. 216. Principal’s right to benefit gained by agent dealing on his own account, in business of agency.- If an agent, without the knowledge of his principal, deals in the business of the agency on his own account instead of on account of his principal, the principal is entitled to claim from the agent any benefit which may have resulted to him from the transaction. 217. Agent’s right to retainer out of sums received on principal’s account.- An agent may retain, out of any sums received on account of the principal in the business of the agency, all moneys due to himself in respect of advances made or expenses properly incurred by him in conducting such business, and also remuneration as may be payable to him for acting as agent. 218. Agent’s duty to pay sums received for principal.Subject to such deductions, the agent is bound to pay to his principal all sums received on his account. 219. When agent’s remuneration becomes due.- In the absence of any special contract, payment for the performance of any act is not due to the agent until the completion of such act; but an agent may detain moneys received by him on account of goods sold, although the whole of the goods consigned to him for sale may not have been sold, or although the sale may not be actually complete. 261 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
220. Agent not entitled to remuneration for business misconducted.- An agent who is guilty of misconduct in the business of the agency, is not entitled to any remuneration in respect of that part of the business which he has misconducted. 221. Agent’s lien on principal’s property.- In the absence of any contract to the contrary, an agent is entitled to retain goods, papers, and other property whether movable or immovable, of the principal received by him, until the amount due to himself for commission, disbursements and services in respect of the same has been paid or accounted for to him. 222. Agent to be indemnified against consequences of lawful acts.- The employer of an agent is bound to indemnify him against the consequences of all lawful acts done by such agent in exercise of the authority conferred upon him. 223. Agent to be indemnified against consequences of acts done in good faith.- Where one person employs another to do an act and the agent does the act in good faith, the employer is liable to indemnify the agent against the consequences of that act, though a causes an injury to the rights of third persons. 224. Non-liability of employer of agent to do a criminal act.Where one person employs another to do an act which is criminal, the employer is not liable to the agent, either upon an express or an implied promise to indemnify him against the consequences of that act. 225. Compensation to agent for injury caused by principal’s neglect.- The principal must make compensation to his agent in respect of injury caused to such agent by the principal’s neglect or want of skill. 226. Enforcement and consequences of agent’s contracts.Contracts entered into through an agent, and obligations arising from acts done by an agent, may be enforced in the same manner, and will have the same legal consequences as if the contracts had been entered into and the acts done by the principal in person. 227. Principal how far bound, when agent exceeds authority.- When an agent does more than he is authorised to do, and when the part of what he does which is within his authority, can be separated from the part which is beyond his authority, so much only of what he does as is within his authority is binding as between him and his principal. 228. Principal not bound when excess of agent’s authority is not separable.- Where an agent does more than he is authorized to do, and what he does beyond the scope of his authority cannot be separated from what is within it, the principal is not bound to recognise the transaction. 229. Consequences of notice given to agent.- Any notice given to or information obtained by the agent, provided it be given or obtained between the principal and third parties, have the same legal consequences as if it had been given to or obtained by the principal. 262 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
230. Agent cannot personally enforce nor be bound by contracts on behalf of principal.- In the absence of any contract to that effect, an agent cannot personally enforce contracts entered into by him on behalf of his principal, nor is he personally bound by them. Presumption of contract to contrary.- Such a contract shall be presumed to exist in the following cases: (1) Where the contract is made by an agent for the sale or purchase of goods for a merchant resident abroad; (2) Where the agent does not disclose the name of his principal; (3) Where the principal, though disclosed, cannot be sued. 231. Rights of parties to a contract made by agent not disclosed.- If an agent makes a contract with a person who neither knows, nor has reason to suspect, that he is an agent, his principal may require the performance of the contract; but the other contracting party has, as against the principal, the same rights as he would have had as against the agent if the agent had been principal. If the principal discloses himself before the contract is completed, the other contracting party may refuse to fulfill the contract, if he can show that, if he had know who was the principal in the contract, or if he had know that the agent was not a principal, he would not have entered into the contract. 232. Performance of contract with agent supposed to be principal.- Where one person makes a contract with another, neither knowing nor having reasonable ground to suspect that the other is an agent, the principal, if he requires the performance of the contract, can only obtain such performance subject to the rights and obligations subsisting between the agent and the other party to the contract. 233. Right of person dealing with agent personally liable.In cases where the agent is personally liable, a person dealing with him may hold either him or his principal, or both of them, liable. 234. Consequence of inducing agent or principal to act on belief that principal or agent will be held exclusively liable.When a person who has made a contract with an agent induces the agent to act upon the belief that the principal only will be held liable, or induces the principal to act upon the belief that the agent only will be held liable, he cannot afterwards hold liable the agent or principal respectively. 235. Liability of pretended agent.- A person untruly representing himself to be the authorized agent of another, and thereby inducing a third person to deal with him as such agent, is liable, if his alleged employer does not ratify his acts, to make compensation to the other in respect of any loss or damage which he has incurred by so dealing. 236. Person falsely contracting as agent notentitled to performance.- a person with whom a contract has been entered
into in the character of agent, is not entitled to require the performance of it, if he was in reality acting, not as agent, but on his own account. 237. Liability of principal inducing belief that agent’s unauthorized acts were authorized.- When an agent has, without authority, done acts or incurred obligations to third persons on behalf of his principal, the principal is bound by such acts or obligations, if he has by his words or conduct induced such third persons to believe that such acts and
obligations were within the scope of the agent’s authority. 238. Effect, on agreement, of misrepresentation or fraud by agent.- Misrepresentations made, or frauds committed, by agent acting in the course of their business for their principals, have the same effect on agreements made by such agents as if such misrepresentations or frauds had been made or committed by the principals; but misrepresentations, made, or frauds committed, by agents, in matters which do not fall within their authority, do not affect their principals.
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13. CASE LAW R.L. Khanna v. Simla Banking and Industries [AIR 1959 Punj. 100] A, the petitioner, gave the respondent Bank B certain treasury bills for collection. B passed them on to C, the Federal Bank of India for collection. The Treasury paid the amounts to C before C went into liquidation. B claimed from the official liquidator of C the said amounts. B and official liquidator entered into an arrangement by which B was to be paid in full satisfaction fifty percent of the amount. A applied under section 45B of the Banking Companies Act claiming the entire amount from C. The court held that A was entitled to priority to the extent of the entire amount as A and B were principal and agent and C was only B’s sub-agent. There was no privity of contract between A and C. Walsh v. C-Jones [(1978)2 App ER 1002] In this case the plaintiffs had a block of three flats which they desired to sell with vacant possession. They appointed an estate agent to get occupants of the flats, but gave him no authority to enter into any agreement for occupation without reference to the principal. The defendants wanted a short term tenancy of one of the flats. The agent allowed them three months with option to renew and with an assurance that they could occupy the flat to the exclusion of anyone else. The issue before the court was whether such an agreement was binding on the plaintiff and whether the agent created a tenancy or a mere licence? The court said; The agreement gave the defendants jointly an exclusive possession of the flats. The reservation by the plaintiffs of right of access did not of itself destroy the right granted to the defendants of the exclusive possession of flats since the plaintiffs had no right to occupy the flats as a residence or to put in anyone else. The form signed by the defendants was a sham designed to conceal the true nature of the agreement which was the grant of a joint tenancy of the flat for three months. The plaintiffs were bound by the agreement made by the agents with defendants notwithstanding that he had been expressly told not to create tenancy. Per curiam, although the grant of the right of exclusive possession may create a licence and not a tenancy, there was no authority for denying them exclusive possession. The National Tobacco Co. of India Ltd., Calcutta v. Simla Banking & Industrial Co. (AIR 1969 Punj. 121) The Simla Bank in this case collected money from the customer of the plaintiff company and remitted the same to plaintiff by draft. The draft was dishonoured as there was no credit for the bank which went into liquidation. The evidence disclosed that the drafts were issued by the bank without making arrangements to meet them, knowing full well they were not likely to be honoured. The issue involved was whether the agency had terminated on the completion of the business. 264 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
The court held under such circumstances wherein the bank did not discharge its primary fiduciary duty of providing the funds to meet the drafts the fiduciary relationship between the bank and the company was not terminated by merely issuing the drafts. The plaintiff company was hence held entitled to claim the amount as preferential creditor of the bank in liquidation. Keighley Maxsted & Co. v. Durant [1901) A.C. 240] In this case X was authorised to buy wheat on the joint account of X and Y with a limit as to the price he could pay. X entered into a contract for the purchase of wheat at a price in excess of the limit on behalf of himself and Y. But he did not disclose to the seller of the wheat his intention to contract on Y’s behalf as well as his own. Y later purported to ratify X’s act and was subsequently sued by the seller for breach of contract. The issue involved was whether a contract made by a man purporting and professing to act on his own behalf alone and not on behalf of a principal but having an undisclosed intention to give the benefit of the contract to a third party, can be ratified by that third party so as to render him able to sue or be liable to be sued on the contract. The court held this could not be done. The court stated that civil obligations are not to be created by or founded upon undisclosed intentions. If a relationship of principal and agent is to exist and affect third parties, it must be based upon knowledge on the part of all concerned, and their joint intention that such a relationship should exist and affect rights and liabilities. Bolton Partners v. Lambert [1889)41 Ch.D. 295] The defendants made an offer to the Managing Director of a company, who having no authority to do so accepted it. That gave the company an option to ratify the contract. But the company ratified only after the defendant had withdrawn his offer. The company brought an action against the defendants for specific performance. The issue was whether the doctrine of ratification related back to the date when the offer was accepted first. The court held that company was entitled to it. The company’s ratification related back to the date on which the Managing Director first accepted the offer. Thus there was a contract between the company and the defendant from that date. The defendant’s revocation of his offer was ineffective. It was further pointed out that it was not a question of withdrawal of offer, but withdrawal from contract. The Managing Director having accepted the offer though without authority there was a contract, but it was not an offer, but a contract that was ratified. Almunium Industries v. R. Almunium Ltd [(1976)2 All ER 552] The plaintiff, a Dutch company, which manufactured almunium foil, sold quantities of it to the defendants, an English Company. A clause of the agreement of sale conferred on the defendant’s
a power to sell unmixed foil and also imposed on them an obligation to account to the plaintiff’s for the proceeds of sales to other. The question involved was whether the defendants were accountable to the plaintiffs. The court held that although the defendants sold the unmixed foil as principals, the foil nevertheless continued to be the property of the plaintiff which the defendants were selling as the plaintiff’s agents. As such they were clearly accountable to the plaintiffs and the latter were entitled to trace the proceeds of the sale of unmixed foil, and to recover them in priority to the secured and unsecured creditors of the ultimate purchasers, who were in financial difficulties necessitating the appointment of a receiver to disburse their estate according to law. Wheels India Ltd., Mount Road v. Khem Chand Raj Kumar 1970(2) MLJ 648. In this case the issues raised were whether the first defendant was the agent of the second defendant ? Whether the defendant had any responsibility to bear any extra freight ? The contract of sale was concluded between the plaintiffs and the second defendant, a foreign firm operating in Pittsburg, Pennsylvania, U.S.A., for the goods which were shipped at Baltimore.The second defendant was paid the price on tendering the bill of lading to the American Bank. The ship got tied at Saigon Port and was consequently delayed by six weeks in coming to Madras, for the carrier had gone bankrupt and the goods were of-loaded.The plaintiffs got worried as the steel plates were required for immediate manufacture.They requested the first defendant to intercede with his principal and arrange for transhipment. It was only after the plaintiff had been obliged to make their own arrangements for the transhipment that they thought of the first defendant as a target for recovery of the actual expenses to be incurred by them towards the shipment. The defendants repudiated the liability to pay the charges incurred by the plaintiff for the transhipment of goods from Saigon to Madras. Thereupon the plaintiffs sued to recover the expenses they had incurred. The Court held as follows :(i) An agent cannot be personally bound by a contract entered into by him on behalf of his principal in the absence of any provision to that effect in the contract. The law will however
presume such a contract in a case where the contract is by the agent for sale or purchase of goods from a foreign merchant. The presumption arising under Section 230(2) is only a prima facie one rebuttable by the language or the provisions of the contract. The first defendant was acting as a representative or as a home agent of the second defendant who was resident abroad during negotiations. All that the first defendant did was only to bring the plaintiffs and the second defendant together into contractual relationship. When the ship was delayed in Saigon the plaintiff looked to the defendant only for the transhipment. The first defendant had no direct hand in that. Hence there was no basis for holding that the contract for the supply of goods was made by the 1st defendant on behalf of the second defendant. (ii) The second defendant’s liability to pay freight charges from Baltimore to Madras was there and they paid it once. To saddle them again with charges from Saigon to Madras occasioned by the transhipment cannot be upheld as the contract did not lay upon them an absolute obligation to deliver possession of the goods to the plaintiff at the Port of Madras. The C.I.F. contract was entered into by plaintiff with open eyes and so he cannot contend that the defendants promised to deliver physical possession in Madras. (iii) It may be correct to say that the second defendant, having undertaken the responsibility of shipping the goods was under a legal obligation to choose a carrier who could transport the goods from Baltimore to Madras without any impediment. There is however no evidence for charging the second defendant with negligence in their choice of the carrier. (iv) The second defendant being a foreign firm resident in U.S.A. is not ordinarily subject to the jurisdiction of the Madras High Court. It is a well settled rule of Private International Law, that where a foreign company had chosen to appear before the Court of another country and further to plead on the merits of the case, it must be deemed that the foreign company had submitted to the jurisdiction of this Court, voluntarily notwithstanding its plea as to want of jurisdiction.
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14. PROBLEMS 1. A entrusts B, a minor with a diamond ring worth Rs.1000/ - enjoining him not to sell the same for credit or any amount less than Rs.900/-. B sells it to C on credit for Rs. 800/-. Examine the position of A, B and C. 2. A enters into a contract with B for buying B’s motor car as agent of C, but without C’s authority. B repudiates the contract before C comes to know of it. C subsequently ratifies the contract and sues for specific performance. How would you decide ? 3. A employed B to bet in a horse race. The agent carried out the instructions and lost Rs.1000/-. Then A instructed the agent not to pay the amount but the agent who was a member of the race club paid the amount as he would otherwise be expelled from the club. He then brought a suit to recover the amount from A. Decide. 4. A employs B as his agent in Bombay to sell 100 bags of turmeric and directs him to sell at Rs. 125/- per bag. The agent sells the goods at Rs.112/- per bag but it was discovered that the actual market rate on that date was Rs.115/-. Is A entitled to any, and if so, to what damages. 5. A enters into a contract with B for purchase of yarn for Rs.1000/-. B was acting as the agent of C but did not disclose this fact to A. A claims to set off a sum of Rs.3000/ - due to him from B against the purchase price. How would you advise ? 6. A employs B an auctioneer to sell his furniture in auction. In the auction the custom of the business is to collect the price before goods are delivered to the buyers. B sells the furniture of A to C on credit as C’s credit is very high. Before payment C becomes insolvent. Who is to bear the loss ? 7. A owes B Rs. 500/-. He sells Rs.1000/- worth of rice to B. B does not know that A is acting as agent for an undisclosed principal, C. What are the rights of the parties ? 8. A is the owner of a motor lorry plying for hire. A engages B and C as its driver and conductor respectively. The terms
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of business for the carriage of goods are usually settled by the driver and conductor and they collect the charges and pay the same to A. D entrusts his goods to B and C for carriage and pays the charges. B and C misappropriate the goods. Is A liable to make good the loss to D ? A, an auctioneer, is employed to sell the goods of B. A is put in possession of goods to deliver the same to the purchaser after sale. He has to retain his commission and make over the balance to B. The purchaser takes delivery of the goods but does not pay and says he will settle the matter with B. Can A maintain an action against the purchaser. Give reasons for the answer. A , a merchant in Calcutta, has an agent B in London to whom a sum of money is paid on A’s account with orders to remit. B retains money for a considerable time. A in consequence of not receiving the money becomes insolvent. To what extent is B liable under the circumstances. Firm was doing the business of buying and selling potatoes. C, a partner entered into arrangement with the third person to buy jointly a part of a cargo of potatoes for sharing the profits of the venture. The venture having resulted in a loss. Decide whether the partner had the implied authority to bind the firm to a partnership with the third person, the joint venture and whether a partner can enter into a partnership on behalf of the firm. A partner of a firm of manufacturers of Lungi cloth contracted without the knowledge of his copartners to supply a cloth dealer 3000 pieces of lungi cloth at a certain rate. A sum of money was also advanced to him as an earnest money. His firm failed to supply and was, therefore, sued for damages for breach and refund of earnest with interest. Discuss the liability of the firm. One of the five brothers who inherited the business after their father was infant. One application was filed to have the partners of the firm adjudicated as insolvents. Discuss whether minor can be adjudicated insolvent and his share be seized by the receiver.
[Note: Specify your name, ID no. and address while sending answer papers]
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15 SUPPLEMENTARY READINGS 1. 2. 3. 4. 5. 6. 7.
Bangia, R.K., Indian Contract Act, (1994) Allahabad Law Agency, Allahabad. Cheshire and Fifoot, Law of Contract, (1986), Butterworths, London. Fired, G.H.L., The Law of Agency, (1976), Butterworth, London. Guest, A.B. (etd.), Chitty on Contracts, (1983), 25th Sweet & Maxwell, London. Iyer, T.S.V., The Law of Contract (1983) Asia Law House, Hyderabad. Iyer, T.S.V., Sale of Goods and Partnership Acts, Asia Law House. Justice Malik and Justice Gyanakumar, Rajgopalachari's Commentaries on Indian Partnership Act, (1987), Law Publishers, Allahabad. 8. Ramachandran, V.B., Law of Agency (1985), Eastern Book Company, Lucknow. 9. Reynolds, F.M.B., and Davenport, B.J. : Bowstead on Agency, (1976), Sweet & Maxwell, London. 10. Singh, Avtar : Law of Contract (1994), Eastern Book Co., Lucknow.
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Master in Business Laws Law of Contracts Course No: I Module No: VIII
SPECIAL CONTRACTS
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 268 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
Material Prepared by : 1. Prof. P.C. Bedwa, LL.M., Ph.D. 2. Mrs. Radha Pyari, LL.M. Material Checked by : 1. Ms. Archana Kaul, B.Sc., LL.M. 2. Ms. Sudha Peri, M.A., LL.M. Material Edited by : 1. Prof. V.S. Mallar, M.A., LL.M. 2. Prof. N.L. Mitra, M.Com., LL.M., Ph.D.
© National Law School of India University Published by : Distance Education Department National Law School of India University Post Bag No. 7201 Nagarbhavi, Bangalore - 560 072
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Instructions After knowing the general principles of contract one has to apply the knowledge in understanding the basic issues involved in various types of contract. Contract Act of 1872 included laws governing various types of commercial contracts like the Sale of Goods (Sections 76 - 123 of the original Contract Act, since repealed), Indemnity and Guarantee (Section 124-147); Bailment and Pledge (Sections 148 - 181); Agency (Sections 182-238); Partnership (Sections 239 -266) since repealed). Over the years Sale of Goods and partnership Contracts assume high importance in the commercial world as a result of which separate Sale of Goods Act was passed in 1930 and a separate Partnership Act was enacted in 1932, on which the law laid down in the Contracts Act stood repealed. In this Module we will be examining the character of the contract of some of the special commercial contracts. Many of the commercial contracts which are very common now do not have an updated legal structure or any law at all. As for example, Bailment and Pledge are having minimum legal structure with definitional outline. But transactions like hypothecation, leasing of movable goods and hire purchase are not having any legal definition nor do they have clear legal structure. Similarly law relating to carriers, specially , 'by land' including the Railway Act, 1890 requires updating, and so also carriage by sea. We have discussed in detail the essential features of these commercial Contracts many of which bear the standard from. It is necessary to remember in the changing commercial world various other classes of contracts do evolve through commercial practices. Many of these types of contracts have either special laws for themselves or attract special laws to be evolved. As for example, contracts relating to negotiable instruments are regulated by Negotiable Instruments Act, 1881. Contracts relating to investments in securities presently attract updated structure for stipulating the rule of the game. Therefore, this Module is not exhaustive. It only contains some special contracts which are mentioned in the Contract Act and some other very close to the same. You will be benefited to properly appreciate these contracts, if you talk to your friends in the commercial world who enter these types of contracts every day. As for example, to understand bailment you can discuss with the owner of a repairing shop or a dry cleaning agency. In order to appreciate guarantee you may discuss with your friend working in a bank. All these contracts have practical involvement in our day to day life. Therefore understanding them in depth shall benefit you in your profession or service.
N. L MITRA Course Co-ordinator
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SPECIAL CONTRACTS
TOPICS 1.
Introduction ....................................................................................................................
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Contract of Indemnity ...................................................................................................
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Contract of Guarantee ...................................................................................................
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Contract of Bailment .....................................................................................................
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Pledge & Hypothecation ................................................................................................
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Leasing & Hire-purchase ..............................................................................................
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Carrier .............................................................................................................................
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Relevant provisions of the Act ......................................................................................
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Case Law .........................................................................................................................
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Problems..........................................................................................................................
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Supplementary Readings ...............................................................................................
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1. INTRODUCTION Several instances of special contracts are included in the Contract Act as for example, (a) Contract of Indemnity & Guarantee (Sections 124-147); (b) Contract of Bailment (Sections 148-181); and (c) Contract of Agency (Sections 182 - 238). Several other special types of contracts were initially included in the Contract Act but afterwards separate statutes were made in those areas and consequently those chapters were repealed from the Act. As for example, the Sale of Goods Act dealing with sale of movable commodities was passed in 1932 and chapter seven of the Contract Act dealing with Sale of Goods in between Sections 76 - 123, was repealed. Similarly on passing of the Partnership Act, 1932, chapter 11 of the Contract Act on partnership was deleated. The word 'Special Contract' signifies only a specialised type of contract. Naturally the list is not exhaustive. The Contract Act, in fact deals with general principles of contracts within Chapter I to Chapter VI, i.e., in between Sections 1 - 75. From Section 76 some types of contracts were discussed as stated above. This chapter contains only those types of contracts still provided in the Contract Act, and laws relating to Sale of
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Goods or Partnership shall not be discussed unless otherwise needed. It is also to be noted that many other types of contracts can be made by the parties as for example, contracts dealing with immovable properties can also be classified as special contracts. For which there is a specific statute known as Transfer of Property Act, 1882. Many types of contracts in movable & immovable goods are not yet covered by specific statutes, such as leasing of movable commodities, hire purchase and instalment purchase etc. Whatever may be the special nature of the contract requiring certain special rules, all contracts entered into have to fulfil the general principles as laid down in the Contract Act. Contract Act is a definitional and amending Act. Therefore it allows common practices in the trade and profession regulating a special kind of contract peculiar to trade, commerce , industries and profession. In so far types of contract of these nature, the statute is not exhaustive. In many cases it may be observed that the conventions on which commercial world reposes nationally & internationally are based on common practices. As such law relating to many types of commercial contracts are not yet fully codified in India.
2. CONTRACT OF INDEMNITY SUB TOPICS 2.1 Definition & Meaning 2.2 Nature 2.3 Distinction: English and Indian law 2.4 Validity of indemnity 2.5 Contract when enforceable 2.6 Rights of indemnity holder 2.7 Rights of indemnifier promisor 2.8 Contract of Insurance as a Contract of indemnity 2.1 DEFINITION & MEANING The term 'indemnity' literally means security against loss. In a contract of indemnity one party viz., the indemnifier promises to compensate the other party viz., the indemnified against loss suffered by the latter. For example, A tells B "Let C have these goods. I shall see you are paid." This is a contract of indemnity. The English law definition of a contract of indemnity is that "it is a promise to save a person harmless from the consequences of an act." Thus it enfolds within its ambit losses caused not merely by a human agency but also those caused by accident or fire or other natural calamities. The definition of a contract of indemnity as laid down in S.125 of the Indian Contract Act confines itself to losses occasioned due to the act of the promisor or due to the act of any other person. For example, A promises to save B against any suit which C may bring against B. This is a contract of indemnity. Similarly if A promises to pay a certain amount owed by B to C but B fails to pay and C files an action against B, A is liable to indemnify B. According to Sec. 124 of the Indian Contract Act a contract by which one party promises to save the other from 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 promise to be primarily and independently liable for another person's conduct may amount to a contract of indemnity. Under a contract of indemnity, liability of the promisor arises from loss caused to the promisee by the conduct of the promisor himself or by the conduct of another person [Punjab National Bank, Ltd. v. Vikram Cotton Mills, (1970) 1 SCC 60]. Every contract of insurance, other than life insurance, is a contract of indemnity. The definition is restricted to cases where loss has been caused by some human agency [Gajanan Moreshwar v. Moreshwar Madan, AIR 1942 Bom 302]. Although the definition under Indian law contemplates only losses of the above nature it cannot be said that the other types of losses do not fall within the net of indemnity. The Act has very well taken care of such losses under other chapters. For example, loss due to fire or accident may be brought under S.30 of the Act dealing with contingent contracts. Similarly loss occasioned to the agent can be dealt under S.222 of the Act defining the liability of the principal . Therefore though there is a difference between English and Indian definitions as
to the term indemnity it need not be considered as material. This has also been clarified in the case of Moreshwar v. Moreshwar [AIR 1942 Bom 302] when Chagla J. observed :"The Contract Act is both an amending and a consolidating Act, and it is not exhaustive of the law of contracts to be applied by the Courts in India. Section 124 deals only with one particular kind of indemnity which arises from a promise made by an indemnifier to save the indemnified from the loss caused to him by the conduct of the indemnifier himself or by the conduct of any other person, but does not deal with those classes of cases where the indemnity arises from loss caused by events or accidents which do not depend upon the conduct of indemnifier any other person, or by reason of liability incurred by something done by the indemnified at the request of the indemnifier....." Therefore according to the learned Judge in the above case the definition of indemnity is not merely confined to that mentioned in S. 124. 2.2 NATURE A contract of indemnity may be express or implied depending upon the circumstances of the case, though S.124 of the Act does not seem to cover the cases of implied indemnity. This aspect was recognized in Secretary of State v. Bank of India Ltd [(1938) 65 IA 286 (PC)] where a broker in possession of a government promissory note endorsed it to a bank with forged endorsement. The bank acting in good faith applied for and got a renewed promissory note from the Public Debt Office. Meanwhile the true owner sued the Secretary of State for conversion who in turn sued the Bank on an implied indemnity. The Judicial Committee observed that even the fact that S.21 of the Securities Act provides that an express indemnity demanded was not inconsistent with the existence of an implied right to indemnity under the law of India. Their lordships thus laid down the principle: "It is general principle of law when an act is done by one person at the request of another which act is not in itself manifestly tortious to the knowledge of the person doing it, and such act turns out to be injurious to the rights of a third party, the person doing it is entitled to an indemnity from him who requested that it should be done". The Indian Contract Act has also dealt with special cases of implied indemnity under Sections 69, 145 and 222. Under S. 69 if a person who is interested in the payment of money which another is bound by law to pay and therefore pays it, he is entitled to be indemnified. For example, if a tenant pays certain electricity bills to be paid by the owner, he is entitled to be indemnified by the latter. Sec. 145 speaks of the right of a surety to claim indemnity from the principal debtor for all sums which he has rightfully paid towards the guarantee. Implied indemniy is also embodied in S.222 dealing with the liability of the principal to indemnity the agent in respect of all amounts paid by him during the lawful exercise of his authority. The case of Adamson v. Jarvis [(1827)4 Bing 66], illustrates this 273 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
point. The plaintiff, an auctioneer, acting on the instruction of the defendant sold certain cattle which subsequently turned out to belong to some one else other than the defendant. When the true owner sued the auctioneer for conversion, the auctioneer in turn sued the defendant for indemnity. The court held that the plaintiff having acted on the request of the defendant was entitled to assume that, if what he did turned out to be wrongful, he would be indemnified by the defendant.
In Shanker Nimbaji v. Laxman Sapdu, the plaintiffs filed a suit to recover Rs.5,000/- and interest from defendant by the sale of a mortgaged property and, in case of deficit, for a decree against the estate of defendant 2 which was in the hands of his sons, the defendant 2 having died during the pendency of the suit. It was held that the plaintiffs could not sue the defendant in anticipation that the proceeds realised by the sale of the mortgaged property would be insufficient and there would be some deficit.
2.3 DISTINCTION: ENGLISH & INDIAN CONCEPTS
Similarly in the case of Chand Bibi v. Santhosh Kumar Pal, the defendantís father while purchasing certain property covenanted to pay off a mortgage debt incurred by the plaintiff and also promised to indemnify him if they were made liable for the mortgage debt. The defendantís father failed to pay off the mortgage debt and the plaintiffs filed an action to enforce the covenant. It was held that as the plaintiffs had not yet suffered any damage, the suit was premature so far as the cause of action on indemnity was concerned.
In English law, a contract of indemnity has been defined as a promise to save another harmless from loss caused as a result of a transaction entered into at the instance of the promisor”. This definition is of wider import than the definition under section 124 of the Indian Contract Act, 1872, given above. Under English law loss need not be the result of the conduct of the promisor himself or another person. It may have been caused by accident or events beyond anyone's control. In Indian law the nature of loss is confined to the conduct of some person, whereas in English law the nature of loss is not so restricted i.e., loss may entirely be unconnected with the conduct of any party. 2.4
VALIDITY OF INDEMNITY AGREEMENT
A contract of indemnity is one of the species of contracts. The principles applicable to contracts in general are also applicable to such contracts so much so that for the validity of a contract of indemnity rules as to free consent, legality of object etc., are equally applicable. Thus where consent to an agreement is caused by coercion, fraud or misrepresentation, the agreement is voidable at the option of the party whose consent was so caused [See Sec. 19 read with Secs.15, 17 & 18]. As per the requirement of the Contract Act, object of the agreement must also be lawful. An agreement the object of which is opposed to the law of the land or against the public policy, is either unlawful or void depending upon the provision of the law to which it is subject [See sec.23]. For example, an agreement to indemnify sureties on a bail bond would be void, being against public policy. Likewise where one requires another to perform an illegal act promising to indemnify him for the consequences, the agreement cannot be enforced. 2.5 CONTRACT WHEN ENFORCEABLE Commencement of the liability of the indemnifier was a matter of controversy for sometime. The question was whether the liability of the indemnifier commences only when the indemnified has actually suffered loss or when there is an apprehension that the indemnified by all chances is likely to suffer it. The former view can be traced from cases like Shanker Nimbaji v. Laxman Sapdu [AIR 1940 Bom.161]; Chand Bibi v. Santhosh Kumar Pal [(1933)146 I.C. 863] etc., which were all rested on the principle that you must be deminified before you can claim indemnity. 274 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
A different view-point regarding this was expressed as early as 1911 in the case of Re Richardson, Ex Parte The Governors of St. Thomas Hospital where Buckley J. observed indemnity is not necessarily given by repayment after payment. Indemnity requires that the party to be indemnified shall never be called upon to pay." This view was subsequently upheld in the case of Osmal Jamal & Sons Ltd. v. Gopal Purushotham [(1728) ILR 56 Cal. 262]. In that case the plaintiff company agreed to act as commission agents for the defendants firm for the purchase and sale of hessian and gunnies and charge commission on all such purchases and the defendant firm agreed to indemnify the plaintiff against all losses in respect of such transactions. Relying on that agreement the plaintiff purchased certain hessian from one Maliram Ramjidas. The defendant firm failed to pay for or take delivery of the hessian. Then Maliram Ramji Das resold it at a lesser price and claimed the difference as damages from the plaintiff company. The plaintiff company went into liquidation and the Official Liquidator filed a suit to recover the amount claimed by Maliram from the defendant firm under the indemnity. The defendants argued that in as much as the plaintiffs had not yet paid any amount to Maliram in respect of their liability they were not entitled to maintain their suit under indemnity. Lord William J. negatived the contention and decided in plaintiff's favour with a direction that the amount when recovered from the defendant firm should be paid to Maliram Ramjidas. After the landmark decision in the case of Gajanan Moreshwar v. Moreshwar Madan Mantri [AIR 1942 Bom. 302] it has been well established that the liability of the indemnifier commences as soon as the loss of the indemnified becomes absolute. The facts of that case are that in the year 1934 the plaintiff entered into an agreement with the Municipal Corporation of Bombay for the lease of a particular plot of land for a stipulated term. Pursuant to that agreement the plaintiff was put into possession of that plot of land. At the request of the defendant the plaintiff agreed to transfer the benefit of the
aforesaid agreement to the defendant. Thereupon the defendant entered into possession of the said plot and commenced to erect a building thereon. Materials for construction were supplied by one Keshav Das Mohan Das which amounted to more than Rs.5,000/-. Keshav Das Mohan Das made pressing demands upon the defendant for payment of that amount and at the request of the defendant the plaintiff mortgaged the property to Keshav Das Mohan Das by depositing the title deeds relating thereto to secure payment of a sum of Rs.5,000/- with interest. Later a futher sum exceeding Rs.5,000/- become payable by the defendant to Keshav Das. The plaintiff again at the request of the defendant effected a further charge on the property for a further sum of Rs.5,000/- and interest. Later on the transfer of the plot was duly sanctioned by the Municipality although no formal lease was executed in favour of the defendant. In the meantime the plaintiff had on several occasions requested the defendant to release him of the mortgage debt and the further charge to which the defendant did not react. Hence the plaintiff filed a suit for indemnity in respect of liability arising under the mortgage and charge. Counsel for the defendant argued that unless and until the indemnified had suffered actual loss he was not entitled to sue the indemnifier and until the mortgagee filed a suit against the plaintiff and obtained judgment, he was not entitled to sue the defendant. Rejecting the above argument the learned Judge observed : It is true under English Common Law no action could be maintained until actual loss had been incurred. It was very soon realised that an indemnity might be worth very little indeed if the indemnified could not enforce his indemnity till he had actually paid the loss. If a suit was filed against him he had actually to wait till a judgment before he could sue on his indemnity. It is clear that this might under certain cirucmstances throw an intolerable burden upon the indemnity holder. He might not be in a position to satisfy the judgement and yet he could not avail himself of his indemnity till he had done so. Therefore, the Court of Equity stepped in and mitigated the rigour of the Common Law. The Court of Equity held that if his liabiity had become absolute then he was entitled either to get the indemnifier to pay off the claim or to pay into Court sufficient money which would constitute a fund for paying off the claim whenever it was made. Therefore, if the indemnified has incurred a liability and that liability is asbolute, he is entitled to call upon the indemnifier to save him from the liability and to pay it off. It therefore follows from the above decisions that an indemnifier's liability commences as soon as the loss of the promisee becomes absolute, certain or imminent. It is not necessary that the promisee should pay for the loss. This principle has been followed in many subsequent cases. 2.6
RIGHTS OF INDEMNITY HOLDER
According to S. 125 of the Act, an indemnity holder is entitled to recover:
(a) all damages paid in connection with any suit to which the promise of indemnity applies; and (b) all costs and sums which he may have paid in bringing or defending any suit and any sum paid to effect a compromise, provided he has acted as a prudent man in the absence of indemnity would act, and he has not contravened the orders of the promisor or acted upon the promisor's authorisation. An established rule of law is that if a promisee acts on the faith of a contract of indemnity or at the request of the promisor he should be entitled to claim indemnity. This rule was applied in a catena of English and Indian cases. It has been rightly observed in the case of Lampleigh v. Braithwait {80 E.R. 255), that when a person has .... altered his position in any way on the faith of indemnity, and an action is brought against him for the matter against which he was indemnified, and a verdict of a jury obtained against him, it would be very hard indeed if when he came to claim the indemnity the person against whom he claimed it could fight the question again, and run the chance of whether a second jury would take a different view and give an opposite verdict. Therefore, by reasons of that contract of indemnity, the judgment is conclusive, although the promisor was not a party to it. A corresponding Indian case of this point was that of Chiranjilal v. Naraini [(1919)41 All. 395] where it was held that a promisee had a cause of action as soon as a decree was passed against him. This right cannot be negatived in case of oversight [Yeung v. Hongkong and Shanghai Banking Corp. (1980)2 All E.R. 599]. However, the right to indemnity cannot be claimed in the event of dishonesty, lack of good faith and contravention of the promisor's request. 2.7 RIGHTS OF PROMISOR Section 125 of the Act only lays down the rights of the promisee and is quite silent of the rights of the promisor as if the promisor has no rights but only liability towards the promisee. It cannot be presumed that as there is no specific provision in the Act about the promisor's rights he cannot possess any rights. In the logical state of things if we read S.141 of the Act which deals with the rights of surety, we can easily conclude that the promisor's rights would also be the same as that of the surety. In Simpson v. Thomson [(1878) 3 AC 279] it was thus observed: "Where one person has agreed to indemnify another, he will, on making good the indemnity, be entitled to succeed to all the ways and means by which the person indemnified might have protected himself against, or reimbursed himself for the loss". Furthermore, as regards the rights of promisor under a contract of indemnity, the principle of subrogation is applicable because it is an essential part of the law of indemnity, and is based on equity and the Contract Act contains no provision in 275 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
contravention with it [Maharana Shri Jarvat Singhji v. Secy. of State for India, (1889) ILR 14 Bom 299]. 2.8 CONTRACT OF INSURANCE AS A CONTRACT OF INDEMNITY In the contract of insurance, the insurer agrees to insure against all losses arising out of any incident, on the property of the insured. Thus any type of property insurance is basically a contract of indemnity where the insurer agrees to indemnify the loss of the assured. As such the contract of insurance must have the following incidence of indemnity: (1) the assured has to show that he has an interest in the subject matter which may be subjected to loss [Castallial v. Preston (1883)11 QBD 380] ; (2) the insurer is to make good the loss on the happening of the event against which the goods are insured ; (3) the indemnity is related to the stipulated amount ; [Carriers v. Cunard Steam Ship Company (1918) IKB 118] ; (4) the contract is to pay up to the amount of the loss. The assured cannot profit out of the insured event, and (5) the amount of indemnification is dependant on the market value. According to Lord Justice Perbret the very foundation to the insurance law is that..... the contract of insurance contained in a fire or marine policy is a contract of indemnity and of indemnity only, and that this means that the assured in the case of loss against which the policy has been made, shall be fully indemnified, but never more than fully indemnified. That is the fundamental principle of insurance, and if ever a proposition is brought forward which is at variance with it, that is to say
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which either will prevent the assured from obtaining a full indemnity, that position must certainly be wrong. Therefore, all policies on property are contracts of indemnity and law would not permit them to be otherwise construed [London Insurance Co., v Preston, (1883) 11 QBD 380]. A fire or burglary insurance sometimes may not strictly be a pure indemnity contract, when parties agree between themselves that a definite amount shall be given by the insurer to the insured irrespective of the amount of loss. In such a case, though the contract is a contract of indemnity, the insurer is entitled to the stipulated value in the event of the happening of the insured event. Life insurance on the other hand cannot be called as a contract of indemnity. In Godsall v. Boldero [(1807)9 East 1972], the court held that the policy for life insurance is a contract not to make good a loss but to pay a sum of money on the death of the party. In a life policy the loss of the policy holder cannot be calculated on the basis of any reason or rhyme. Therefore, a person may have several life policies and on his death, his beneficiary will receive insured amount from all policies, but in case of a property insurance, if a person has several policies he is not entitled to all the policy amount in the event of loss of the property. He is entitled to only the exact amount of loss prorata from all policies. Sometimes a life policy may also be an indemnity policy. As for example, if a creditor takes a policy on the debtor, he is entitled to the exact amount of the debt on the death of the assured. Therefore the nature of the contract has to be understood from the terms and conditions of the contract as a whole.
3. CONTRACT OF GUARANTEE SUB-TOPICS 3.1. Definition and Meaning 3.2. Distinction between Indemnity and Guarantee 3.3. Essentials of a contract of guarantee 3.4. Kinds of guarantee 3.5. Rights of a surety 3.6. Liability of a surety 3.7. Discharge of surety 3.1 DEFINITION AND MEANING A contract of guarantee is in essence a contract by which one person (the guarantor) agrees to answer for some liability of another (the principal debtor) to a third person (the creditor). The contract may be constituted by a personal engagement on the part of the guarantor, or by a charge on property without any personal liability or by both. Prima facie a guarantor does not merely undertake to perform if the principal debtor fails to do so; he undertakes to see that the principal debtor will perform. Important results flow from this prima facie rule of construction. In particular it means that a guarantor is normally liable to the same extent as the principal debtor for damages for breach of the later's obligations even though he has not in terms guaranteed the payment of damages [Moschi v. Lep Air Services Ltd (1973) AC 331]. In English law guarantee has been defined as "a promise to answer for the debt, default or miscarriage of another". Thus a contract of guarantee is a collateral engagement to be liable for the debt of another in case of his default. The basic function of a contract of guarantee is to enable a person to get a loan, or goods or an employment. Some person to whom we may call guarantor comes forward and promises the lender, or the supplier or the employer that he (who requires loan, goods or employment) be trusted and in case of his default, he (guarantor) undertakes to be responsible. Likewise were the observation of the court in Birkmyr v. Darnell [(1704) 91 ER 27]. Section.126 of the Indian Contract Act defines contract ofguarantee as: "A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third person in case of his default. 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', and the person to whom the guarantee is given is called the ‘creditor'. A guarantee may either be oral or written" Section 126 of the Act specifically indicates that the contract of guarantee postulates concurrence of three persons i.e., the surety, the principal debtor and the creditor. A contract of guarantee must therefore involve a contract to which all these three parties are privy. In Duncan Fox & Co v. North & South Wales Bank [(1880) 6 App Cas 1], it was pointed out by Lord Selborne that there are three possible variations in the parties to a contract of guarantee. The first and simplest case is that in which all three parties concerned are parties to the contract in
the sense that both the principal debtor and the creditor agree that the guarantor's liability is secondary only, and that the principal debtor is primarily liable for the obligations guaranteed. But it is also possible that the contract of guarantee may be recognized only as between the principal debtor and the guarantor, or as between the creditor and the guarantor, in which event the rights and duties arising out of the contract of guarantee only affect these parties. A contract of guarantee or suretyship, is formed, like any other ordinary contract, by offer and acceptance, supported by consideration. That is to say it requires for its formation the two positive elements of consensus ad idem and the presence of either form of consideration and should not be vitiated by the presence of any of the three elements of incapacity to the contract, flaw in consent and the unlawful character of the agreement. As per section 126 of the Act, guarantee may be either oral or written and in this respect it is distinct from English law where under section 4 of the Statutes of Frauds, 1677, a contract of guarantee must be evidenced by a memorandum in writing and signed by the party charged therewith. Furthermore in India guarantee may be express or implied or it may be inferred from the course of conduct of the parties concerned. [See Mir Niyamath Ali Khan v. Commercial and Industrial Bank Ltd., AIR 1969 AP. 294]. 3.2 DISTINCTION BETWEEN INDEMNITY AND GUARANTEE The distinction between a contract of guarantee and that of indemnity is important and remains clarified in the Common Law system. As per Halsbury, although a contract of guarantee maybe described as a contract of indemnity in the widest sense of the term 'indemnity', yet contracts of guarantee are distinguished from contract of indemnity ordinarily so called by the fact that a guarantee is a collateral contract, i.e., ancillary or subsidiary to another contract, whereas an indemnity is a contract by which the provision undertakes an original and independent obligation. In certain cases, where there is primary and secondary liability of two persons for one and the same debt, they may stand in relationship to one another as principal debtor and surety, even though no express contract of suretyship exists. The existence of such a primary and secondary liability does not, however in every case necessarily create the relationship of principal debtor and surety. Thus despite the fact that there is a primary and secondary liability, for instance, between the transferee and the transferor of shares, the relation between them is not that of principal debtor and surety. [Halsbury, p.416]. As pointed out earlier there should be three sets of contractual relationships in a contract of guarantee under S. 126, in contradiction to contract of indemnity. One is between the creditor and the principal debtor; the second between the creditor and the surety; and the third, between the principal debtor and the surety. If the first two are the only contracts, the case is 277 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
clearly one of indemnity. It is the third contract-the one where the principal debtor requests a third person expressly or by necessary implication to act as surety that constitutes a contract of guarantee.[Ramchandra B. Loyalka v. Shapurji N. Bhownagree AIR 1940 Bom.315; Janwatory v. Jethmal AIR 1958 Raj. 343]. One of the essential elements required for a transaction of a guarantee is the presence of three different parties collaborating in the execution of a deed of guarantee. Where this element is missing and the principal debtor is not taken into consideration at all, the deed is not one of a guarantee but is only an indemnity bond. [Ms.Radha Kanwar v. Ram Narain AIR 1952 All 587]. Thus if a person undertakes to reimburse another for some loss which may be caused to him, by a third party or by himself, but not at the request, express or implied, of the third party, then the person who, having undertaken the liability and having been called upon to make good the loss, will not be able to recover the loss so caused to him from the principal debtor, the latter not being privy, but virtually a stranger to the undertaking given to the promisee, such a contract is not a contract of guarantee but one of indemnity [Janwatory v. Jethmal AIR 1958 Raj. 343].
The term liability in section 126 means liability enforceable by law and there cannot be a contract to guarantee a time barred debt. For example, A borrows money from B, C undertakes that he will pay that debt in case A fails to pay. C has guaranteed the repayment of debt on A's default. Thus the surety agrees to run the risk for the payment of the principal debt on the default of the principal debtor.
Amongst the procedural distinction between indemnity and guarantee, one has to know that indemnity contracts are required to be in writing and necessary stamp duty is to be paid, but a contract of guarantee does not require any stamp duty and hence it need not be in writing. The importance of this distinction cannot be highlighted because guarantee contracts are obligatory to be in writing if not compulsorily on an agreement bond, which is the common practice. The guarantor has a contingent liability which is collateral to the main transaction and arising only on default of the principal debtor.
Surety for past debt is valid when there is fresh consideration for the promise. It must be necessary that the intention to include a past promise must be made clear so as to bind the surety for a past debt. It has been stated that once a fresh obligation is incurred, the liability for all obligations is coupled up. In Carlesbury Brewery Malaysia v. Soon Heng AW & Sons, [(1989)1 Mal LJ. 104 HC Kota Bahri], the court on going through the guarantee found that it was within the contemplation of the parties that the guarantors were to be saddled with the liabilities accruing not only after but also before the signing of the guarantee.
3.3 ESSENTIALS OF A CONTRACT OF GUARANTEE Some of the essential features of guarantee are as follows: 1. Contract of guarantee may be oral or written According to English Law section 4, of the Statute of Frauds, 1877 renders an unwritten contract of guarantee unenforceable on an action before a court of law. A valid guarantee contract must be in writing and signed. Whereas under section 126 of the Indian Contract Act, 1872, a contract of guarantee need not necessarily be in writing. It may be expressed by word of mouth or it may also be tacit or implied and may also be inferred from the course of conduct of the parties. 2. Principal debt The object of guarantee being securing the payment of debt, the existence of a recoverable debt is necessary. Contract of guarantee requires that there should be principal debtor and the guarantor (surety) should undertake to pay the debt to the creditor if the principal debtor fails in the performance of his liability. For a valid guarantee there must be a principal debt and there must be one who should undertake the liability of the payment of principal debt on the default of the principal debtor. 278 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
3. Consideration The question as to what constitutes consideration for the promise of surety has been discussed in many cases. In Marely v. Boothby [(1825)3 Bing 107], Best C.J. observed, no court of common law has ever said that there should be a consideration between the persons giving and receiving the guarantee. It is enough if the person for whom the guarantor becomes surety receives a benefit, or the person to whom the guarantee is given suffers inconvenience, as an inducement to the surety to become guarantor for the principal debtor. However, under English Law, the general rule of consideration that, it must be either executed or executory but cannot be past also applies to contracts of guarantee.
Under Indian Law, S.127 of the Act, 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." Different interpretations are given to this section by various High Courts. Some High Courts viewed that past consideration also constitutes a valid consideration in a contract of guarantee. Thus in Gulam Husain v. Faiyaz Ali Khan, [AIR 1940 Oudh 346], a surety bond was executed for an amount including a past debt of the principal debtor - lessee. The surety contended in appeal that his promise was not supported by consideration. The court holding that the surety bond was not without consideration observed, there is nothing in the bond to show if arrears upto that amount were due from the lessee in respect of any period of the lease subsequent to the first year. The surety would not be liable. In Prasanjit Mahtha v. United Commercial Bank, [AIR 1979 Pat. 151], it was held that a guarantee given after the execution of the loan document is valid. In a recent case the Bombay High Court in Union Bank of India v. Avinash P. Bhonsle, [(1991) M.L.J. 1004], accepting the validity of past consideration as good consideration in a contract of guarantee, observed :
It is well settled that just as illustrations should not be read as extending the meaning of a section, they should also not be read as restricting its operations, especially so, when the effect would be to curtail a right which the plain words of the section would confer.It is, therefore, clear that when the language of the text of Sec. 127 of the Contract Act is clear and unambiguous, the sweep of the text cannot be curtailed by using illustration (c) to impose a limitation on the expression "anything done or any promise made for the benefit of the principal debtor" that it should be done at the time of giving the guarantee. The language is wide enough to include anything that was done or a promise made before giving the guarantee and would not restrict the application of the section only to what was contemporaneously done. There are also contradictory judgments given by Andhra Pradesh High Court in the case of M.N.A. Khan v. Commercial & Industrial Bank, [AIR 1969 AP 294] and Calcutta High Court in Allahabad Bank v. S.M. Engg. Industries [(1992)1 Cal.L.J. 448] where past consideration was held not to be a valid, good consideration. In that case the bank was not allowed to sue the surety without further or any advance made after the date of the guarantee. In Kalicharan v. Abdul Rehman, [AIR 1918 PC. 226], a guarantee for leasing transactions was held not to cover agreement which was concluded before the date of the guarantee. A keen insight into the above cases shows that the former view regarding the validity of past consideration seems to be more just. Moreover, the definition in S.2(d) of the Act also contemplates past consideration as valid consideration and therefore there should not be any reason why it should not be applied in the case of contract of guarantee. 4. Consent of the surety should not have been obtained by misrepresentation or concealment Any guarantee which has been obtained by means of misrepresentation made by the creditor or with his knowledge of and assent, concerning a material part of the transaction is invalid [S. 142]. And any guarantee which the creditor has obtained by means of keeping silence as to the material circumstances is invalid [S. 143]. For example: 1) A engages B as clerk to collect money for him. B fails to account for some of his receipts and A in consequence calls upon him to furnish security for his duly accounting. C gives his guarantee for B's duly accounting. A does not acquaint C with B's previous conduct, B afterwards makes default. The guarantee is invalid; 2) A guarantees to C payment for iron to be supplied by him to B to the amount of 2000 tons. B and C have privately agreed that B should pay five rupees per ton beyond the market price, such excess to be applied in liquidation of an old debt. This agreement is concealed from A. A is not liable as surety. Concealment under S. 143, is fraudulent. Indian law makes a distinction between intentional concealment and mere nondisclosure. To invalidate a guarantee thus, two points have to be proved, first that there was misrepresentation as to a material part of the transaction, or silence as to material circumstance
and, second, that the guarantee was in fact obtained by means of such misrepresentation or silence. Indian courts have, however, distinguished between fiduciary guarantees by person in favour of banks. In the first case, the requirement as to the disclosure of all material circumstances has to be strictly satisfied. But, where the suretyship is with regard to an advance to be made by a bank, the bank need not disclose part indebtedness to the surety [Imperial Bank of India v. V. P. Avanasi Chettiar AIR 1930 Mad 874; See also A. R. Krishnaswamy Iyer v. Travancore National Bank AIR 1940 Mad 437 ]. 5. Legal A contract of guarantee must also satisfy the element of legality. Illegality of object or consideration vitiates a contract of guarantee. The term 'liability' under S.126 envisages a liability enforceable by law. Therefore a contract to guarantee a timebarred debt is void for illegality. 6. Flaw in consent A contract of guarantee becomes invalid by reason of flaw in consent. According to Ss.142 and 143, a contract of guarantee becomes invalid if there is a misrepresentation or concealment of material circumstances by the creditor. Hence if a creditor knows of a previous misconduct of the principal debtor but does not discloses it to the Surety, the Surety cannot be made liable. 7. Existence of principal Debt In addition to all the above essentials, it is necessary for a contract of guarantee to be valid that there should be a principal debt which forms the very basis of the contract. In Swam v. Bank of Scotland[ (1836)10 Bligh NS 627] where a surety guaranteed an overdraft which was declared void under a statute the surety was discharged of his liability and the Court observed, 'if there is nothing due, no balance, the obligation to make that nothing good itself amounts to nothing. If no debt is due, if the banker is forbidden from having any claim against his customer, there is no liability incurred by the co-obligers. 3.4
KINDS OF GUARANTEE
The liability of a surety squarely depends upon the nature of guarantee stipulated in the contract. Since the obligation of a surety arises on account of a debt or duty owed by the principal debtor, the surety, who is altogether a stranger to the main contract, may of his own will stipulate conditions or terms which bind him to the contract, or he may make himself to be strictly bound by the obligations of the principal debtor. Hence the liability of the surety depends upon the nature of guarantee which was agreed upon between the parties. The following are the various kinds of guarantee which varies the obligations of a surety according to its nature. (i) Conditional Guarantee A Surety may require a condition precedent to be fulfilled by the creditor failing which he should not be made liable. A partial 279 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
recognition of this principle is to be found in section 144 under which it is stated that where a person gives a guarantee upon a contract that a creditor shall not act upon it until another person has joined it as co-surety, the guarantee is not valid if that other person does not join. In National Provincial Bank of England v. Brakenbury [ (1906)22 TLR. 797], the defendant signed a guarantee which on the face of it was intended to be a joint and several guarantee of three persons with him. One of them did not sign. There being no agreement between the bank and the co-guarantors to dispense with his signature, the defendant was held not liable. In a similar case, James Graham & Co. v. South-Gate Sands, (1985)2 All E.R. 344 CA, the plaintiff supplied timber to a company of which the defendant was a director. The company being unable to pay, the plaintiff agreed to suspend the claim for a year provided the debt was jointly and severally guaranteed by Company's three directors. A guarantee apparently signed by the defendant and other directors, was duly provided. The Company went into liquidation. The plaintiff sought to enforce the guarantee. Before the trial of the action it was discovered that the signature of one of the directors had been forged. The Court said : "A joint guarantor under a guarantee which showed on its fact that the other joint guarantors were intended to be parties is not liable at law if the signature of one of the guarantors is forged, since there is no contract of guarantee unless all the anticipated parties to the Contract in fact became bound". (ii) Limited Guarantee A surety may, while undertaking to guarantee a debt, place a limit upon his liability, by which he expressly declares that my liability under the guarantee shall not at any time exceed the sum of Pound 500". In such a case, whatever may be owing from the principal debtor, the liability of the surety cannot go beyond the sum so specified. In Yarlagadda v. Devata China Yerkayya, a case before A.P. High Court, a clause in a contract of suretyship making the surety liable upto Rs.15,000/- further declared that he would be liable for any amount that might be finally decreed. It was held that the clause should be construed as meaning not exceeding Rs.15,000/-. If however, the surety undertakes to repay the whole debt of Rs.5,000/ then his liability will be Rs.5,000/- plus interest thereon. (iii) Continuing Guarantee Section 129 of the Indian Contract Act, 1872 defines a continuing guarantee as one which extends to a series of transactions. This kind of guarantee is intended to cover a number of transactions over a period of time. The essence of a continuing guarantee is that is applies not to a specific transaction but to any number of transactions and makes the surety liable for the unpaid amount at the end of the guarantee. Examples (a) I do hereby guarantee the payment for goods to be delivered in umbrellas and parasols to J in the sum of Pound 200. 280 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
(b) A guarantees payment to B, a Tea dealer to the amount of Pound 100, for any tea he may from time to time supply to C. B supplies C with tea to the above value of Pound 100 and C pays B for it. Afterwards B supplies C with Tea to the value of Pound 200. C fails to pay. The guarantee given by A was a continuing guarantee and hence he was liable to B to the extent of Pound 100. Whether in a particular case the guarantee is continuing or not is a question of the intention of the parties, "as expressed by the language they have employed, understanding it fairly in the sense in which it is used; and this intention is best ascertained by looking to the relative position of the parties at the time the instrument is written. The Court has power "not to alter the language but to fill up the instrument where it is silent. In construing the language of the parties the whole of their expressions must be looked to, not merely the operative words. Thus the following words were held to show that a guarantee, which otherwise might have been confined to a single transaction, was intended to be continuing : "Having every confidence in him, he has but to call upon us for a cheque and have it with pleasure for any account he may have with you; and when to the contrary we will write you". Explaining the distinction between a continuing guarantee and a specific guarantee. Chorley and Tucker commented that a specific guarantee provides for securing of a specific advance or for advances upto a fixed sum, and ceases to be effective on the repayment thereof, while a continuing guarantee covers a fluctuating account such as an ordinary current account at a bank and secures the balance owing at any time within the limits of the guarantee. (Chorley and Giles, P. 332). Thus in the case of Kay v. Groves [(1829)80 ER 1274], the guarantee was in these terms. "I hereby agree to be answerable to K for the amount of five sacks of flour to be delivered to T, payable in one month." Five sacks were actually supplied and T paid for them. Further supplies were actually made during the same month for which T failed to pay. When the surety was sued, the Court held that it was not a continuing guarantee, and therefore,there was no liablity for parcels delivered for various subsequent periods." Revocation of Continuing Guarantee Under S.130 of the Contract Act, a continuing guarantee may at any time be revoked by the surety as to future transactions, by notice to the creditor. In such a situation, a surety becomes liable for transactions already entered into whereas the future transactions are affected by revocation. The case of Offord v. Davies is a fitting illustration in this context. The defendants guaranteed the repayment of bills to be discounted by the plaintiffs for twelve months not exceeding Pound 600. The defendants revoked the guarantee before any bill was discounted. But the plaintiffs discounted the bills which
remained unpaid. The question was whether the surety had a right to revoke. The Court said that they had and consequently they were not liable. [(142 ER 1336)]
but the seller is assured of payment irrespective of the compliance or non-compliance of the terms of the contract between the seller and the buyer.
In the case of a continuing guarantee, every credit given is a separate transaction which makes the surety irrevocably liable, but he may free himself from further liability.
It is an established rule laid down in many English and Indian cases that where a bank gives a guarantee to pay on ‘first demand' and ‘without contestation' and ‘without reference to such party' and without questioning the legal relationship in whose favour the guarantee was given and the party on whose behalf it was given ‘not withstanding any dispute between the parties' the bank if obliged to pay according to the contractual obligation and the court will not give an injunction restraining to pay.
Where the directors of a company guaranteed the payment of the company's overdrafts and subsequently resigned their office and the bank was informed, it was held that the liability of the directors would be confined to the amount due up to the date of resignation. (Hargopal Agarwal v. State Bank of India, [AIR 1956 Mad. 211)]. Whether a guarantee for payment of rent can be revoked depends upon the fact of each case and the language employed by the parties to express their intention. In a guarantee of this kind where the surety died, the Court held that neither he could have revoked the guarantee during his lifetime nor was his estate released from liability. [ (Belfour v. Crace (1902, 1 Ch. 733)] Joyle J. observed : "The right to determine or withdraw a guarantee by notice forthwith cannot possibly exist when the consideration for it is indivisible, so to speak, and moves from person to whom the guarantee is given once for all, as in the case of the consideration being the giving or conferring an office or employment upon any person whose integrity is guaranteed." However when a person guaranteed the payment of rent by his servant and revoked the guarantee as soon as the servant left his employment, he was held not liable for rents which became due after the revocation. [Windfield v. Dest Croin, (1919 35 TLR, 432)]. For a revocation to be effective, notice to the creditor must be clear and specific, and intended to terminate liability under the guarantee. A denial of liability in a previous suit was held to be not serving as a notice.(Bhikabhai v. Bai Bhuri, ILR 27 Bom.418). (iv) Bank Guarantee The wheels of international trade are largely run due to the significant role played by modern banks. Banks play the role of an intermediary between traders in and out of the country. Bank guarantee acts a motivating force for buyers and sellers to involve in international trade. Under a Bank guarantee, the bank gives a 'performance bond' at the instance of a seller for fulfilment of seller's obligation under the contract of sale, the guarantee being that the guarantor would pay on first demand without any condition or proof. In the words of Pollock & Mulla, a bank guarantee has a dual aspect. It is not merely a contract between a bank and the beneficiary of the guarantee, it is also a security given to the beneficiary by a third party. In seeking to enforce the guarantee the beneficiary in effect seeks to realise the security furnished by the third party. The third party, has, therefore locus standi to challenge the guarantee enforcement. The Courts are slow to interfere with its operation not merely on the ground of its importance in international trade
A leading case on this principle is the case of Maharashtra Electricity Board, Bombay v. The Official Liquidator, High Court, Ernakulam, [AIR 1982 SC 1497]. The main issue in that case relates to the effect of liquidation proceedings on the right of the Electricity Board to recover from the bank the sum of Rs.50,000/- as per the terms of the bank guarantee. Under the contract the bank has undertaken to pay any amount not exceeding Rs.50,000/- to the Electricity Board within forty eight hours of the demand. The payment of the amount guaranteed by the bank is not dependent upon the proof of any default on the part of the company in liquidation. When the Electricity Board sought to enforce the guarantee, the Official Liquidator filed an application before The Company Judge praying for an order restraining the Electricity Board from realising the amount covered by the guarantee on the ground that since the company in liquidation had been ordered to be wound up the Electricity Board could not claim the amount from the bank. The bank contended that the amount of Rs.50,000/- was not being claimed as a creditor of the company in liquidation but on the basis of the bank guarantee, the liability under which was not affected by the liquidation proceedings. The learned Company Judge upheld the plea of the Official Liquidator and issued an order restraining the Electricity Board from realising the amount from the bank on the ground that since the bank would have recourse to other securities given by the company in liquidation to the bank for realising the amount paid by it in accordance with the bank guarantee and such action of the bank would affect the assets of the company in liquidation, it was not open to the Electricity Board to claim the amount of guarantee from the bank except as a creditor in the winding up proceedings. An appeal filed by the Electricity Board before the Division Bench of the High Court was dismissed. Hence the appeal was filed in the Supreme Court. The Supreme Court setting aside the order of the Company Judge and the Division Bench allowed the appeal saying that the liability of the bank under the guarantee is not dependant upon prior proof of any default on the part of the company in liquidation. Hence the bank has to pay the amount due under the guarantee. In Banwari Lal v. Punjab State Co-op. Ltd. [AIR 1983 Del.86, 89], the Delhi High Court said that if scrutiny is commenced in respect of the underlying contract, obviously the autonomy and independence of an absolute guarantee would be lost. Its enforcement would depend upon the result of an inquiry. This would defeat the very purpose of a bank guarantee. 281 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
The obligation of a bank under a bank guarantee is absolute and the autonomy of a bank to honour it on demand should not be normally interfered with, by an order for injunction restraining the bank from paying. The Supreme Court in U.P. Co.-op. Federation Ltd. v. Singh Consultant and Engineers Ltd. [(1988)1 SCC 174], emphasised that the operation of a bank guarantee should be stayed only in cases of serious dispute, fraud or special equities. In that case two bank guarantees were furnished by a contract or for the proper construction and successful commissioning of a vanaspati plant. The bank was not to revoke the guarantees upto a fixed date and was to make unconditional payment on demand. The Board was to be the sole judge of the fact whether the contractor has fulfilled the terms of the contract. Disputes arose as to the erection and performance of the plant between the contractor and the Board. The contractor sought an injunction to restrain the Board from enforcing the guarantee. The court found no serious ground for doing so. The court felt that respectability and reliability of the assured mode of payment through confirmed letters of credit in international trade and bank guarantee in national trade is necessary for the growth and promotion of trade. Shetty J. cited the dictum of Lord Diplock in U.C.M. (Investments) v. Royal Bank of Canada who reviewing the American authorities stated that fraudulant use of guarantee papers by the seller is the only case in which the court should stay misuse of a credit system. The exception for fraud on the part of the beneficiary seeking to avail himself of the credit is a clear application of the maxim ex turpi causa non oritur actio, or if plain English is to be preferred, 'fraud unravels all.' The case of Dai-ichi Karkaria Pvt. Ltd. v. Oil and Natural Gas Commission, [AIR 1992 Bom.309] holds a good illustration of this kind of fraud where the Bombay High Court emphatically asserted that the law cannot allow the benefit of a bank guarantee to be claimed by unscrupulous methods. In this case the party in question was compelled at the pain of stopping business with him to drop from his bank guarantee the original requirement that it would be encashable only when the parallel amount of import duty paid by him was refunded to him. As soon as ONGC attempted to enforce the altered guarantee, he applied for and was granted a stay against such encashment. He was the victim of undue influence bordering on fraud and the special equities thus generated created the necessity of rescuing the party from being victimised. In Kirloskar Pneumatic Co. Ltd. v. National Thermal Power Corporation, [AIR 1987 Bom.308], where a contractor gave a bank guarantee along with his bid as was required by the tender notice, the bidder, having the right to do so, withdrew his bid before its acceptance, the Department was restrained encashing the guarantee. There was no contract yet about which it would be said that there was a breach. However, in D.T.H. Construction Pvt. ltd. v. S.A.I.L., [AIR 1986 Cal. 31], injunction was not granted as the grounds for preventing 282 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
enforcement of guarantee were held not to be sufficient. The facts of the case are that the contract was for dredging and deepening a reservoir. Advance payment was made to the contractor for purchase of essential machinery on bank guarantee. SAIL sought encashment on account of the contractor's default. The contractor tried to prevent it on the ground that the work assigned to him was impossible and that important facts were suppressed from him. These grounds were held not to be sufficient to prevent encashment. The case law on this subject is immensely growing along with the increasing international trade. Bank guarantee is enforced with little interference from third party viz., the person on whose behalf it was given. In the words of Sen J. in Centex (India) Ltd. v. Vinar Impex Inc. [(1986)4 SCC 136], "Commitments of banks must be allowed to be honored free from interference from the courts. Otherwise, trust in international commerce would be irreparably damaged." It is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by banks. They are the life blood of international commerce - Kerr.J in R.D. Barbottle (Mercantile) Ltd. v. National West Minister Bank Ltd. [(1977)3 WLR,. 752]. The only exception for enforcement of bank guarantee is that of fraud. Another important aspect in relation to bank guarantee is that writ jurisdiction is not a proper remedy for demanding stay. Further, enforcement of a bank guarantee cannot be made the subject matter of arbitration proceedings. But where a bank found that there was a pending arbitration under which the liability of all parties had to be ascertained, the Karnataka High Court upheld the decision of the bank to withhold payment in the case of Kudremukh Iron Ore Co. v. Kerala Rubber Ltd.,[ AIR 1987 Kant. 139]. The majority view as expressed by the Supreme Court is that it cannot be subject to arbitration proceeding. 3.5 RIGHTS OF SURETY I Rights against Principal Debtor The rights enjoyed by a Surety can be well explained under three important doctrines viz., i) doctrine of subrogation (S.140), ii) doctrine of indemnity (S.145), and iii) doctrine of contribution (S.147). The rights of a surety lies against the principal debtor, creditor and co-sureties. The rights of a Surety as against the principal debtor can be discussed under two heads viz., 1) before payment; and 2) after payment. The two rights of sureties arising before and after payment are described in Snell's Principles of Equity, 467 (28th ed. by P.V.Baker and St.Langan as under :
"The Surety has an equitable right to compel the Principal debtor to pay the debt and so relieve the Surety from the necessity of paying it out of his pocket. It is in the nature of quia timet, and is based on the principle that is unreasonable that a man should always have a cloud hang over him, so that he ought to be entitled to remove it. It is therefore immaterial that the creditor has refused to sue or that he has made no demand. A fortiori, the action lies where the Principal debtor threatens to commit a breach of the obligations which the Surety has guaranteed and an order may be made even though the Principal debtor is without funds. But an action will not lie where the debt is not an actual, accrued or definite debt or, if on its true construction, the guarantee precludes action before the Creditor demands payment". The case of Mamata Ghose v. United Industrial Bank, [AIR 1987 Cal.280], is a leading example regarding the right of a surety before payment. In that case the surety found that the amount having become due, the principal debtor was disposing of his personal properties one after the other lest the surety, after paying, may seize them, and sought a temporary injunction. The Court granted the injunction. Sukumar Chakravarty J said that if in any suit it is proved by affidavit or otherwise that the defendant threatens, or is about to remove or dispose of property with intent to defraud his creditors, the Court may grant a temporary injunction to restrain such act or give such other order for the purpose of staying or preventing the removal or disposition of the property. (i) Doctrine of Subrogation Under Section 140 of the Act a surety on payment of the amount due under the contract of guarantee to the creditor steps into the shoes of the creditor and is invested with all the rights which a creditor had before such payment. This doctrine derives its source from the equitable principles laid down in the early 19th century as propounded in the argument of the learned counsel Sir Samuel Romilly in the case of Huguenin v. Basetey [9 R.R. 148] which was approved by the Court. The statement of the principle was to this effect : "A Surety is to be entitled to every remedy which the creditor has against the principal debtor; to enforce every security and all means of payment; to stand in the place of the creditor, not only through the means of contract, but even by means of securities entered into without the knowledge of the Surety, having a right to have those securities transferred to him, though there was no stipulation for that, and to avail himself of all those securities against the debtor. This right of Surety also stands not upon contract, but upon a principle of natural justice." A right of subrogation is available to the surety on payment of the amount due to the creditor. One important point which needs to be clarified at this juncture is the question as to the right of a surety to avail the securities in case of payment against part of the debt. Sometimes a surety guarantees only a part of the debt by imposing a limit on the amount. For example A
acts as surety for the debt due by B to C to the extent of Rs.10,000/- whereas the actual sum due is Rs.20,000/-. The question here is whether on payment of Rs.10,000/the surety can claim a right over securities over which the creditor has a right. The amount of Rs.10,000/- paid by surety may be payment of full amount so far as he and the principal debtor are concerned. But it does not amount to full satisfaction of the debt so far as the creditor is concerned. Hence the surety cannot have any right over the securities till the whole debt of the creditor is paid. This principle was applied in the case of Goverdhan Lal v. Bank of Bengal [(1890)15 Bom.48] where it was held that the surety cannot have any rights until the creditor has been paid in full, even though the surety might have paid all that he was bound to pay under the contract. Farran J said : "The creditor's right to hold his security until his whole debt is paid, is paramount to the surety's claim upon such securities which only arises when the creditors claim against such securities has been satisfied." However if the surety is given for a part of debt and payment is made thereof, which amounts to payment of the whole debt as between him and the creditor, then such payment entitles the surety a right over the securities. This can be illustrated by a simple example. A guarantees the unpaid calls on shares of a company on shares held by B. B commits default and A pays the amount due to such shares. On such payment, though only a part of the debt due by B, which amounts to payment for the whole debt as against the Company, the surety 'A' is entitled to dividends on those shares. The intention of the legislature while enacting s.140 is to keep alive for the surety's benefit any right of the creditor, under a security or otherwise, which would otherwise have been extinguished at law by payment of the debt or performance of the duty. We are not interested in anything else, at the moment, If the right arising under this section can be exercised only in respect of benefits/securities arising from the same transaction but not in respect of others. Therefore as held in Bank of Baroda v. Krishna Balab,[ (1975) A. Raj.1], where the surety's liability is on the credit loan account of the debtor, he cannot, on payment of that loan, claim the benefit of money lying in the cash credit account. The rights of a surety as against the principal debtor are also embodies in S.141 by which he is entitled to the benefit of every security which the creditor has against the principal debtor whether he knows of its existence or not. If the security is lost or parted with without his consent, he is entitled to a partial discharge of his liability. However, loss arising due to an act of God does not fall within S.141 so as to give the surety a right of discharge. The distinction between S.140 and 141 is that the former speaks of right of a surety before payment while the latter speaks of rights after payment. The only distinction between S.141 and 283 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
the English Law is that under S.141 a surety's right is limited only to securities at the time of contract whereas under English law 'after taken' securities are also equally available to the surety. Commenting on this aspect Sir Frederick Pollock stated that a deliberate change from the English Law was not intended but that the Act is only codification of equity some what out of date. (Indian Contract Act and Specific Relief Act, Tenth Edn., 1986 at P.757) (2) Right to indemnity This right is contained in section 145 of the Act which reads - " Implied promise to indemnify surety.- In every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the guarantee, but no sums he has paid wrongfully". Illustrations appended to the section make the right to indemnity clear. These read: (a) B is indebted to C, and A is surety for the debt. C demands payment from A, and on his refusal sues him for the amount. A defends the suit, having reasonable grounds for doing so, but is compelled to pay the amount of the debt with costs. He can recover from B the amount paid by him for costs, as well as the principal debt. (b) C lends B a sum of money, and A, at the request of B, accepts a bill of exchange drawn by B upon A to secure the amount. C, the holder of the bill demands payment of it from A, and on A's refusal to pay, sues him upon the bill. A, not having reasonable grounds for so doing, defends the suit, and has to pay the amount of the bill and costs. He can recover from B the amount of the bill, but not the sum paid for costs, as there was no real ground for defending the action. (c) A guarantees to C, to the extent of 2000 rupees, payment for rice to be supplied by C to B. C supplies to B rice to a less amount than 2000 rupees, but obtains from a payment of the sum of 2000 rupees in respect of the rice supplied. A cannot recover from B more than the price of the rice actually supplied.
"141. Surety's right to benefit of creditor's securities - A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such surety or not; and if the creditor loses, or, without the consent of the surety, parts with such security, the surety is discharged to the extent of the value of the security". Illustrations (a) C advances to B, his tenant, 2,000 rupees on the guarantee of A. C has also a further security for the 2,000 rupees by a mortgage of B's furniture. C cancels the mortgage. B becomes insolvent, and C sues A on his guarantee. A is discharged from liability to the amount of the value of the furniture. (b) C, a creditor, whose advance to B is secured by a decree, receives also a guarantee for that advance from A. C afterwards takes B's goods in execution under the decree, and then, without the knowledge of A, withdraws the execution. A is discharged. (c) A, as surety for B, makes a bond jointly with B to C, to secure a loan from C to B. Afterwards, C obtains from B a further security for the same debt. Subsequently, C gives up the further security. A is not discharged.
II Rights against Creditor
The right under the section is limited to the securities existing at the time of the formation of the suretyship contract [Govardhan Lal v. Bank of Travancore, AIR 1968 SC 1432; see also illustration (c) to the Section]. But the sale in English law does not place any such limitation. In Forbes v. Jackson [(1882) 19 ChD 615], where brief facts were: the principal debtor borrowed 200 Pounds against the mortgage of his lease hold premises and a policy of life insurance, the defendant joining as surety. The debtor borrowed further sums on the same securities without the knowledge of the surety. The principal debtor failed to pay. Surety paid the debt along with the interest and claimed both securities. The creditor demanded payment of the further advance also. It was held that the surety was entitled to have any security held by the creditor, irrespective of whether it was taken before or subsequent to the contract of surety. The difference between the Indian and English law was explained in Amritlal v. State Bank of Travancore, [AIR 1968 SC 1432] thus"It is true that section 141 has limited the surety's right to securities held by the creditor at the date of his becoming surety and has modified the English rule that the surety is entitled to the securities given to the creditor both before and after the contract of guarantee. But subject to this variation, section 141 incorporates the rule of English law relating to discharge from liability of a surety when the creditor parts with or loses the security held by him".
(1) Right to Securities
When right to securities accrues
Section 141 contains the most practical application of the principle laid down in section 140 which we have discussed earlier. Section 141 reads:
This aspect was discussed in Govardhandas v. The Bank of Bengal [(1890) 15 Bom 48]. It was there laid down that the
Thus the relation of surety and the principal debtor gives rise to an implied promise on the part of the latter to indemnify the former. Under this right the surety is entitled to recover from the principal debtor whatever he has rightfully paid by virtue of his being a surety to the creditor. This right of indemnity is only in respect of payments which the surety has made rightfully [Chekkera Ponnamma v. A. S. Thammayya, [AIR 1983 Kant 124]. The above referred illustrations make the point clear. This must be noted that the various heads of indemnity that could be claimed are those which we have studied under section 125 in the module.
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creditor's right to hold his security until his whole debt is paid, is paramount to the surety's claim on such securities, which only arises when the creditor's claim against surety, securities has been fully satisfied. (2) Right to share reduction The section deals with the protection of the surety and the reduction of his liability in proportion to the security lost or parted with by the creditor without the surety's consent. Mere passive inactivity or passive negligence of creditor by failing to realize the debt from a collateral security may not in itself be sufficient to discharge the surety since he can himself avoid the consequence of such possibility by himself paying the debt and becoming subrogated to the rights of creditor. It has already been noted earlier that u/s 128 the liability of the surety is co-extensive with that of principal debtor, unless it is otherwise provided by the contract. It means that the contract can provide about the lesser liability of surety than the debtor. Thus if the surety undertakes to be liable to the extent of Rupees 1000/-, his liability is limited to that extent. It was held in Hobson v. Boss [(1871) 6 ChD 792], that where the surety has guaranteed only part of the debt, and pays it, he will be entitled to the dividend from the debtor's estate, along with the creditor, who may prove for the balance of the debt, the excess over the amount guaranteed. (3) Right of set-off If the creditor sues the surety, the surety may have the benefit of the set-off, if any, that the principal debtor has against the creditor. He is entitled to use the defence of the debtor against the creditor. If for example, the creditor owes him something, or the creditor has in his hands some thing belonging to the debtor for which the debtor could have counter claimed, the surety can also put up that counter claim. He can claim such a right not only against the creditor, but also against the third parties who have derived their title from the creditor. Thus where a mercantile agent sold the goods of his principal and, being a surety for payment of the price to the principal, had to pay it, he was held to have become entitled to the unpaid seller's lien against the buyer and those deriving title from him [Avtarsingh pp.471-72]. III Rights against co-sureties (1) Effect of releasing a surety Section 138 reads thus: "Release of one co-surety does not discharge others. Where there are co-sureties, a release by the creditor of one of them does not discharge the others; neither does it free the surety so released from his responsibility to the other sureties". A creditor is fully competent to discharge any of the co-sureties from his liability, but the release of one surety will not have the effect of releasing the other sureties [Sri Chand v. Jagdish Prashad, AIR 1966 SC 1427], as the liability of sureties is
joint as well as several. Though the surety may be released by the creditor, he would remain liable to the other sureties for contribution in the event of default. According to section 138 of the Contract Act if a plaintiff has chosen not to proceed against one or other of the sureties but has chosen to proceed against the rest then the release of the one or the other co-sureties by plaintiff will not free the guarantor from his responsibility to the other sureties [United Bank of India v. Modern Stores Ltd and others, AIR 1988 Cal 18]. (2) Right to contribution Sections 146 and 147 fix the liability of co-sureties for the same debt. Section 146 speaks thus: " Co-sureties liable to contribute equally. Where two or more persons are co-sureties for the same debt or duty, either jointly or severally, and whether under the same or different contracts, and whether with or without the knowledge of each other, the co-sureties, in the absence of any contract to the contrary, are liable as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor". Illustrations appended to the section make the meaning clear regarding the liability of the co-sureties thus-(a) A, B and C are sureties to D for the sum of 3000 rupees lent to E. E makes default in payment. A, B and C are liable, as between themselves, to pay 1000 rupees each. (b) A, B and C are sureties to D for sum of 1000 rupees lent to E, and there is a contract between A, B and C that A is to be responsible to the extent of one-quarter, B to the extent of one-quarter and C to the extent of one-half. E makes default in payment. As between the sureties, A is liable to pay 250 rupees, B 250 rupees and C 500 rupees. Above illustrations indicate that the co-sureties are liable to contribute between themselves equally or in accordance with the contract among themselves. Here, for a clear understanding of this section you may refer to S.43 which is analogous to this section. S. 43 deals with copromisor and this section deals with co-sureties. As under the former section joint promisors are bound inter se to contribute equally to the payment, so co-sureties have also the same obligation. The right of contribution is not dependant on any express agreement or contract. Any co-surety who has paid the whole or part of the debt is, in the absence of any contract to the contrary, entitled to recover the excess over his share [See Kamal Chunder v. V Susila Bala, AIR 1938 Cal 405; Davies v. Humphreys, (1840) 151 ER 361]. But where any co-surety becomes insolvent, the other sureties must pay the whole amount between them. Section 141, which we have discussed earlier, is also applicable to co-sureties i.e., they will also be entitled equally to the benefit of securities. The rule is that a co-surety who has received a counter security from the debtor must bring it in for the benefit of his co-sureties [Muthuswami v. Rajalu AIR 1924 Mad 848]. Section 147 reads thus285 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
"Liablity of co-sureties bound in different sums. Co-sureties who are bound in different sums are liable to pay equally as far as the limits of their respective obligations permit”. Illustrations to the section are (a) A, B and C as sureties for D, enter into three several bonds, each in a different penalty, namely: A in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditioned for D's duly accounting to E. D makes default to the extent of Rs 30,000 rupees. A, B and C are each liable to pay 10,000 rupees. (b) A, B and C as sureties for D, enter into three separate bonds, each in a different penalty, namely: A in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditioned for D's duly accounting to E. D makes default to the extent of 40,000 rupees. A liable to pay 10,000 rupees and B & C 15,000 rupees each. (c) A, B and C as sureties for D, enter into three several bonds, each in a different penalty, namely; A in the penalty of 10,000 rupees, B in that of 20,000 rupees, C in that of 40,000 rupees, conditioned for D's duly accounting to E. D makes default to the extent of 70,000 rupees. A, B and C have to pay each the full penalty of his bond. Under this section equal contribution is subject to the maximum limit, if any, fixed by a surety of his liability. This section contemplates cases where several sureties make themselves responsible for a debt, but upto a certain limit fixed by each. This section says that each surety must contribute equally subject to the limit given by each. It may be noted that the contribution under the section is equal and not ratable or proportionate to the maximum liability of each as in English law [See Ellsmere Brewery Co v. Cooper (1896) I KB 75; Davies v. Humphreys, (1840) 151 ER 361; Iyer, 515]. 3.6 LIABILITY OF SURETY I Liability of General Section 128 sketches the ambit of the liability of the surety when it enacts that his liability is co-extensive with that of the debtor. At the same time it is impliedly indicative that surety's liability would be reduced if the liability of the principal debtor is reduced under a decree of the court, or his liability is reduced or extinguished if the liability of the principal debtor is reduced or extinguished in whole or in part by virtue of a statute. Hence a statutory reduction or extinguishment of the principal debtor's liability will operate as a pro-tanto reduction or extinguish much of the surety's liability. In Narayan Singh v. Chatar Singh [AIR 1973 Raj 347] the liability of an agriculturist, who was the principal debtor, was scaled down under the Rajasthan Relief of Agricultural Indebtedness Act, 1957. It was held that the effect of scaling down the principal's liability was that the surety's liability has also been reduced. It was thus held by Tyagi, J.: "The question may be viewed from another angle also and it is that the surety, who has a right to be reimbursed by the principal debtor for the amount paid by him on his behalf, 286 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
it allowed to realize the entire amount from the agriculturist principal debtor after the decree-holder is permitted to get the entire decretal amount from the surety then it would mean that whatever benefit agriculturist debtor is entitled to get under the provisions of the Act shall be denied to him if the decree is allowed to be executed against the surety judegment debtor because after its satisfaction the principal judgement holder shall be required under the contract Act to reimburse the surety". Creditors option to sue As under section 128 the liability of the surety is co-extensive with that of the principal debtor unless it is otherwise provided by the contract. It means that on making a default, the creditor has the remedy to sue either the debtor or the surety for the realization of the debt or he may sue both of them, the debtor and the surety. Hence the liability of the surety is joint and several with the principal debtor. It cannot be said that the creditor must proceed against the debtor first and should only approach the surety if he fails to realize the debt from the principal debtor. Creditor has a right to proceed against the surety directly without exhausting his remedies against the principal debtor for realizing the decretal amount. The Supreme Court in Bank of Bihar Ltd. v. Dr. Damodar Prasad [AIR 1969 SC 297 at p. 298] held that "before payments the surety has no right to dictate terms to the creditor and ask him to pursue his remedies against the principal in the first instance. In the absence of some special equity the surety has no right to restrain an action against him by the creditor on the ground that the principal is solvent or that the creditor may have relief against the principal in some other proceedings. Likewise where the creditor has obtained a decree against the surety and the principal, the surety has no right to restrain execution until the creditor has exhausted his remedies against the principal." But were the decree is passed against the mortgaged property, principal debtor and the surety,the decree holder is required to proceed first against the mortgaged property for the realization of the debt and then against the guarantor [Union Bank of India v. Manku Narayan, AIR 1987 SC 1078]. This decision of the Supreme Court has curtailed the option available to the creditor in the particular situation. But in 1992 the Supreme Court in State Bank of India v. Industrial Export Registration Ltd. [(1992) 3 SCC 159], held that the surety's liability is co-existensive with that of the principal. It further held that a decree does not put any fetter on any of the rights of the decree holder... The choice of execution of the decree against the mortgaged property or the money decree was the decree holder's discretion. Section 128 also gives option to the surety to specify in the contract that his liability is limited and that it is not co-extensive with that of the principal debtor. In the absence of any such stipulation by the surety, his liability under the section must be deemed co-extensive. The burden to prove that the liability is limited is upon the surety. [Bharat National Bank Ltd.and another v. Thakur Dass Madhok, AIR 1935 Lah. 729]. Hence
in a contract of guarantee, the guarantor can limit his liability under this section and in that case his liability would not be beyond the limit. Condition Precedent Where a person gives a guarantee upon a contract that a creditor shall not act upon it until another person has joined in it as cosurety, the guarantee is not valid if that other person does not join (Section 144). It emphasizes that the liability of the surety is dependent on the condition precedent that a co-surety will join. The liability of the surety would only arise if the co-surety joins. Hence a surety who entered into the obligation upon the understanding and faith that another person would also enter into it, has a right in equity to be relieved on the ground that the instrument has not been executed by the intended co-surety [Erans v. Bremridge (1856) 8 D.M.G. 100]. Such a term is usually inserted in contracts of guarantee in order to insure the right of contribution from the co-surety. II. Liability under continuing guarantee The guarantees in trade transactions are usually given either to secure the supply of goods on credit or advances of money and may be limited in amount or absolutely unlimited, so far as the surety's liability there under is concerned. Were there is pecuniary limit, the guarantee continuing is not exhausted by the first advance or credit equal to the prescribed amount. But a guarantee though continuing and limited to a given sum, may and sometimes does, stipulate that the surety shall only be liable for a definite period of time and not longer. In the latter case, it is obvious. It is often an interesting question of construction whether the guarantee covers the transaction completed but not matured during the time limit. The question whether a particular guarantee is a continuing or non-continuing guarantee, is also a question of construction of the contract, where it is not clear either way from the face of the contract. Section 129 of the Act defines a continuing guarantee as a guarantee which extends to a series of transactions. The important and noteworthy point in this regard is the fact that the section does not define nor lay down any criteria of practical value as to what exactly a series of transactions” means. However, the Madras High Court has for long been of the view that a request to advance money to another person upto a certain limit for his trade is a continuing guarantee [T.N.S. Fim v. V.P.S. Mohammad Hussain and Others, (AIR 1933 Mad. 756]. At the same time we can take help of the illustrations appended to section 129, which throw enough light on the way to interpret the words "series of transactions”." The illustrations read: (a) A, in consideration that B will employ C in collecting the rents of B's zamindari, promises B to be responsible to the amount of 5,000 rupees for the due collection and payment by C of those rents. This is a continuing guarantee. (b) A guarantees payment to B, a tea dealer, to the amount Pounds 100 for any tea he may from time to time supply to C. B supplies C with tea to the above value of Pound 100,
and C pays for it. Afterwards, B supplies C with tea to the value of Pounds 200. C fails to pay. The guarantee given by A was a continuing guarantee, and he is accordingly liable to B to the extent of Pounds 100. (c) A guarantees payment to B of the price of five sacks of flour to be delivered by B to C and to be paid for in a month. B delivers five sacks to B. C pays for them. Afterwards B delivers four sacks to C, which C does not pay for. The guarantee given by A was not a continuing guarantee, and accordingly he is not liable for the price of the four sacks. A guarantee for a single specific transaction comes to an end as soon as the liability under that transaction ends [Kay v. Groves (1829) 80 ER 1274]. Where the plaintiff stood guarantee for a licence for sale of liquor and under the terms of the licence, the money was payable in installments, it was held that guarantee was not a continuing one [Bhagvan Dass v. Secretary of State AIR 1926 Bom. 465]. In Hasan Ali v. Waliulllah [(1930) All. 730] the Allahabad High Court laid down the test of a continuing guarantee thus: where the guarantee has been given for the performance of a definite engagement which has already come into existence and is not contingent and the consideration for which is not variable as the result of future dealings between the parties, the contract is not one of continuing guarantee. The essence of a continuing guarantee is that it applies not to a specific number of transactions, but to any number of them and makes the surety liable for the unpaid balance at the end of the guarantee. The liability of the guarantor to pay remains alive as long as the principal debtor does not clear the account [Union Bank of India v. T.J. Stephens, AIR 1990 Ker.180]. III.
Liability under a Bank Guarantee
The bank guarantee constitutes an agreement between the bank and the creditor under which there is an absolute obligation of the bank to make the payment of the creditor merely on demand from the latter. The bank is prohibited under the guarantee from raising any objection. Demand made on the bank in accordance with the eventualities mentioned in the deed of the guarantee is conclusive as regards the amount due and payable by the bank [National Project Construction Corporation v. M/s. Sadhu and Company, AIR 1990 P & H 300]. Thus the Bank guarantee is an absolute undertaking for the payment of amount whenever the creditor demands. Moreover the money is payable on demand and not on breach [Maharashtra State Electricity Board v. Official Liquidator, Ernakulam, AIR 1982 SC 1492]. Likewise suspension of the contract between the contractor and the department on account of the contractor's default did not have the effect of suspending the enforcement of the bank guarantee given by an other person for the contractor's due performance [Dena Bank v. Fertilizers Corporation of India, AIR 1990 Pat.221]. Courts always (except in cases of serious dispute, fraud or special equities) refrain from granting injunction restraining performance of contractual obligations arising out of bank guarantee between the bank and another [United Commercial Bank v. Bank of India, AIR 1981 SC 1426]. 287 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
3.7 DISCHARGE OF SURETY Indian contract Act provides for discharge of surety under the following circumstances: 1) Revocation by the surety [Section 130] 2) Surety's death [Section 131] 3) Variance in the terms of the contract [Section 133] 4) Release or discharge of principal debtor [Section 134] 5) When creditor compounds with, gives time to, or agrees not to sue principal debtor [Section 135] 6) Creditor's act or omission impairing surety's eventual remedy [Section 139] 7) Loss of security by the creditor [Section 141] 1. Revocation by the Surety Section 130 says that a continuing guarantee may at any time be revoked by the surety as to future transactions by notice to the creditor. The act having left open to the parties to provide as to the manner in which notice to the creditor under S. 130 could be given. If therefore the parties think of laying down a particular method by which such a notice for revocation of the guarantee under S. 130 has to be given, then such a contract is binding contract and it cannot be easily brushed aside on a priori consideration [Seth Dhanoomal Parsaram V. P. Kuppuraj, AIR 1977 Mad 277]. Here under this section only a continuing guarantee can be revoked and that too for future transactions. It is worth noticing that revocation becomes effective for the future transactions while the surety remains liable for transactions already entered into. The following illustrations appended to the section make the law well understandable. a) A, in consideration of B's discounting, at A's request, bills of exchange for C, guarantees to B, for twelve months, the due payment of all such bills to the extent of 5000 rupees. B discounts bills for C to the extent of 2000 rupees. Afterward, at the end of twelve months, A revokes the guarantee. This revocation discharges A from all liability to B for any subsequent discount. But A is liable to B for the 2000 rupees, on default of C. b) A guarantees to B to the extent of 10000 rupees, that C shall pay all the bills that B shall draw upon him. B draws upon C. C accepts the bill. A gives notice of revocation. C dishonours the bill at maturity. A is liable upon his guarantee. Illustration (a) makes the point clear that the surety's notice of revocation is applicable on future transactions and not on the transactions already made, whereas illustration (b) indicates that where transactions have already been made they cannot be revoked by a subsequent notice. Revocation as to future transaction is possible, when there are separate distinct transactions contemplated in the contract. When the consideration is single and indivisible, for instance where a continued relationship is established on the faith of a certain guarantee, no revocation of the same is possible. Thus, 288 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
if a servant is employed on the basis of a guarantee as to his good conduct, the guarantee is not revocable so long as the servant continues in service [Lloyds v. Harper, (1880) 16 ChD 290]. 2. Surety's death Section 131 reads: "The death of surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee, so far as future transactions". The section is very clear to the fact that death of the surety results in automatic revocation of the continuing guarantee hence forth. This will effect the future transaction only. But if there is any contract to the contrary surety's death would not automatically revoke the guarantee. For example, if the contract provides that in case of surety's death, his property or legal representatives would be responsible for his liability under the continuing guarantee, then the guarantee is not automatically revoked on surety's death. A guarantee for the good behaviour of a servant is not a continuing one and is not revocable as long as he continues in job. Hence such a guarantee is not determined by the surety's death unless there is agreement to the contrary [Balur v. Crace, (1902) 1 ChD 733]. 3. Variance in the terms of the contract Section 133 reads: "Any variance, made without the surety's consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance". Hence the surety is discharged when any variance is effected to the main contract between the principal debtor and the creditor. However, to cause discharge of surety, the variance must have been made without the surety's consent". In Partap Singh v. Keshavlal [AIR 1935 P C 21], an authoritative expression to this point has been made. The case involved a guaranteed transaction of an advance of Rs.1,25,000 on security of four properties, where as the real transaction carried out was one of an advance of Rs.1,000,000 on security of three properties. It was held by the Privy Council that the sureties could not be held liable in respect of the performance of the latter transaction, which was not what they had contracted to guarantee. The council, speaking through Lord Atkin, clarified the legal position thus: "the law on the discharge of sureties has been somewhat obscured by the emphasis laid in the cases on an agreement between the parties to vary in the terms of the original agreement. The principle is that the surety, like any other contracting party, cannot be held bound to something for which he has not contracted. If the original parties have expressly agreed to vary the terms of the original contract no further question arises. The original for several ycontract has gone, and unless the surety has assented to the new terms, there is nothing to which he can be bound,
for the final obligation of the principal debtor will be something different from the obligation which the surety guaranteed. Presumably he is discharged forth with on the contract being altered without his consent, for the parties have made it impossible for the guaranteed performance to take place". Lord Atkin, expounding the principle, was indeed circumspect. He thus found its desirable to add that the application of this principle must always depend upon a correct analysis of the contract in fact made. Guarantees", he pointed out frequently relate to obligations without special reference to any specific contract between the creditor and the debtor. In such a case the doctrine referred to would have a very limited application [p25]. The true rule, applicable to the contract of guarantee is that if there is any agreement between the principals with reference to the contract guarantees, the surety ought to be consulted. If the alteration is to the disadvantage of the surety, or its unsubstantial nature is not self evident, the surety can claim to be discharged. The contract of surety should not be altered without his consent and the creditor should not undertake to alter the contract and then say, that though the contract had been altered, it was not done to the disadvantage of the surety, especially when such alterations were made with respect to material particulars regarding the contract of guarantee [S. Perumal Reddiar v. Bank of Baroda and Others, AIR 1981 Mad 180 at pp.191, 192]. In Ramanund v. Choudhury Soonder [(1878) 4 Cal 311 (P. C)] where, under the consent decree, it was provided that in default of one instalment, the properties in suit may be sold, and the surety proceeded against for any deficiency, the Privy Council held that the decree holder's delay in actually bringing the properties to sale had the effect of discharging the surety pro tanto, as to interest due from the date of the order for sale, because the act of the creditor in postponing the sale laid an additional burden on the surety by increasing the interest. In Bonar v. Macdonald [(1850) 3 HLC 226], where the defendant guaranteed the conduct of Bank manager and the bank afterwards without any communication to the surety raised his salary on the condition that he would be liable for one fourth of the losses on the discounts allowed by him. The manager allowed a customer to over draw his account and the bank suffered a loss. It was held that the new arrangement had resulted in the discharge of surety. It was observed: "Any variance in the agreement to which the surety has subscribed, which is made without the surety's knowledge or consent, which may prejudice him, or which may amount to a substitution of a new agreement for a former agreement, even though the original agreement may, notwithstanding such variance, he substantially performed, will discharge the surety". One of the questions that concerns the courts is that where a variation is not substantial or material or is beneficial to the surety, will it discharge the surety. A problem of this nature was before the Supreme Court in the Case M. S. Anirudhan v. Thomco's Bank Ltd [AIR 1963 SC 746]. The appellant agreed
to stand surety upto Rs.25000/- to be allowed by the respondent bank to the principal debtor. The bank agreed for an overdraft upto Rs.20000/- only. Principal debtor himself altered the amount from Rs.25000/- to Rs.20000/- without the consent of the surety. The question before the supreme court was whether such an alteration which was to the benefit of the surety, had discharged the surety. The majority decision was that when alteration is to the benefit of the surety, that is not a material alteration. Such an alteration is unsubstantial and that does not discharge the surety from liability. Hidayatullah J. observed: "The question before me is whether a document jointly executed by two persons creating a liability equal for both is to be regarded as materially altered if the liability is reduced equally for both but the alteration is made only by one of them. In my opinion such an alteration to be regarded as unsubstantial and not otherwise — In my judgement, the particular document, in this case cannot be said to have been materially altered -- The alteration does not save the surety from liability arising under it". It is submitted that it is worth noticing that the Act does not make any distinction between beneficial or prejudicial variances to the surety in material particulars as compared to the original one. If the terms of the contract are changed, the person who signed the original contract cannot be made liable either on the basis of original contract, because that has been destroyed by alteration, or on the basis of altered contract, because he never agreed to that [Bangia p.381]. 4. Release or discharge of principal debtor Section 134 of the Act provides that the surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. Mahanath Singh v. U Ba Yi [AIR 1939 P. C. 110] was a case that arose out of a suit against debtors and the surety, where the names of the original debtors were struck upon an application by the creditor. The Privy Council held that the only result of the creditor's act was to preclude the bringing by the creditor of a fresh suit in respect of the subject matter against them, and is not to release or discharge the principal debt. Lord Porter, speaking for the council, observed that a surety is discharged if the creditor, without his consent, either releases the principal debtor or enters into a binding arrangement with him to give him time. In such a case the ground of discharge is that the surety's right to pay the debt at any time and after paying it, to sue the principal in the name of the creditor is interfered with". " While an absolute release is given", held his lordship, there is no room for any reservation of remedies against surety.... Where, however, the debt has not been actually released, the creditor may reserve his right by notifying the debtor that he does and this reservation is effective not only where the time of payment is postponed but even where the creditor has entered into an agreement not to sue the debtor. In neither case is there any deception of the debtor since he knows that he is still exposed to a suit of the will of the surety". 289 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
The council found that if the only result of striking out the original debtors from the action was to preclude the bringing by the creditor of a fresh suit in respect of the subject-matter against them, and was not to release or discharge, the principal debt, "then the debt remains debt though the creditor by reason of rule of procedure cannot himself bring an action upon it". Thus it was held that the surety could not be said to have been discharged under those circumstances. Section 134 provides two rules of discharge i.e., (i) release of the principal debtor, and (ii) Act or omission of the creditor. We may make these two kinds clear hereunder which release or discharge the surety from his liability: (i) Release of the principal Debtor As the liability of the surety is co-existent with the principal debtor, if the creditor makes any contract with the principal debtor by which principal debtor is released of his lability, the necessary liability of the surety also disappears. As was observed in George v. Jonesion [(1873) 8 Ex 81], "if the creditor, without the consent of the surety by his won act destroys the debt or derogate from the power which the law confers on the surety to recover it against the debtor in case he shall have paid it to the creditor, the surety is discharged". This is what the following illustrations to the section indicate: a) A gives a guarantee to C for goods to be supplied by C to B. C supplies goods to B, and afterwards B becomes embarrassed and contracts with his creditors including C to assign to them his property in consideration of their releasing him from their demands. Here B is released from his debt by the contract with C, and A is discharged from his suretyship. Hence any release of the principal debtor is a release of the surety. Likewise where the liability of the principal debtor is reduced or extinguished under the provision of a statute, it will operate as a pro tanto reduction or extinguishment of surety's liability [Subramania Chettiar v. M. P. Narayanaswami Gounder, AIR 1951 Mad 48]. But at the same time it should be noted that a discharge which the principal debtor may secure by reason of winding up or insolvency does not absolve the surety of his liability [Mahrashtra State Electricity Board v. Official Liquidator, AIR 1982 SC 1497]. Similarly the take over of undertakings under Statutory power, such as Sick Textiles undertakings Notification Act 1974 does not discharge the sureties of the borrowings of such undertakings [Bank of Madura Ltd v. Bank of Baroda, (1987) 1 Mad L J 393]. b) A contracts with B to grow a crop of indigo on A's land and to deliver it to B at a fixed rate, and C guarantees A's performance of this contract of. B diverts a stream of water which is necessary for irrigation of A's land and thereby prevents him from raising the indigo. C is no longer liable on his guarantee. This illustration is also an instance of the surety being discharged by an act of the creditor which has the effect to making performance by the debtor impossible. Likewise, by operation 290 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
of law there is merger of the estate of the debtor and the creditor, the surety's obligation comes to an end. (ii) Act or omission of Creditor Illustration (c) to the section reads: c) A contracts with B for a fixed price to build a house for B within a stipulated time. B supplying the necessary timber. C guarantees A's performance of the contract. B omits to supply the timber. C is discharged from his suretyship. From this illustration it is clear that the act or omission of the creditor should be something in the nature of a breach of the contract on its part. For example, where the payment of rent due under a lease is guaranteed and the creditor terminates the lease, or where the payment of installments due under a hire purchase is guaranteed and the creditor prematurely determines the agreement, the effect would be the release of the surety also. While analyzing the impact of section 134 on the liability of sureties, we should keep in mind the impact of section 136 read with section 146. Under section 136 where there are more than one sureties a release of one of them by the creditor will not discharge the others and under section 146 even if one of the co-sureties is released by the creditor, he would not be released from his responsibility to contribute to the other sureties. 5. When creditor compounds with, gives time to or agreed not to sue the principal debtor Section 135 of the Act reads: "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". In this section three different circumstances releasing the surety of his liability have been envisaged: (1) When a creditor compounds with the principal debtor, (2) When the former promises to give time to the latter, and (3) When the former agrees not to sue the latter. In all these three situations, the conditioning factor is undoubtedly unless the surety assents to such contract". This principle has been derived from the English common law [Polak v. Everett, 1 GBD 669 at p.673-74]. However, the provisions of section 135 have not been liberally construed by the Indian courts. In Damodardas v. Muhammad [ILR 22 All 35], it was held that a mere gratuitous agreement by a creditor to give time to the principal debtor could not discharge the surety, but the agreement must amount to a contract. In fact in Lal Behar v. Allahabad Bank [27 All L J 1137], it was even held that the section contemplated a subsequent contract between the creditor and the principal debtor where by the time originally fixed was subsequent contract the section had no application. However, the subsequent contract may be either express or implied, i.e., inferred from the acts of the parties [Kally prosunnu v. Umbica, 18 WR 417].
Here under we may discuss in some detail circumstances referred to in Section 135 for clear understanding: (1) Creditor compounds with the principal debtor When in a composition, the creditor voluntarily takes a certain amount in full settlement of his claims against the debtor, without the consent of surety, it means variation in the original contract. Its obvious consequence is the discharge of surety. For example, A stands surety for the repayment of a loan of Rs.4000/- to B for C. If B and C thereafter agree that B would accept Rs.2000/ - in satisfaction of the whole amount of debt. C pays Rs.2000/ -, the surety is automatically discharged from his liability. In Bombay Co v. Official Assignee, Madras [(1921) 44 Mad 381], it was held that a private composition with the debtor, behind the back of the surety, will have the effect of discharging the surety, but if the composition is made under the supervision of the court and after notice to the surety, the liability of the surety is not effected. At the same time it must be noted that a compromise in terms of a court decree is different from private composition. This does not discharge the surety, unless the decree is collusive [City Bank N.A v. J. K. Jute Mills, AIR 1982 Del 487]. In Appunni Nair v. Issac [(1920) 43 Mad 272], in the case of consent decree without the surety's knowledge or concurrence, the court observed that as the bond was given to the court, the present section has no application at all and held the surety not discharged. (2) Creditor Promising to give time to the principal debtor Giving time is the extension of the period at which by the contract between them the principal debtor was originally obliged to pay to the creditor by substituting a new and valid contract between the creditor and the principal debtor to which the surety does not assent [United Commercial Bank Ltd v. Chara Grain Buyers Syndicate Ltd, AIR 1968 SC 1115]. In"brief giving time" contemplates a subsequent contract between debtor and creditor whereby the time originally fixed is extended without the surety's consent and the creditor then precludes himself from suing for a certain time. In such a case surety is discharged. The reason for such a discharge was thus explained by the privy council in Mahanath Singh v. U Ba Yi [AIR 1939 PC 110 at p. 111]: "A surety is discharged if the creditor, without his consent, either releases the principal debtor or enters into a binding agreement with him to give him time. In each case the ground of discharge is that the surety's right to pay the debt any time and after paying it, to sue the principal in the name of the creditor is interfered with". Where under an agreement the creditor agrees to receive payment in instalments from the debtor instead of in lumpsum, it amounts to giving time to the debtor and it results in the discharge of the surety. It must be remembered that surety is only discharged where there is a contract between the creditor and the principal debtor for extension of time, but where a contract to give time to the principal debtor is made by the creditor with a third person and not with the principal debtor, the surety is not discharged [Section 136]. At the same time
judgement of Supreme Court in Amrit Lal v. State Bank of Travancore [AIR 1968 SC 1432] is worth noticing - An agreement between a creditor Bank and principal debtor provided that the later should be responsible for the quality and quantity of goods pledged with the bank and also for the correctness of the statements and returns furnished to the bank from time to time. The goods pledged were further declared and agreed to be not actually weighed or valued in order to verify the returns furnished by the debtor. When one occasion the bank on actual weighment found some deficit in the quantity of goods, it granted some time for the principal debtor to make up the deficiency. It was held that the Bank's act of giving time to the principal debtor did not tantamount to giving time with in the meaning of this section so as could exonerate the surety. So too in the case of a surety bond given to a court, the mere fact that the court grants time to the debtor to pay does not discharge the surety [Yusuf Moidu v. Haji Abdul Kadir & Bros (1938) MWN 1131]. (3) Creditor agreeing not to sue the debtor If the creditor under an agreement with the principal debtor promises not to sue him for the payment of debt, the surety is discharged from his liability. The main reason is that a surety is entitled at any time to require the creditor to call upon the principal debtor to pay off the debt when it is due and this right is positively violated when the creditor promises not to sue the principal debtor. Or we can say that the promise by the creditor not to sue the principal debtor is inconsistent with the right of the surety and that is why such action on the part of creditor discharges the surety. Judgement in Ma Kwi v. On May [(1929) Ran 187], illustrates the position that there must be a binding contract, and not a bare statement of intention. In that case, a tradesman supplied goods to certain employees and the employer had stood surety for them. A statement by the trader that he did not intend to sue the employees was held not to discharge the surety. Forbearance to Sue Section 137 of the Act reads: "137. Creditor's forbearance to sue does not discharge surety- Mere forbearance on the part of the creditor to sue the principal debtor or to inforce any other remedy against him, does not, in the absence of any provision in the guarantee to the contrary, discharge the surety". The section indicates that mere forbearance on the part of the creditor does not discharge the surety [Union of India v. Modern stores India Ltd, AIR 1988 Cal 18; Ushadevi v. Bhagawandas, AIR 1967 M P 250]. This point is made clear in the illustration appended to the section thus - B owes to C a debt guaranteed by A. The debt becomes payable. C does not sue B for a year after the debt has become payable. A is not discharged from his suretyship. Section 137 clarifies in express terms which is clearly implied in Section 135, that what is needed to cause the discharge of the surety is not "mere forbearance" on the part of the creditor to sue the principal debtor, but a positive act, a promise or a contract, to give time 291 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
or not to sue. In Hajarimal v. Krishna Rao [(1881) 5 Bom 647) Westropp, C.J.; observed that mere ‘forbearance' means "a forbearance not resting upon or in consequence of such a promise to give time to, or not to sue the principal debtor, as is the subject of S.135". In Kalicharan v. Abdul Rehman [(1919) 23 CWN 545], the judicial committee said that a mere forbearance to sue the debtor does not discharge the surety. The effect of an omission or forbearance to sue till the period of limitation elapses, we have studies earlier in connection with section 134. It may be mentioned that if the forbearance really gives an advantage to the creditor, the court will adjust the equities between the parties in such a manner that the surety's liability is not enhanced. In the case of Ramanand v. Chowdhury Soonder Narain, [(1878) 4 Cal 331 (P.C)], where a decree-holder by postponing the sale of properties under a decree increased burden of interest on the sureties who had guaranteed payment of any deficiency after sale, the sureties were held discharged from liability for interest subsequent to the court's order for sale. 6. By impairing Surety's Remedy The basic principal of section 139 of the Act is that it is the duty of the person who has secured a guarantee to do every act necessary for protection of the rights of the surety, as a surety is a person who receives no benefit and no consideration out of the transaction but has voluntarily accepted the liability of the principal debtor to the creditor. By application of this section, surety is discharged, when a creditor does any act which is in consistent with the rights of the surety, or omits to do any act which his duty to the surety required him to do and the eventual remedy of the surety is impaired as a consequence thereof. The impairment of the eventual remedy of the surety is essential for application of section 139 in addition to the acts of commission and omission on the part of the creditor. Section 139 reads as under: "If the creditor does any act which is inconsistent with the right of the surety, or omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired, the surety is discharged". Illustrations appended to the section are: (a) B Contracts to build a ship for C for a given sum, to be paid by instalments as the work reaches certain stages. A becomes surety to C for B's due performance of the contract. C, without the knowledge of A, prepays to B the last two instalments. A is discharged by this prepayment. (b) C lends money to B on the security of a joint and several promissory note made in C's favour by B, and by A as surety for B, together with a bill of sale of B's furniture, which gives power to C to sell the furniture, and apply the proceeds in discharge of the note. Subsequently, C sells the furniture, but owning to his misconduct and wilful negligence, only a small price is realized. A is discharged from liability on the note. 292 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
(c) A puts M as apprentice to B, and gives a guarantee to B for M's fidelity. B promises on his part that he will, at least once a month see M make up the cash. B omits to see this as promised, and M embezzles. A is not liable to B on his guarantee. After the surety has made the payments or performed the duty on default of the principal debtor he is conferred with the same rights which the creditor had against the principal debtor. This means that firstly, the surety can claim indemnity from the principal debtor for all the sums he has rightfully paid under the guarantee. And secondly, he is also entitled to the benefits of every security which the creditor has against the principal debtor when the contract of surety is entered into [Sections 140, 141, and 145]. If the creditor's act or omission deprives the surety of the benefit of this remedy, the surety is discharged [Unity Finance Ltd v. Woodcock, (1963) IWL 455]. Thus where the integrity of a cashier is guaranteed and the employer undertakes to check his work once in a month ersion, namely accepting Jesus Christ as the personal Saviour but neglect to do so, the cashier embezzles, the surety is not liable. The same duty requires the creditor to preserve the securities, if any, which he has against the principal debtor. If he loses or parts with the securities, the surety is discharged to that extent [State Bank of India v. Praveen Tanneries, (1992) 2 An LT 5]. Similarly in State of M.P. v. Kaluram, [AIR 1967 SC 1105], the M. P. state made a contract for the sale of ëfelled trees' to the highest bidder in the auction sale. Payment was to be made in instalments. Kaluram was a surety for the payment by the purchaser. Purchaser failed to pay second and subsequent instalments. The government allowed the purchaser to remove felled trees from the forest despite default of payment. It was held that since the state government had failed to take necessary steps to recover the amount from the purchaser by allowing him to take away the trees, the surety's remedy against the purchaser had thereby been impaired, the surety (Kaluram) was discharged from his liability. It may be noted that if the goods are lost without the fault of the creditor, the surety is not discharged thereby. For instance, when the hypothecated goods are lost without any fault of the creditor that does not discharge the surety [R. Lilavati v. Bank of Baroda, AIR 1967 SC 1105]. 7. Loss of security by the creditor Section 141 reads: "A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not; and if the creditor loses, or without the consent of the surety, parts with such security, the surety is discharged to the extent of the value of the security". The expression "security" in section 141, is not used in any technical sense; it includes all rights which the creditor had against the property at the date of contract. The surety is entitled on payment of the debt or performance of all that he is liable
for, to the benefit of the rights of the creditors against the principal debtor which arise out of the transaction which give rise to the right or liability; he is therefore on payment of the amount due by the principal debtor entitled to be put in the same position in which the creditor stood in relation to the principal debtor. If the creditor has lost or has parted with the security without the consent of the surety, the latter is, by the express provision contained in section 141, discharged to the extent of the value of the security lost or parted with [see State of M.P. v. Kaluram, AIR 1967 SC 1105]. But it must be noted that a surety in the case of hypothecation is not entitled to invoke section 141 of the Act for the benefit under the said section if
the creditor loses or without the consent of the surety, part will the surety pledged, the surety is discharged to the extent of the value of the security. Such a question cannot arise in the case of hypothecation of goods for the simple reason that when the goods are not in his possession, no question of losing or parting with the same arises. As in hypothecation, the possession of the goods hypothecated is with the borrower, it would be wrong to say that the goods are in the constructive possession of the creditor because it has no effective control over them by hypothecation, only an equitable charge is created and nothing more [Bank of India, Bombay v. Yogeswar Kant Wadhera, AIR 1987 P&H 176].
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4 CONTRACT OF BAILMENT SUB TOPICS 4.1 Introduction 4.2 Definition 4.3 Essential features 4.4 Bailor's Duties 4.5 Duty of bailee 4.6 Rights of bailee 4.7 Duty of Finder 4.8 Rights of Finder 4.1 INTRODUCTION Bailment implies a sort of relationship in which the personal movable property of one person temporarily goes into the possession of another. The ownership of goods or articles is in one person and the possession in another. It is the delivery of person's movable property by one party (known as bailor) to another (known as bailee) on the condition express or implied that the property shall be returned to the bailor or shall be delivered as soon as the purpose for which the bailment was created is over. The transaction may be by way of lending, pledge, hire or deposit for safe custody. Though bailment is founded upon a contract, but a contract is not essential for bailment. A bailee may be liable in tort to the bailor whether or not there is any valid contract between the parties. Gratuitous bailment in particular, is independent of the law of contract. Again, a bailment created by contract is not necessarily terminated by the contract coming to an end; and there may be a valid bailment even though the contract from which it arises is invalid or voidable, as where the bailee is a minor, or where the bailee obtains goods by false presences. The essence of bailment is possession. Bailment, at the present time, has come to be recognized as a transaction sui generis. Lord Denning observed in Building and Civil Engineering Holidays Scheme Management v. Post office [(1965) All ER 163 at p.167] : "At common law, bailment is often associated with a contract but that is not always the case — An action against a bailee can often be put, not as an action in contract, nor in tort, but an action on his own, sui generis, arising out of the possession had by the bailee of the goods". Thus a bailment is more than a contract in the sense that it involves the transfer to or acquisition by the bailee of possession, a proprietary interest less than ownership and several remedies in tort and crime are available to the bailee in virtue of his enjoyment of possession. In State of Gujarat v. Memon Mohammad Haji Hasan [AIR 1967 SC 1322] the Supreme Court has observed thus: "bailment is dealt with by the contract Act only in cases where it arises from a contract, but it is not correct to say that there cannot be a bailment without an enforceable contract - - Nor is consent indispensable for such a 294 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
relationship to arise. A finder of goods of another has been held to be a bailee in earlier instances". 4.2 DEFINITION "Bailment" has been defined under section 148 of the Act in the following terms: 148."Bailment", "Bailor", and "Bailee" defined - 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, be returned or otherwise disposed of according to the directions of the person delivering them. The person delivering the goods is called the" bailor". The person to who they are delivered is called the "bailee". Explanation --- If a person already in possession of the goods of another contracts to hold them as bailee, he thereby becomes the bailee, and the owner becomes the bailor of such goods, although they may not have been delivered by way of bailment. 4.3 ESSENTIAL FEATURES S.148 of the Act emphasises the following essential ingredients of bailment: 1) there must be a delivery of possession; 2) the delivery be of the goods; 3) delivery be made by the owner, called bailor; 4) delivery be to another person, known as bailee; 5) delivery be for a specific purpose; and 6) delivery be on condition that the goods be returned in their We may now discuss in detail the essentials in a compact form: I. Delivery of possession of goods for some purpose by the bailor to bailee. II. Delivery arising out of contract. III. Return of goods by the bailee to bailor when purpose accomplished. I. Delivery of possession of goods by the bailor to the bailee for some purpose The important feature of bailment is the delivery of possession of goods by one person (bailor) to another (bailee) for some purpose. It follows that bailment can be of Chattels or goods only, though money can also be a subject matter of bailment under certain circumstances like coins or notes which have ceased to be legal tender and have become the object of curiosity. The bailment relates to a specific movable property of which delivery of possession must be effected i.e., change of possession is a must. Bare custody with out possession, like a servant, or a guest using his host's goods is not a bailee [Reaves v. Capper, (1838) 132 ER 1057]. Hence to constitute bailment possession of goods must be handed over to the bailee for some purpose i.e., for safe custody, for carriage or for repair etc. Whatever the purpose may be, once the possession of goods is
handed over, a bailment arises irrespective of the manner in which this happens.
of goods as bailee [Trustees, Port Trust of Bombay v. Premier Automobiles Ltd, 1981 SC 1982].
Where the bailor hands over the physical possession of goods to the bailee it is called actual possession, but delivery need not be always actual. Constructive or symbolic delivery will also create the relation of bailor and bailee. Section 149 of the Act clarifies this aspect, which reads: "149. Delivery to bailee how made -- Delivery to bailee may be made by doing anything which has the effect of putting the goods in the possession of the intended bailee or any person authorised to hold them on his behalf".
III. Return of goods by bailee to bailor when purpose is accomplished
Explanation to S.148 provides that where the original delivery is not by way of bailment, it may be possible to constitute the relation of bailor and bailee by subsequent agreement. It is a constructive delivery. A railway receipt is a document of title relating to the goods covered by it, hence a transfer of it for consideration effects a constructive delivery of the goods [Morvi Mercantile Bank Ltd v. Union Bank of India, AIR 1965 SC 1954]. Handing over the keys of the godown may be deemed to be delivery of goods - handing over the keys is the symbolic or constructive delivery of goods. Likewise where a bailor requests the bailee to allow him to retain the bailed goods in his possession with a promise to hold the same for the bailee and render possession whenever demanded by the bailee, it is constructive delivery of goods [Bank of Chittoor v. Narasimhulu Naidu, AIR 1966 AP 163]. In such situations there may not be change in actual and physical custody but there is a change in legal character of the possession of goods. Thus delivery of goods, either actual or symbolic is a sine qua non of a valid bailment. When a person keeps goods in the possession of another person but himself continues to have control over them this is not sufficient delivery to constitute bailment. In Kaliaporumal Pillai v. Visalakshmi [AIR 1938 Mad 32] plaintiff took her old jewellery to the defendant (goldsmith) for melting and converting them into new jewellery. Every evening she used to receive the half made jewellery, locking them in the box and leaving the box in the premises of the goldsmith, by keeping the keys in her possession. One night jewellery was stolen. It was held that mere leaving the box containing jewellery in the defendant's house where they were being made by goldsmith under the supervision of the plaintiff is not sufficient to constitute delivery when particularly the keys were taken away by the plaintiff. It was held that there was no bailment as the plaintiff had not handed over the possession of the jewellery to the defendant, and, therefore, the defendant could not he held liable for the loss. II. Delivery arising out of contract Strictly speaking by virtue of S.148, the obligation of a bailee can arise only out of a contact of bailment and not otherwise, but as we have noticed earlier in introduction, the relation of bailor and bailee can be created without a contract. Earlier view of judiciary that bailment u/s 148 can only arise out of contract is not convincing and logical [Ram Gulam v. Govt. of U P, AIR 1950 All 106]. The law itself recognizes the finder
S.148 says that "the goods shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them". Hence it is necessary that the goods which form the subject matter of the bailment should be returned by the bailee to the bailor after the purpose or after the period of bailment. If the person to whom the goods are delivered is not bound to restore them to the person delivering them or to deal with them according to his directions, their relationship will not be that of a bailor and bailee. 4.4 BAILOR'S DUTIES Section. 150 of the Act deals with the duty of the bailor in respect of the goods bailed by him. The section reads: "The bailor is bound to disclose to the bailee faults in the goods bailed, of which the bailor is aware, and which materially interfere with the use of them, or expose the bailee to extraordinary risks; and, if he does not make such disclosure, he is responsible for damages arising to the bailee directly from such faults. If the goods are bailed for hire, the bailor is responsible for such damage, whether he was or was not aware of the existence of such faults in the goods bailed". This section enunciates the duty of the bailor to disclose the faults in the goods of which he has the knowledge and the bailment of such goods without disclosure may interfere with the use of the goods or expose the bailee to risks. On failure of the duty to disclose, the bailor would be responsible for the damages directly traceable to such fault in the goods bailed. In case if the goods are bailed for hire, the bailor is responsible whether he was aware or not of the existence of the fault in the goods bailed. This aspect of the section imposes duty on the bailor in two capacities or we may say that under this section bailors are of two kinds : 1) gratuitous bailor, and 2) bailor for reward 1) Gratuitous bailor A person who lends goods without any charge is known as 'gratuitous bailor'. Gratuitous bailor's duty has been laid down in the first para of the section and law is made clear in illustration (a) appended to the section which reads - 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. B is thrown and injured. A is responsible to B for damages. The liability of the bailor is subject to two conditions i.e., 1. Bailor should have the knowledge of the defect in the goods bailed. 2. The defect in the goods must be such as exposes the bailee to extraordinary risks or materially interferes in the use of goods. 295 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
In Maffatt v. Bateman, [(1869)3 PC 115], where the defendant took the plaintiff in his carriage gratuitously, without previously examining the bolts and fastening of his carriage and during the journey, an accident happened, the failure to examine the carriage was held not to be negligence sufficient to charge the owner. Here the bailor has no knowledge of the defect so there was no failure on his part to disclose. He could only be liable under the section if he had the knowledge of the fault and he did not disclose.
down in the section but we must take stock of the actual facts in each individual case whether bailor to pay expenses or not. Generally, ordinary and reasonable expenses of the bailment are borne by the bailee but for any extraordinary expenses bailor could be held liable to pay to the bailee. For example, if a horse is sent for journey, feeding expenses of the horse would be borne by the bailee. But if the horse is injured or falls sick all reasonable expenses incurred on treatment by the bailee would be borne by the bailor.
2. Bailor for reward
Further section 164 provides that : "The bailor is responsible to the bailee for any loss which the bailee may sustain by reason that the bailor was not entitled to make the bailment, or to receive back the goods or to give direction respecting them".
Second para to the section deals with bailment of goods for reward. Here bailor is liable irrespect of the fact whether he had or had not the knowledge of the existence of the fault in the goods bailed. Hence greater degree of responsibility is laid on the bailor when the bailment is for hire. The rule is made clear in the illustration (b) appended to section 150 thus - A hires a carriage of B. The carriage is unsafe, though B is not aware of it, and A is injured. B is responsible to A for injury. It indicates that where the bailment is for hire or for reward, then the bailor is liable to the bailee if he suffers any loss from the goods bailed. This duty is based upon the principle that there is an implied warranty of fitness, for the purpose for which the goods are bailed. In Hyman v. Nye & Sons [(1881)6 QBD 685], plaintiff hired a carriage and the horses and a driver from the jobmaster for a particular journey. The carriage being defective broke down and the plaintiff suffered injury thereby. The court held that the jobmaster's duty was "to supply a carriage as fit for the purpose for which it is hired as care and skill can render it." that he has not discharged this duty, and that he was liable for the injury to the plaintiff. Similarly in Reed v. Dean [(1949) 1 KB 188], where the plaintiff hired a motor launch, from the defendant for a holiday on the river Thames, caught fire and the plaintiff failed to extinguish the fire as the fire fighting equipment was out of order and injured. Defendant was held liable as there was an implied undertaking that the motor launch was as fit for the purpose for which it was hired as reasonable care and skill could make . In addition to the study of section 150 concerning the duty of the bailor, we have to study sections 158 and 164 which also deal with the duty of bailor to pay to the bailee necessary expenses incurred by him for the purpose of the bailment and the bailor's duty to indemnify the bailee against any loss or damage caused by bailor's want of title.
This section lays down the duty on the bailor to indemnify the bailee if his title to make the bailment is defective. In this context one thing must be remembered that this section practically creates a warranty of title in case of bailment, and provides that the bailor shall indemnify the bailee against any loss or damage caused by his (bailor's) want of title. The bailee as observed earlier, cannot set up the title of third parties, or set up any adverse title to the property [Rogers v. Lambert, (1891) 1 QB 318]. But where both the bailor and a third party claim the article bailed, the bailee may either return the goods to the bailor or may file an interpleader action [Iyer 446]. 4.5 DUTIES OF A BAILEE I. Duty to take reasonable care A bailee should act as a prudent man. Section 151 of the Act provides a uniform standard of care for all cases of bailment, to be observed by the bailee of the goods bailed to him. Under this section even a gratuitous or involuntary bailee is bound to bring into his duty the same amount of care as required of a man of ordinary prudence under similar circumstances taking of his own goods of the same type. If the bailee falls below this standard, he will be liable for loss of or damage to the goods. Section reads"In all cases of bailment the bailee is bound 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 of the same bulk, quality and value as the goods bailed".
Section 158 provides as follows : "Where, by the conditions of the bailment, the goods are to be kept or to be carried, or to have work done upon them by the bailee for the bailor and the bailee is to receive no remuneration, the bailor shall repay to the bailee the necessary expenses incurred by him for the purpose of bailment."
Along with this section it would be better if we refer to section 152 which is relevant to comprehend the application of the duty of reasonableness casts on the bailee concerning the goods bailed. Section provides: "The bailee, in the absence of any special contract, is not responsible for the loss, destruction or deterioration of the thing bailed, if he has taken the amount of care of it described in section 151."
Hence the section lays duty on the bailor to pay the necessary expenses of the bailment, where bailment is gratuitous and the bailment is for the benefit of the bailor. It is but natural that the bailee must be reimbursed for the expenses incurred by him upon the bailed goods. Though it has not been specifically laid
Thus section 152 is subject to 151 which requires the bailee to take care of the goods bailed to him as a man of ordinary prudence would take of his own goods. Thus in cases governed by sections 151 and 152 the loss or damages of goods entrusted to a bailee is prima facie evidence of negligence. In Central
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Bank of India, Raigarh v. M/s. Grains and Gunny Agencies and others [AIR 1989 MP 28], the bank filed a suit for the recovery of loan advanced against pledge of certain goods. The suit was dismissed as bank was unable to return the pledged goods. The bank filed the appeal and contended that the goods pledged were lost due to negligence of its staff, but it was exonerated from the liability to return the goods in view of the clause in the pledge agreement to the effect that the bank shall not be responsible not withstanding anything to the contrary in section 152 of the Indian Contract Act for any loss or deterioration or damage to the pledged goods caused by theft, fire, rain flood, earthquake, lightening or any other cause whatever. The plea of the bank was that the expression 'any other cause whatever' covered loss due to negligence of its staff members. It was held, that the clause in the pledge agreement nowhere exempts the bank from the liability for negligence of its servants. The causes laid down in agreement are natural causes without human intervention and which could not be prevented by any amount of foresight or care. The loss of goods on account of theft is an act of third party despite the care taken by the bailee. Even assuming that the bank had a right to claim exemption by virtue of special contract including negligence of its servants, still the bank had to show that it took as much care of the pledged goods as an ordinary prudent man under similar circumstances takes of his own goods of the same quality and value as required by section 151. In cases governed by section 151 and 152 the loss or damages of goods entrusted to a bailee is prima facie evidence of and therefore the burden to disprove negligence lies on the bailee. The bailee has to prove that he exercised due care and was not negligent. If inspite of this loss occurred, he is absolved of all responsibility. In instant case bank failed to prove that it took care of goods as a prudent man and was not in a position to return them to the defendants. The bank was not entitled to claim amounts since it failed to mitigate the loss. Hence bank cannot be absolved from its liability by immunity clause in invoking pledge agreement. The same rule as to burden of proof applies to the case of railway administration. In Union of India v. Udho Ram & Sons [AIR 1963 SC 422] certain goods were consigned to the railway by the plaintiffs from Calcutta to Delhi. During the transit some of the goods out of the consignment were stolen. The plaintiff filed a suit for the recovery of compensation for the same. The trial court found that the wagon containing the consignment was properly rivetted and sealed when train left Howrah at 1.30, am but when the train reached Chandpur station after about 2 hours, the seals and rivets of one of the doors of the wagon were found opened. The theft took place within 15 minutes when the train stopped at the home signal at 2.05 am. It was found that the railway protection force was also there in the guard's van. The question for adjudication in this case was, could the railway authorities be held liable for negligence in the discharge of duty to take due care as prescribed by section 151 of the Act ? It was held that the railway did not take due care. Firstly, they did not prove from record that the railway protection police which escorted the train was sufficient in
strength and secondly, that unlike a prudent man, the railway protection police did not keep an eye on wagons, particularly when the train stopped, to prevent the theft of goods. The defendants were held liable. Referring to the duty of care expected of a bailee u/s 151, Justice Raghubar Dayal, observed: "Needless to say that an ordinary person traveling in a train would be particular in keeping an eye on his goods specially when the train stops. It is not therefore imposing a higher standard of care on the railway administration when it is said that its staff, and especially the railway protection police specially deputed for the purpose of seeing that no loss takes place to the goods, should get down from the wagon and keep an eye on the wagons in the train in order to see that no unauthorized person gets at the goods". But where bailee's own goods are lost along with the bailor's goods then what would be the liability of the bailee towards the bailor's goods ? In this situation it is natural that the bailee would plead that he took as much care of bailor's goods as he did for his own goods and therefore he is not liable. In Calcutta Corporation Ltd. v. Prince Peter [AIR 1964 Cal. 374], where a car delivered for repairs to a automobile garage was damaged by fire, the plaintiff sued for compensation on the ground that the defendants did not take as much care of the car bailed as a man of ordinary prudence would under similar circumstances take of his own goods. To come to the decision following facts came to be noted. The garage was a pucca structure, walled with wooden planks. In the garage were put not only vehicles containing petrols but also other combustibles like thinners and paints. The garage was partitioned by wooden walls and a part of it was allowed to be used for cooking purposes. There was inadequate arrangement for extinguishing fire. The room in which plaintiff's car was kept could not be opened for 15 minutes as the keys of the room were not available. It was held that the defendants had not taken due care and they were liable. The defendants in this case in order to avoid responsibility pleaded that they took as much care of plaintiff's car as they took of their own ones and that must be deemed to be sufficient care on their part towards the car bailed. They further pleaded that the plaintiff had the knowledge that the defendants keep the cars in certain manner and therefore law of estoppel should apply against the plaintiff. Both the contentions were repelled by the court with the following observations : "The words ‘as a man of ordinary prudence would take of his own goods' do not mean that if the bailee's own goods are lost together with the bailed goods, kept at the same place, it necessarily shows that the bailee has taken the reasonable care required of him by law with respect to the bailed goods. Even a knowledge on the part of the bailor that the bailee keeps the goods in his possession in a particular manner would not stop the bailor from pleading that the bailee had failed to take the care required of him by statute. A plea of this nature, based on the maxim ‘volenli non fit injuria' was rejected by the House of Lords in Barbant and Co. v. King [(1895) AC 632]. The only cases where the bailee would be immune are laid down in 297 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
India, expressly in section 152 of the Contract Act, namely, if he has taken the amount of the care of it as described in section 151". It was also observed in this case that the degree of care needed varies with the kind of engagement, and therefore when a person undertakes such a job, the law not only requires that he should possess the requisite skill but also that he has the requisite plants and appliances and that his premises are also reasonably suitable for doing that job. Likewise where a commission agent purchased on instruction silver bars and placed them in his pedhi unlocked and unattended he would be guilty of negligence and liable for loss of the bars [Lekhaji v. Mahadeo , AIR 1938 Bom 101], or where a pawnee kept the goods after tender of the debt amount and the goods were stolen, he is liable for the loss since to keep the goods after tender of the amount is at his peril [Rampal v Gowrishankar, AIR 1952 Nag.8], or when a carrier of goods transports jute in a boat which has number of leaks and the goods get lost, carrier is guilty of negligence in sending goods in defective boat [Lakshmi Narayan v. The Secretary of State (1932) 27 Cal.W.N. 1017], or where the plaintiff stayed at a hotel and his goods were stolen while he was away, the hotel keeper was held liable as the room was, to his knowledge, in an insecure condition [Jain & Sons v. Comeron, (1922)44 All 735]. Each case referred to above illustrates the example where the bailee was held liable for the loss caused to the bailor due to lack of care on his part. Involuntary Bailee We have studied that bailment is a contract between the bailor and bailee, still there may be situations where there may not be any contract in that sense, but one person is held to be liable as a bailee under the contract of bailment. This happens in the cases where a person gets possession of goods without his consent and through no conscious act on his part. In such a situation the person who gets possession unconsciously is known as involuntary bailee. For example, A goes to a certain shop for certain purchases and leaves behind his brief case, which is found by the owner of the shop who keeps it at his table from where it is stolen by some one. In such a situation though there is no contract between the owner of brief case and the shopowner, but still he would be liable to the owner of the loss to the extent as a bailee under the contract of bailment because he failed to exercise that degree of care which was due from him. In Newman v. Bourne & Hollings worth [(1915) 31 TLR 209], A a customer in B's shop puts down a brooch with her coat, and forgot to pick it up, and left the shop. One of B's assistants found the brooch and handed it over to B.. B, put it in his desk instead of taking it to the lost property office, from where it was lost. B was held liable to A because of the absence of that ordinary care which in the circumstances a prudent man would have taken. The taking of possession in the circumstances involves an assumption of responsibility for the safe keeping of goods. It was further held that the degree of negligence must be measured by the apparent value of the article. In a further case Elvin & Powell Ltd. Plummer Roddis Ltd. [(1933)50 TLR 158] it was held that : 298 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
"If persons were involuntary bailees and had done everything reasonable, they were not liable to pay damages if something which they did resulted in the loss of the property". Under the above referred situation the position is that when a finder accepts the responsibility to the goods his liability is that of a gratuitous bailee. The finder of lost goods is not really a bailee but he is treated as a gratuitous bailee for some purpose. II. Duty not to make unauthorised use The bailee is under a duty not to use the goods in any unauthorised way. If he makes any unauthorised use of the goods bailed there are two remedies available to the bailor : 1) The bailor may terminate the bailment 2) The bailor may recover compensation for any damages to goods due to unauthorised use. 1) The bailor may terminate the bailment If the bailor finds that the goods bailed are being used by the bailee in a manner inconsistent with the condition of bailment, he is entitle to terminate the bailment and claim back the goods under section 153 of the Act which reads : "A contract of bailment is voidable at the option of the bailor, if the bailee does any act with regards to the goods bailed, inconsistent with the condition of the bailment". Illustration : A lets to B, for hire, a horse for his own riding. B drives the horse in his carriage. This is, at the option of A, a termination of the bailment. Thus the bailee is therefore, precluded from using the goods bailed, for his own personal advantage in any manner, what so ever, without the consent of the bailor, express or implied, unless such use is needful for its preservation. This is clear from the illustration appended to the section which authorises the termination of bailment. 2) The bailor may recover compensation Section 154 of the Act emphasis that the goods bailed must be used by the bailee strictly for the purpose for which have been bailed. If the bailee uses the goods bailed in a many inconsistent with the condition of bailment, he is liable to make compensation to the bailor for any damage to the goods due to unauthorised use. Any unauthorized use of goods makes the bailee absolutely liable for any loss or damage to goods. Even an act of God or inevitable accident would be no defence [L & N.W.Ry.Co.v. Nielson, (1922)2 AC 263] such a liability arises even if the unauthorised use was being made with care. Section 154 of the Act which makes a provision in this respect reads as under: "` If the bailee makes any use of the goods bailed, which is not according to the conditions of the bailment, he is liable, to make compensation to the bailor for any damage arising to the goods from or during such use of them". Illustrations: (a) A lends a horse to B for his own riding only. B allows C, a member of his family, to ride the horse. C rides with care, but the horse accidentally falls and is
injured. B is liable to make compensation to A for the injury done to the horse. (b) A hires a horse in Calcutta from B expressly to march to Banares. A rides with due care, but marches to Cuttack instead. The horse accidentally falls and is injured. A is liable to compensate B for the injury to the horse. III. Duty not to mix (i) Mixture of goods with bailor's consent The bailee should maintain the separate identity of the bailor's goods. He should not mix the goods of the bailor with his own goods without the permission of the bailor. Where the bailee mixes the goods of bailor with those of his goods with bailor's consent, in such case the bailor and the bailee have proportionate interest in the mixture thus produced. Section 155 which contains this provision runs thus : "If the bailee, with the consent of bailor, mixes the goods of the bailor with his own goods, the bailor and the bailee shall have an interest, in proportionate to their respective shares, in the mixture thus produced". (ii) Mixture of goods without bailor's consent When the goods of the bailor are mixed by the bailee with his own goods, depending upon the nature of goods, there are two possibilities : 1. Bailor's and bailee's goods can be separated. 2. Bailor's and bailee's goods cannot be separated. 1) When mixed goods can be separated When the bailee mixes the bailor's goods with his own, without the consent of the bailor, and where the goods are separable, then the bailor and the bailee remain the owners in accordance with their respective shares, but the bailee is bound to bear the cost of such separation and any damage arising from the mixture. To this effect section 156 runs thus : "Effect of mixture without bailor's consent when the goods can be separated : If the bailee without the consent of the bailor, mixes the goods of the bailor with his own goods, and the goods can be separated or divided, the property in the goods remains in the parties respectively but the bailee is bound to bear the expense of separation or division, and any damage arising from the mixture". Illustration: A bails 100 bales of cotton marketed with a particular mark to B. B. without A's consent, mixes the 100 bales with other bales of his own bearing a different mark. A is entitled to have his 100 bales returned, and B is bound to bear all the expenses incurred in the separation of the bales, and any other incidental damages. 2. When the mixed goods cannot be separated Where there has been a wrongful mixing, and where separation is impossible, the bailor is only entitled to compensation. Section 157 makes the following provision in this regard. "If the bailee, without the consent of the bailor, mixes the goods of the bailor with his own goods in such a manner
that it is impossible to separate the goods bailed from the other goods, and deliver them back, the bailor is entitled to be compensated by the bailee for the loss of the goods". Illustration: A bails a barrel of cape-flour worth Rs. 45/to B. B. without A's consent mixes the flour with country flour of his own, worth only Rs. 25/- a barrel. B must compensate A for the loss of his flour. Where a bailee mixed his own goods with those of the bailor and when ordered to return the goods of the bailor he offered to return the goods without sorting them out, it was held that the bailor was entitled to refuse to take delivery in toto and claim compensation for loss or damage. The option is entirely his [Dhanpatram v. Jaynarayan, (1961) 27 Cut LT 340]. IV. Duty to return According to Ramana Maharshi there is a single immanenThe bailee must return the goods to the bailor on the expiry of the time fixed or when the purpose is accomplished without demand from the bailor. If the bailee fails to return the goods he is liable for damages occasioned by loss, distinction, or deterioration during the period for which goods are detained. Sections 160 and 161 make the under mentioned provisions respectively in this regard: "160: It is the duty of the bailee to return, or deliver according to the bailor's directions, the goods bailed, without demand, as soon as the time for which they were bailed has expired, or the purpose for which they were bailed has been accomplished". "161: If, by the default of the bailee, the goods are not returned, delivered or tendered at the proper time, he is responsible to the bailor for any loss, destruction or deterioration of the goods from that time". By virtue of statutory provision if the bailee fails to return the goods and keeps them at his own risk he would be responsible for any loss or of damage to goods arising howsoever. For instance, in Shaw & Co. v. Symmons & Sons [(1917)1 KB 799], were certain books were handed over to the book binder (defendant) for binding and the book binder promised to return with in a reasonable time, but failed to deliver when required by the defendant within time.The books were subsequently burnt in an accidental fire, it was held that the defendant was liable in damages for the loss of books. When the loss takes place while the bailee's wrongful action is in operation, there is no question of any defence like act of God or inevitable accident being set up. He is liable in any case. As stated earlier, in keeping with the provision of section 151 and 152 a bailee is excused from realising the goods bailed to the bailor where these have been taken away from him by authority of law exercised through regular and valid proceedings. In Jaggilal Kamlapat Oil Mills v. Union of India [AIR 1976 SC 227] appellants gave consignments of mustard oil to the respondents to be transported from Kanpur to Calcutta, when the wagons carrying mustard oil reached Calcutta, Food Inspector under lawful orders of the competent authority under 299 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
the Calcutta Municipal Act seized the wagons on suspicion of adulterated oil. On examination it was found that wagons contained adulterated oil, thus oil was destroyed by the orders of Calcutta High Court. It was held that the loss, damage or destruction of the goods was not due to the misconduct of the Railway administration or its servants, and the respondents were not liable for the failure to deliver the goods back to the appellants. U/s. 161 bailee's liability to return the bailed articles presupposes delivery of the articles to the bailor. Non return of the articles on demand by the bailor gives the latter at his choice either to sue for wrongful conversion or wrongful detention. The bailor will become entitled to compensation calculated on the value as on the date of the judgement in his favour. As in the case of bailee making an unauthorised use of the goods bailed, so also in case of default in returning the goods on the due date, the bailee becomes responsible for loss, destruction or deterioration of the article as from the date fixed for return. Thus a railway company will be responsible for delay in the delivery of goods at the proper time. Refusal to grant delivery except upon an unjust or unreasonable condition may amount to default within the meaning of the section [G.I.P. Ry.Co. v. Manickchand Premji, (1931) Nag. 29; Hafizullah v. Montague, (1934) 35 PLR 705; Iyer p. 534]. But in case the goods are lost not because of the negligence or default of the bailee but because of the bailor's own default, the bailee cannot be held liable for the loss. In Boseck & Co v. Mandlestan [(1906) Punj Rec No. 70], the plaintiff sent uninsured parcel of jewellery to defendant for repairs, directing defendant to return them after repair as a value payable parcel (value payable being the cost of repair of the jewellery), and defendant acted accordingly. When parcel was tendered to the plaintiff by the postal authorities he told post office to keep it for him till he should send for it. The parcel was then lost when it was with the post office. In an action by the plaintiff against the defendant to recover the value of the contents of the parcel, it was held that: "1) there was no negligence on the part of the defendant in sending an uninsured parcel, because it was sent uninsured by the plaintiff's consent, as suggested by the course of dealings between the parties, and 2) when the parcel was tendered by the post office to the plaintiff, and he instead of taking the delivery, has asked the post office to keep the same for him until he sends for it, the post office became the plaintiff's agent in holding the parcel. Since there was no negligence by the defendant and the parcel was lost by the plaintiff's agent, the defendant could not be made liable for the same". Restoration of goods bailed gratuitously When the goods are bailed gratuitously, i.e., when the bailor is to receive no remuneration in respect of the goods bailed, then the bailor will have to return goods bailed at any time on demand by the bailor. Of course, if the bailor demands the return unreasonably so that it causes any injury or loss to the bailee, 300 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
he can sue for compensation. Section 159 of the Act provides the following provision in this regard: "The lender of a thing for use may at any time require its return, if the loan was gratuitous, even though he lent it for a specified time or purpose. But, if, on the fact of such loan made for a specified time or purpose; the borrower has acted in such a manner that the return of the thing lent before the time agreed upon would cause him loss exceeding the benefit actually derived from the loan, the lender must, if he compels the return, indemnify the borrower for the amount in which the loss so occurred exceeds the benefits so derived". A gratuitous bailment is also terminated by the death either of the bailor or the bailee. In this regard Section 162 states thus: "Termination of gratuitous bailment by death: A gratuitous bailment is terminated by the death either of the bailor or the bailee". Return when bailment by several joint owners As regard the duty to return the goods, where the bailment is made by two or more bailors, section 165 of the Contract Acts provides : "Bailment by several joint owners : If several joint owners of goods bail them, the bailee may deliver them back to, or according to the directions of, one joint owner without the consent of all, in the absence of any agreement to the contrary". V. Duty not to set up jus tertii Section 166 of the Act reads : " If the bailor has no title to the goods, and the bailee, in good faith, delivers them back to, or according to the directions of the bailor, the bailee is not responsible to the owner inrespect of such delivery". The section emphasises that even if the bailor of goods has no title to the goods and somebody else claims a better title, the bailee cannot be made liable for the return of goods to the bailor. The bailee's duty to return the goods is to the bailor only and nobody else. A bailee is not entitled to set up, as against the bailor's demand, the defence of jus tertii, that is to say, that the goods belong to a third person [Rodgers Sons & Co. v. Lambert & Co. (1891)1 QB 318 at p.325]. The bailee is estopped from denying the right of the bailor to bail the goods and to receive them back [J.L.Kamlapat Oil Mills v. Union of India [AIR 1976 SC 227; section 117 of the Indian Evidence Act 1872]. The third person, who claims better title than that of the bailor, may take their delivery from the bailee only through a court of law. Where the goods were returned to the warehouse keeper who had pledged them without the authority of the owner and the pledgee did not know this fact, the pledgee was held to be not liable to the true owner (Bank of Bombay v.Nandalal Thakersey Das (1912) ILR 37 Bom 122]. Even if there is a person who has a better title to the goods than that of the bailor
or who claims ownership of the goods, the bailee may safely return the goods to the bailor and he will not be liable to the owner for conversion. 4.6 RIGHTS OF BAILEE The bailee under the Indian Contract Act has the following rights: 1. Right to recover expenses 2. Right to recover compensation 3. Right of lien 4. Right to sue 1. Right to recover expenses [S.158] This right of the bailee has already been discussed under the heading duty of the bailor (4.4) 2. Right to recover compensation [S. 164] This right has also been discussed earlier under the heading duty of the bailor (4.4) 3. Right of lien [Ss.170-171] The right of lien is said to be a right to detain goods belonging to another by a person in possession, until the sum claimed or other demands of the person in possession is satisfied [Hammonds v. Barclay, (1802)102 E.R. 356]. It is a principle of English Common Law "that if a man has an article delivered to him on the improvement of which he has to bestow trouble and expense, he has a right to detain it until his demand is paid" [Bevan v. Waters, (1828)3 Car & P 520]. The essential requisite of a lien is therefore possession obtained previously and the possession must have been acquired lawfully. The lien is in its very nature, a right accessory to another right i.e., a right to receive payment. The lien terminates (i) on payment, or (ii) on giving possession, or (iii) by waiver of the lien, as, for example, by making a contract inconsistent with the existence of the lien. The Indian Contract Act recognises two kinds of lien - (1) Particular lien, and (2) General Lien. The right of ‘particular lien' entitles the bailee to retain those very goods for the services regarding which the remuneration is due. The ‘general lien' entitles the bailee to retain the goods of the bailor for a general balance of account. Section 170 deals with a bailee's particular lien and section 171 deals with the bailee's general lien. Now hereunder we may be discussing both kinds of lien. A. Particular Lien Section 170 of the Act reads : "Where the bailee has, in accordance with the purpose of the bailment, rendered any service involving the exercise of labour or skill in respect of the goods bailed, he has, in the absence of the contract to the contrary, a right to retain such goods until he received the remuneration for the services he has rendered in respect of them . Illustration: (a) A delivers a rough diamond to B, a jeweller to be cut and polished, which is accordingly done. B is
entitled to retain the stone till he .lm 5 is paid for the services he has rendered. (b) A gives cloth to B, a tailor, to make into a coat. B promises A to deliver the coat as soon as it is finished, and to give a three month credit for the price. B is not entitled to retain the coat until he is paid. Particular lien is confined to the very goods in respect of which labour or skill has been expended, and for which labour or skill the bailee seeks remuneration. The work 'retain' has been used in section 170 which implies prior possession lawfully acquired. So, if the possession of goods is obtained by misrepresentation or fraud, then no lien is attached to the goods. Further more, the lien subsists only so long as possession lasts. But where the person is deprived of the possession by fraud or force, the lien continues. Again, if the person entitled to the lien parts with the goods for a specific purpose, the lien is not lost. But if the possession is voluntarily parted with, the lien is lost. The lien consists only in the right to retain the goods. It must be noted at the same time that when once the right of the bailee to retain ends by parting with the possession of the goods, it cannot be revived again even if he gets the possession again for some purpose [Eduljee v. Cafe John Bros, AIR 1953 Nag. 249]. In this case a second hand refrigerator was sold and delivery of possession was handed over to the buyer. After sometime, due to two defective parts of the refrigerator, the buyer handed over these two parts for repair to the seller. The seller wanted to exercise the right of lien over these parts for the price of the refrigerator, the which has not been paid to him. It was held that the seller's rights had come to an end when he had delivered the refrigerator to the buyer, and this right was not revived by his getting the possession of some parts of it again. Under section 170 'particular lien' is available under the following situations: 1) The bailee must have acted in accordance with the purpose of bailment In Skinner v. Jager [(1883) 6 All 139] a bailee who undertook certain repairs to a musical instrument for a fixed sum claimed lien not in respect of that amount settled for repair but for some other repair work done to the instrument. The court held that no lien could be had in regard to such work. This principle was applied by the Calcutta High Court in Jaddah v. King Emperor [(1926)53 Cal.174]. Brief facts were: A had given an electric kettle to B an electric repairer, on the condition that the article must be returned completely repaired within a fixed period. Only a part of the work was done within the stipulated time, but the repairer claimed a lien. The court observed that it would be preposterous to lay down as a general rule of law that a person who is entrusted with the repair of an article can refuse to part with after doing a part of the work which perhaps makes no improvement of any kind. Again, it is not open to the bailee to retain goods bailed for one purpose, as security for claims arising out of a different and distinct matter. It must also be noted that where goods are delivered to the bailee under a single contract, the bailee will 301 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
have a lien on all the goods, though they may be delivered at different times in different parcels. Similarly, a bania may retain the whole quantity of goods as security for his claim, and will be justified in refusing to deliver up a part on payment of the value of that part [Miller v. Nasmyth's Press Co Ltd, (1882) 8 Cal 312; Mohari Bibi v. Shyama Bibi, (1930)30 Cal. 937; Iyer p.542.] 2) The service must involve the exercise of labour or skill on the goods bailed In Scarfe v. Morgan [(1838) 150 ER 1430], it wad observed : "Where a bailee has expended his labour and skill in the improvement of the chattel delivered to him, he has lien for his charge in that respect. Thus the artificer to whom the goods are delivered for the purpose of being worked up into form, or the barrier by whose skill the animal is cured of a disease, or the horse breaker by whose skill he is rendered manageable, have liens on the chattels inrespect of their charges". Thus the important condition for exercising lien upon goods is that the bailee must have rendered some service involving the exercise of labour or skill in respect of the goods bailed and the labour or skill exercised by the bailee must be such as improves the goods. It would follow that a bailment for mere custody confers no lien, because no labour or skill is expended. Thus a person receiving horse to graze on stipulated charges is not entitled to claim lien on the horse for the stipulated charges. But a trainer does get a lien upon the horse for the improvements which he effects to the horse. But the right to retain possession or to exercise the right of lien on the goods is available to the bailee u/s.170 if there is no contract to the contrary. In this respect we may refer to illustration (a) appended to the section "A gives cloth to B , a tailor, to make into a coat. B promises A to deliver the coat as soon as it is finished, and to give a three months credit for the price. B is not entitled to retain the coat until he is paid". The section confers only the right to retain the goods inrespect of which labour or skill has been employed. The right does not extend to a right to sell the goods. The right of lien contained in section 170 is available only in the absence of a contract to the contrary”. Hence this right can be waived by the parties by an agreement. It means the bailee may, if he so likes, waive his right of lien. B. General Lien U/s 171 right of general lien is available to certain types of bailees. The section reads : "Bankers, factors, wharfingers, attorneys of a High Court and policy-brokers, may in the absence to the contract to the contrary, retain, as a security for a general balance of account, any goods bailed to them; but no other persons have a right to retain as a security for such balance, goods bailed to them, when there is an express contract to that effect". 302 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
According to the right conferred under this section the bailee may retain not only those goods of the bailor in respect of which some particular services are rendered, but also other goods in the possession of the bailee belonging to the bailor. So to say general right is a privilege and is specially conferred upon the following types of bailees : 1) Bankers; 2) Factors; 3) Wharfingers; 4) Attorneys of a High Court; and 5) Policy-brokers. This means that the right is available to the above categories of baillees only and to none else. For example in re : The Bombay Saw Mills Co. Ltd. [(1889)13 Bom 314], the Secretaries and Treasurers of a company which went into liquidation, claimed to be creditors of the company in respect of advances made to it by them and being in possession of all the property of the company, they claimed lien for the amounts advanced by them. The court held they were not entitled to a lien. They could not claim general lien because they were not within the description of the several persons mentioned in section 171; nor could they claim any of the particular liens dealt within the Act. Hereunder we will discuss each type of bailee's rights : (1) Banker's General Lien In the absence of any special contract to the contrary, the lien extends to all bills, cheques and money entrusted or paid to the bank and all securities deposited with it in its capacity as a banker. The lien is applicable to negotiable instruments which are remitted to the banker by the customer for the purpose of collection. When collection has been made the proceeds may be used by the banker in reduction of the customer's debt balance unless otherwise earmarked. [Re Keever (1967) Ch. 182]. As to the concept of banker's lien, the Supreme Court quotes the following passage from 'Chalmers on Bill of Exchange' in Syndicate Bank v. Vijay Kumar, [AIR 1992 SC 1066]: "A banker's lien on negotiable securities has been judicially defined as an ‘implied pledge'. A banker has in the absence of agreement to the contrary, a lien on all bills received from a customer in the ordinary course of banking business in respect of any balance that may be due from such customer". On the basis of this reservation the Supreme Court held that the fixed deposit receipts deposited by way of security for cash credit facility were usable as security against the customer's other debts also. If, however, the bank knows that securities belong to a third person and not its customer, he cannot exercise the right of lien in respect of them. Lien over money Under the contract of bailment the "goods" are the subject matter of bailment and in the Act itself word "goods" has not been defined though the word 'goods' has been defined u/s 2(4) in
the Indian Sale of Goods Act, 1930 as goods include every kind of property other than actionable claims or money'. Hence strictly speaking money is not goods and its deposit with the bank is not bailment [Devendar Kumar v. Gulab Singh, AIR 1946 Nag.114], but following the English Law various High Courts in India have held that a banker can exercise lien over money deposited with it. For instance, when monies are held in one account and the payer in respect of those moneys owes the bank on another account, the banker's lien gives the bank a charge on all the monies of the payer in its hands, so that they may be transferred to whatever account the bank chooses, to set off or liquidate the debt (Iyer p. 544).
course of his employment [Hammonds v. Barclay (1802)2 East. 227]. The lien does not extend to goods acquired otherwise than as factor or entrusted for a special purpose. [Iyer p.450]. It must be kept in mind that the factor can buy and sell goods in the name of the principal or in his own name. It is not necessary that he must disclose the name of the principal and as per practice he usually buys and sells goods in his own name. Hence a factor is entitled to contract in his own name and to receive payments and his lien over the goods gives a special contractual right. A factor, like a banker, will not have the right of lien on such goods as have come to his possession for a specific purpose which impliedly excludes the right of lien.
But if there is an express contract between the parties contrary to the statutory right of general lien, the right thereby is excluded. For example, in Mercantile Bank v. Rochaldas [AIR 1926 Sind 225], where money was handed over to a bank for transmission to another place and the bank had issued a demand draft, it was held the money must be deemed to be held by the bank under a special contract which excluded the banker's lien. The reason is clear that it would be most unbusinessman like and unreasonable for a banker to expect that a remitter who is in urgent need of money at the place of payment would agree to transmit money through the banker if he is told or has reason to believe that the money is likely to be withheld in the exercise of this alleged lien. [See Krishna Kishore Kar v. United Commercial Bank, AIR 1982 Cal. 62].
(3) Wharfinger's Lien
Similarly in Vijay Kumar v. M/s. Jallunder Body Builders [AIR 1981 Del 126] where the contract between the customer (judgment debtor) and a bank was that the bank was to furnish guarantee for a certain amount on the understanding that the bank was to hold the fixed deposit receipts given by the customer as security for the guarantee and the bank gave the bank guarantee on behalf of the customer to the court. Subsequently, the bank sought to utilise the amount of the fixed deposit receipts to satisfy the claim on the over draft account, in which the amount was due from the customer. It was held that the bank cannot hold the fixed deposit receipts for the general balance due to the customer in the customer's overdraft account, when the endorsement of the bank manager on the reverse of the letter given by the customer in connection with the guarantee on the usual printed form indicated that the fixed deposit receipts were given in connection with the bank guarantee only. The letter had to be read with the endorsement and so read it would constitute a contract to the contrary to the general lien of the bank and the court, in whose favour guarantee was given, could attach the fixed deposit receipts in the hands of the bank. To sum up when the goods or money is for a specific purpose, the bank cannot exercise general lien on the goods or money. (2) Factor's Lien A factor is an agent entrusted with the possession and control of the goods to be sold by him for his principal [Steevens v. Biller (1883) 25 Ch D 31]. He has a 'special property' in the goods consigned to him. His lien extends to all lawful claims against the principal as factor such as for advances or towards remuneration in respect of losses or liabilities incurred in the
'Wharf' means a place contiguous to water, used for the purpose of loading and unloading goods, and over which the goods pass in loading and unloading. It is essential to a wharf that goods should be in transit over it. The primary idea is that, it is a place used, not for storing goods, but in the process of their transit to or from water. A 'Wharfinger' is the person who owns or keeps a Wharf, or has the management of it. A wharfinger has general lien on the goods bailed to him until his wharfage, which means, charges due for the use of his wharf, are paid [Avtar Singh p.503]. In fact wharfinger is a custodian who has by custom acquired a lien. The lien ordinarily is effective against the owner of goods. He cannot claim a lien against the buyer for charges due from the seller after he had notice of the sale. (4) Attorney's Lien Section 171 of the Act enacts a special rule of lien applicable exclusively to attorneys who are also known as solicitors. The nature of an attorney's lien has been discussed in Damodar Dass v. Morgan & Co. [(1934) 60 Cal. 341], where it was pointed out that an attorney in India has two kinds of liens; (1) a passive or retaining lien, and (2) a common law lien on property recovered through his efforts. So where an attorney recovered money for his client, he is only entitled to a particular lien in respect of fees due to him for that matter and cannot have a general lien for other monies due to him on other papers or documents. A solicitor or attorney has no longer right over money which is the fruit of his exertion for the client when he obtains possession of it than he has when it was still in deposit with the court. A solicitor or attorney in India has the same rights as his English counterpart [See Devikabar v. Jafferson, (1886)10 Bom. 248; Mangal Chand v. Purna Chandra, AIR 1949 Cal. 505]. In Damodardas Agarwal v. R. Badrilal [AIR 1987 AP 264] Andhra Pradesh High Court has laid down the law thus : (1) The Common law right of passive and retaining lien available to a solicitor in England is accepted by courts in India as a part of the law of this country. (2) The said Common law right is not abrogated by section 171, Contract Act. (3) Section 171, Contract Act, enacts a special rule of lien applicable exclusively to attorneys who are also known as solicitors. 303 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
(4) The other practitioners, who discharge the functions of solicitors, are entitled to invoke the common law rights applicable to solicitors though section 171 is inapplicable to them. (5) The practitioner forfeits the right of retaining lien the moment he discharges himself or by his client for misconduct. Under the English law, a solicitor has three kinds of liens to protect his rights to recover his costs from his client (1) a passive or retaining lien, (2) a common law lien on property recovered or preserved by his efforts, (3) a statutory lien enforceable by a charging order [Damodar v. Morgan, (1933) 60 Cal.1442]. In India the first two kinds of liens under English law are preserved u/s. 171 of the Act but there is no corresponding provision to the third kind of lien and thus what is clear from the above refered case [Damodardas Aggarwal v. R.Badrilal]. Under Section 171 general lien of attorneys is available to advocates and all other legal practitioners. The attorney can exercise this right of lien in respect of the papers etc. belonging to his client which are with him. He can retain them until his fees for professional services and other costs and expenses incurred by him for the client are paid to him. If a solicitor is discharged by the client, the client cannot take back his documents until the costs etc. incurred by the solicitor and his other charges are paid to him [Bal Keberbai v. Naranji, (1880)4 Bom. 352]. If he has not been discharged by the client, but otherwise refuses to act for the client or is unable to work for him, the right of lien does not exist. This right of the attorney is also subject to any contract, express or implied to the contrary. When a promissory note on which a suit is founded is given to the Advocate it is deemed to be produced in court at the earliest opportunity, the exercise of his lien over the document will therefore be deemed to be excluded. [Lalchand Ram Chand v. Pyare Dasarath Chamar, AIR 1971 MP 245]. (5) Policy-broker's Lien A policy broker is a person who acts as an insurance agent to effect a policy of marine insurance. u/s. 171 he has a general right of lien. His lien extends to any balance on account of any assurance due to him from a client. 4. Right to Sue [S.180] The bailee may maintain an action of trespass or conversion or for damages for destruction or injury to the goods against a wrong doer, just as the bailor or the real owner can [Burton v. Hughes, (1824)130 ER 272]. He is entitled to recover in this manner, even if he is under his particular contract with the bailor, not responsible for loss or damages to the goods. Section 180 of the act provides thus : "If a third person wrongfully deprives the bailee of the use or possession of the goods bailed, or does them any injury, the bailee is entitled to use such remedies as the owner might have used in the like case if no bailment has been made; and either the bailor or the bailee may bring a suit 304 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
against a third person for such deprivation or injury". Under this section it is not only the bailee who can bring the action against the wrongdoer but bailor is also empowered to bring such a action against the third party. This section gives to the bailee full rights of an owner as against the third party. He is entitled to damages against a wrongdoer, irrespective of the consideration whether he is liable to the bailor or not [State Bank of Hyderabad v. Susheela, AIR 1980 AP 1]. If a person fraudulently or forcibly dispossesses the bailee of the goods bailed, the bailee has a right to recover the goods. In Purushottam Das Banarasi das v. Union of India [AIR 1967 All 549], where A took delivery of goods from railway by producing forged railway receipt and subsequently pledged those goods to B, it was held railway authorities had a right to recover those goods from B. Hence section 180 enables a bailee to sue any person who has wrongfully deprived him of the use or possession of the goods bailed or has done them any injury [Karnataka Electricity Board v. Halappa (1987)1 TAC 451. For the complete study of section 180 it is essential to study this section with section 181 which reads : "Whatever is obtained by way of relief or compensation in any such suit shall, as between the bailor and the bailee, be dealt with according to their respective interests." It means that where a bailee receives any relief or compensation from the wrongdoer, he is liable to account to the bailor for everything that he recovers beyond his own interest. It connotes that whatever is obtained by the bailee, that be dealt with between the bailor and the bailee accordingly to their respective rights [Morvi Mercantile Bank v. Union of India, AIR 1965 SC 1984], i.e., bailee cannot keep beyond his interest. At the same time it must be noted that a recovery by one will oust the other of his right to recover, for there cannot be a double satisfaction. 4.7 DUTY OF FINDER A person who finds goods belonging to another and takes them into his custody, is subject to the same responsibilities as a bailee (S71). A person who finds goods and takes them into his custody, takes upon himself all the liabilities and responsibilities of a bailee and he is expected to take as much care of the goods as a man of ordinary prudence would under similar circumstances take of his own goods [S.151]. He cannot make use of goods for his own purpose [S.154] and mix them with his own goods [Ss.155-157]. As we have already studied the liabilities and responsibilities of the bailee, we are not going to discuss them again here. We will discuss next, the rights of finder [Ss. 168-169]. 4.8 RIGHTS OF FINDER Sections 168 and 169 deal with the rights of finder of goods which reads as under : "168: The finder of goods has no right to sue the owner for compensation for trouble and expense voluntarily incurred by him to preserve the goods and to find out the owner; but
he may retain the goods against the owner until he receives such compensation; and where the owner has offered a specific reward for the return of goods lost, the finder may sue for such reward, and may retain the goods until he receives it". "169: When a thing which is commonly the subject of sale is lost, and the owner cannot with reasonable diligence be found, or if he refuses upon demand, to pay the lawful charges of the finder, the finder may sell it (1) when the thing is in danger of perishing or of losing the greater part of its value, or (2) when the lawful charges of the finder, inrespect of the thing found, amount to two-thirds of its value." As per sections 168 and 169 finder has three rights : 1) Right of lien 2) Right of claiming reward, if announced by owner 3) Right to sell goods (1) Right of Lien [S.168) In English law as there is no right of remuneration, so there is no question of lien of the finder upon the goods [Nicholson v. Chapman, (1793)126 ER 536]. Unless the true owner has intentionally abandoned the chattel, his title is not lost, and he can recover it in the hands of anyone other than a purchaser in open market. As against everyone save the true owner, the property in a chattel found in a public or quasi public place vests in the finder on his taking possession of it. Thus a person who picks upon the floor of a shop, a packet of bank notes accidentally dropped by a stranger, is entitled to the notes, as against the whole world except the true owner [Bridges v. Hawkesworth, (1851)21 LJQB 75], and it will not be open to anyone who dispossesses the finder to plead as against him the title of the true owner [Iyer, p.452]. But the position in India is somewhat different in this regard as finder has been provided with certain statutory rights. In India finder has not the right to sue the owner for compensation for trouble and expense voluntarily incurred by him to preserve the goods and to find out the owner as per section 168. He has, however a kind of lien inrespect of the goods found i.e., finder may retain goods till he is compensated for the trouble and expense voluntarily
incurred by him for the preservation of goods and in finding the owner. (2) Right of claiming reward, if announced by owner [S.168] In addition to the right to retain goods till compensation is paid by the owner for trouble and expenses voluntarily incurred by the finder in finding the owner and presenting the goods u/ s.168, finder has an additional right under the same section to sue for reward where the owner has offered the specific reward for the return of the goods lost and retain the goods until he receives the reward. To claim reward under this situation is the statutory right of the finder of goods and thus he has been vested with the power to sue, but where no reward had been announced, finder cannot sue but can retain the goods under the conditions referred to in the section and can claim compensation only [See Lalman Shukala v. Gauri Dutt (1913)11 All LJ 489]. Hence the finder has a right to retain goods and refuse to deliver them up except on payment of compensation or the reward as the case may be. But where the finder hands over the goods to the owner and the owner promises to compensation, this would be a contract and enforceable in view of section 25 (2) read with illustration (c) to the section which reads - A finds B's purse and gives it to him. B promises to give A Rs. 50/-. This is a contract." (3) Right to sell goods [S.169] Ordinarily, the finder, being a bailee of goods found is not competent to sell them for it will be an act of conversion. But section 169 empowers the finder to sell goods in the circumstances referred to in the section. The conditions are : (1) When the owner cannot be found with reasonable diligence, or he refuses to pay lawful charges of the finder ; (2) When the goods are of perishable nature, or in danger of loosing quarter part of their value, or when the lawful charges of the finder in respect of the thing found, amount to two-third of its value. As per the section these conditions apply to the goods which are commonly the subject of sale i.e., the thing to be sold must be an ordinary object of sale. The conditions referred to above indicate this rule.
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5. PLEDGE & HYPOTHECATION SUB-TOPICS : 5.1 Introduction 5.2 Essential features 5.3 Subject matter of pledge 5.4 Distinction: Pledge, Hypothecation, Bailment, Lien and Mortgage 5.5 Who can pledge 5.6 Termination of pledge 5.7 Rights of pledgee/pawnee 5.8 Rights of pledgor/pawnor 5.9 Additional right of the hypothecatee 5.1 INTRODUCTION A pledge or pawn is a bailment of goods by a debtor to his creditor to be kept by him till the debt be discharged; the bailment is intended to be a security for some debt or engagement. Section 172 of the Indian Contract Act, 1972 defines a pledge as the bailment of goods as security for payment of a debt or performance of a promise'. In brief pledge or pawn is a bailment of personal property as a security for some debt or engagement. A pledge can be created only in respect of a chattel capable of delivery; thus, these can be no pledge of a chose-in-action as such [Harrold v. Plenty (1901)2 Ch. 314, 316; Lallan Prasad v. Rahmat Ali, AIR 1967 SC 1322]. The general property in the goods pledged remains in the pawner, but a special property in them passes to the pawnee in order that he may be able to sell the goods if his right to sell arises. This special property is strictly only a right to possession of the goods, together with a power of sale upon default. Sale upon default in payment of the debt is an incident of pledge. Thus a pledge is only a special kind of bailment, and the main basis of distinction is the object of contract. Pledge of the title deeds or ownership and/or possession documents instead of the movable goods itself is known as hypothecation. As for example, loan taken against an omnibus may be secured by sanctioning loan, along with an agreement in writing allowing the bank to secure possession of the property if the payment is not made in time. This is known as hypothecation. The omnibus clearly contains the inscription that it is hypothecated to the concerned bank. This clearly indicates that in pledge there are two parties i.e., pawnor (pledgor) who being liable to an engagement gives a thing to one, called pawnee (pledgee) to whom he is liable, to hold the thing as security for payment of debt or the fulfilment of his liability. 5.2 ESSENTIAL FEATURES There are three essential features of pledge, viz : (1) there must be a bailment of goods i.e., delivery of goods; (2) the bailment must be by way of security; and 306 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
(3) the security must be for payment of debt or the performance of a promise. [See Shasade Begum Saheba v. Girdharilal Sunghi, AIR 1976 AP 273] Hence delivery is the most important requisite of a pledge [Ex parte Parsons (1886) 16 QBD 532; see also Ideal Bank Ltd. v. Pride of India Pictures Ltd, AIR 1983 Del 546]. We may thus discuss in detail all the above essential features of pledge hereunder. (1) Delivery of Possession Delivery is essential to identify a transaction as a pledge within the ambit of section 172 of the Act. As the pledge is a bailment, so the delivery of goods from pawner to pawnee is a must i.e., the transfer of possession from one person to another. Delivery of the goods, either actual or constructive is a sine qua non of a valid pledge. English law on the subject is that for the completion of pledge it is not essential that there must be actual delivery of goods to the pledgee, it is enough if there be a symbolic or constructive delivery. Where it is practically impossible to give physical delivery or possession of goods or where goods remain in the possession of pledger for certain purposes, symbolic delivery is enough. Delivery of the key of the warehouse where the goods are stored or handing over the delivery order directing the ware-houseman to deliver the goods to the pledgee are illustrations of constructive delivery. Also where the goods are in possession of third person and who on the directions of the pledger consents to hold them on behalf of the pledgee also constitutes delivery in law from the pledger to the pledgee. This is also known as delivery by attornment. In such situation we can say that pledge is legally delivered possession though it does not pass from pledger to pledgee in fact. Further the delivery and the loan need not be simultaneous. It is enough if possession is delivered within a reasonable time of the advance, in pursuance of the contract to pledge. [Madras Official Assignee v. Mercantile Bank of India Ltd. (1935) A.C. 53, 58-59] see also Hilton v Tucker, (1888) 39 Ch D 669] . On this aspect Indian law is the same as that of English and the Indian courts invariably follow the English rulings. (2) Pledge must be by way of security The purpose for which the goods are pledged is basically a security for the payment of a debt or performance of a promise as per the directions of section 172 of the Act. When the goods are pledged with the pawnee he becomes the secured creditor of the pawner. Security can be of three types : 1) a simple lien; 2) a mortgage passing the property out and out; and 3) a security intermediate between a lien and mortgage, namely a pledge, where by contract, a deposit of goods is made security for a debt and the right to the property vests in the pledgee so far as is necessary to secure the debt. (3) Security must be for payment of debt or the performance of a promise
As has been said earlier that the purpose of pledging the goods with the pledgee is to serve as security for the payment of loan or for performance of a promise, so thereby the pledgee becomes the secured creditor possessing a prior claim over the goods pledged than other creditors. Thus in Bank of India v. Binod Steel Ltd. [AIR 1977 MP 188] it was held that when certain movables have been pledged by a company with a bank, they cannot be attached and sold for satisfaction of the claims of other creditors of the company without first satisfying the claim of the bank. It must be remembered that a pledge is not a transfer of any interest in the property for the benefit of the pledgee. It only creates a special property on the chattels in favour of the pledgee. Pledge only entitles the pledgee to keep the possession of chattels till the realisation of the debt, the purpose for which chattels have been pledged by way of security. If the pledgee waives his right of possession, his claim over the property (goods) comes to an end. In Syndicate Bank v. Official Liquidator, M/s Prashant Engineering Co. (P) Ltd. [AIR 1985 Del 256], bank had advanced a loan to the company and the company hypothecated the installed machinery in the company with the bank as security for the payment of loan. On the action brought by the bank against the company, simple money decree for Rs. 2,11,897-20, was granted. It is important to note that the bank neither took possession of the hypothecated machinery itself nor it applied to court for its possession. Under the circumstances it was held that as the bank did not avail of its right as a hypothecatee, to have the possession of the machinery itself or through the intervention of the court, so the bank was deemed to have waived its right as a secured creditor against the security. 5.3 SUBJECT MATTER OF PLEDGE It is not all goods that can be the subject matter of a pledge, but only those that the pledgee can sell effectively. Generally speaking any kind of goods or documents may be pledged. A document of title could be pledged by transfer of the same. A bill of lading or railway receipt is document of title and a pledge of it operates as a pledge of the goods. Government securities cannot be pledged except by endorsement and delivery. Title deeds of property are not 'goods' but they may be pledged u/s 172 of the Act. Promissory notes as a security device for a debt is a valid pledge. A mere deposit of share certificates of a limited company will not constitute a pledge as the depositee cannot sell them. But if the deposit is accompanied by blank transfer forms then it will constitute valid pledge. Delivery of negotiable instruments which because of their very nature authorise the pledgee to sell, is a valid pledge. These brief illustrations indicate that any kind of personal property which is movable and saleable can be the subject matter of pledge [Lallan Prasad v. Rahmat Ali, AIR 1967 SC 1322]. 5.4 DISTINCTION : PLEDGE, HYPOTHECATION, BAILMENT, LIEN AND MORTGAGE Pledge and Hypothecation The Indian Contract Act does not contain any specific provision to govern pledge without dispossession exclusively. However, Indian law is familiar with pledges without dispossession through the institution of hypothecation. Hypothecation, not accompanied by possession by the pawnee, is a kind of a pledge.
It confers a good title upon the person in whose favour it is made. The transaction is regarded as security” and equity gives effect to it. In the absence of fraud, there is no inherent illegality, immorality or opposition to public policy in the non-possession by hypothecatee of movables, and therefore, a contract for such a hypothecation is valid contract, for it is a transaction which has become customary throughout the country and is suitable to the circumstances and business transactions of the people. The difference between" pledge" and "hypothecation" lies in the fact that in "hypothecation" possession of the goods is retained by the owner and certain rights in that movable property are transferred to the person in whose favour the property is hypothecated [Bank of Maharashtra Ltd. v. Official liquidator, AIR 1969 Mys. 280 ]; while in the case of" pledge" the possession of the goods is actually delivered to the person for whose benefit the pledge is made. In pledge the possession of goods passes to the pledgee by way of "security" though the possession may be constructive. The true distinction from hypothecation is that the constructive possession of the goods in the case of pledge is specifically secured by the term of the contract and is continued throughout [Nadar Bank Ltd. v. Canara Bank Ltd. AIR 1961 Mad. 326]. In order to determine whether a particular transaction of the type of pledge constitutes a hypothecation without dispossession from the pledger, one should find whether there was an intention to create a security. If such an intention is evident, equity gives effect to it. Indian Courts have also endorsed the English law that hypothecation may be done not only of the movables existing at the time of the transaction, but also of those movables which may be subsequently acquired or bought. [See H.V. Low & Co. Ltd. v. Pulinbihari Lal Singla and Others, AIR 1963 Cal. 154]. In case of pledge since the pledgee has been in possession of goods, in the event of default by the pawner apart from other rights the pledgee has a right of lien over the goods, i.e., he may retain the goods pledged until payment of debt, or performance of the promise etc. In case of hypothecation since the possession of the goods remains with the owner the hypothecatee cannot have the right of lien. He may, sell the property in default [see State Bank of Baroda v. R.B. Hirabai, AIR 1967 Guj 1; Bangia, p. 429] Pledge & Bailment Bailment being a wider term, includes pledge also. Pledge is a kind of bailment of goods as security for the payment of a debt or performance of a promise. it denotes that the goods are with the pledgee as a security against the loan advanced or for the performance of a promise, whereas when goods are given for some other purpose, for example, a cycle is given for repairs, it is bailment. In case of bailment, if the bailor does not pay the lawful charges due to the bailee in respect of the services etc. rendered by the bailee, the bailee can exercise lien over the goods, bailed, i.e., he can retain them until the necessary payment is made to him. In case of pledge the pledgee has not only a right to retain the goods pledged until the repayment of debt or performance of the promise, etc., but in the event of default by the pawnor in payment of the debt, or performance of the promise at the 307 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
stipulated time, he may even sell the goods, after giving a due notice of sale to the pawnor.
When these conditions are satisfied, the pledge though made by a non-owner would be valid.
Pledge, Lien and Mortgage
(i) Pledge should be by Mercantile agent
A pledge differs from both lien and mortgage. While sale upon default of payment is an incident of pledge, in lien there is only right to retain. Again a pledge unlike a lien is assignable.
Non-owner making the pledge should be a ëmercantile' agent as defined in the Indian Sale of Goods Act, 1930. Section 2(9) of the Act defines a mercantile agent” as a person who in the customary course of his agency business has authority to sell or buy goods or raise money on the security of goods.
In a mortgage of chattels, limited property passes by assignment subject to a right of redemption but possession need not pass to the mortgagee. While in a pledge there is only a bailment, under a mortgage there is a sort of transfer of property. 5.5 WHO CAN PLEDGE Ordinarily it is the owner of goods himself or any person authorised by him who has the authority to pledge the goods. A person only having the custody of goods, with the consent of the owner, is not entitled to pledge the goods and if he does so, the pledge will not be valid. Say if the tenant of a house is in possession of all the furnitures provided by the landlord in the house pledges the furniture, it would not be a valid pledge, or if a servant is in possession of a gun of the employer, he is not entitled to pledge the gun. The rule is that where goods are left in the custody or care of a person for some specified purpose, he cannot pledge them. Same would be the case if a person fraudulently obtains the goods and pledges them to some one. In Purshottam Das v. Union of India [AIR 1967 All 549], where certain goods were delivered by the Railway company to a person on a forged railway receipt, were pledged with the defendant, a suit for the recovery of goods against the defendant was filed. Defendant imputed negligence on the part of the railway. But the court held that the pledge was not valid and the defendant did not get any rights as a pledgee, in the goods pledged. Thus the rule laid down is that a bailee of goods is entitled to recover them from a person, who takes them from his possession forcibly or fraudulently. If such a person pledges them with another who may have taken in good faith, the bailee would still be entitled to recover from the pledgee. The principle is to protect the individual interest in the ownership of property. But interest acquired in the course of lawful transactions equally deserves to be protected. Thus under sections 178, 178-A and 179 of the Act certain exceptional cases have been recognised where even a non-owner can make a valid pledge. This happens where a person having possession of goods with the consent of the owner pledges and confers rights on the pledgee. Exceptions recognised by law are : I. Pledge by Mercantile agent [s.178] Section 178 indicates that the undermentioned essentials must be satisfied before the non-owner can lawfully pledge the goods: (1) He must be a mercantile agent. (2) He should be in possession of the goods or of documents of title thereto, with the consent of the owner. (3) Pledge should have been made in the ordinary course of business of the mercantile agent. (4) Pledgee should have acted in good faith and at the time of the transaction the pledgee should have no notice of the fact that the pawner had no authority to pledge. 308 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
Section 178 of the Act reads : "Where a mercantile agent is with the consent of the owner, in possession of goods or the documents of title to goods, any pledge made by him, when acting in the ordinary course of business of a mercantile agent, shall be as valid as if he were expressly authorised by the owner of the goods to make the same: provided that the pawnee acts in good faith and has not, at the time of pledge, notice that the pawner has no authority to pledge." Explanation: In this section the expression mercantile agent” and "documents of title" shall have the meaning assigned to them in the Indian Sale of Goods act, 1930". (ii) Possession with owner's consent Mercantile agent must be in 'possession of the goods' or the documents of title to goods with the 'consent of the owner'. If the possession is obtained dishonestly or by trick, a valid pledge cannot be effected [See M/s Jute Distributors v. Sushil Kumar Gupta, AIR 1974 Cal 386]. The term 'owner' means a person having the right to authorise the sale, the word 'possession' is understood in the ordinary sense and the phrase documents of title to goods has been defined in section 2(4) of the Sale of Goods Act thus : "Documents of title to goods' includes a bill of lading, dockwarrant, warehouse keeper's certificate, wharfinger's certificate, railway receipt, warrant or order for the delivery of goods and any other document used in the ordinary course of business as proof of the possession or control of goods, or authorising, or purporting to authorise, either by endorsement or by delivery, the possession of the document to transfer or receive goods thereby represented". There may be circumstances where the mercantile agent may not have been authorised to pledge the goods by the owner, yet he must have obtained the possession of goods or the documents of title to the goods with the consent of owner. The Supreme Court in Central National Bank v. United Industrial Bank, [AIR 1954 SC 181] laid down that the word 'consent' for this purpose means agreeing on the same thing in the same sense as defined in section 13 of the Contract Act. If the consent is real, it is immaterial that it was obtained by fraud or misrepresentation or with dishonest intention. All these things may make the person receiving possession liable for some offence, but the consent of the owner actually given is not annulled thereby. Thus where a goldsmith obtained possession of certain jewellery under the pretence that he had a customer, and instead pledged it, the pledgee was said to have obtained a good title [See Central National Bank v. United Industrial Bank, AIR 1954 SC 181 at p.185; U.Sulamian v. Ma Ywet, (1934) 151IC 413]
(iii) Possession in the ordinary course of business It is further necessary that the goods or the documents of title to goods must have been pledged by the mercantile agent in the ordinary course of business of a mercantile agent. Hence such possession must have been obtained in his capacity as a mercantile agent, and not in any other capacity. If I send my television set to a mercantile agent to know the maximum amount on which it can be pledged, the agent who has not been authorised to pledge, pledges the same, pledge would be valid. But if the mercantile agent gets possession in other capacity than the mercantile agent, pledge made by him will not be valid. For example, if I hand over certain goods to my friend for safe custody who happens to be a mercantile agent and if he pledges them, pledge would not be valid. (iv) Pledgee acting in good faith The pledgee who obtains a pledge must act in 'good faith', as defined in section 3 (20) of the General Clauses Act, 1895 which reads thus : "A thing shall be deemed to be done in ‘good faith' where it is in fact done honestly, whether it is done negligently or not". In addition to action in 'good faith' of the pledgee, it is required that the pledgee should not have notice of the pledgor's defect of title. If the pledgee knows that the pledgor had a defective title then the pledge would be invalid. In brief where a pledgee knows the fact that the mercantile agent has no authority from the real owner to pledge and is not acting on good faith, he is not entitled to take advantage of the provision that a mercantile agent's business includes making of a pledge and therefore it is presumed that he had the authority to pledge. II. Pledge by a person in possession under voidable contract [S.178-A] Section 178-A reads : "When the pawner has obtained possession of the goods pledged by him under a contract voidable under section 19 or section 19-A, but the contract has not been rescinded at the time of the pledge, the pawnee acquires a good title to the goods, provided he acts in good faith and without notice of the pawner's defect of title". Thus the rule is that if a person obtains possession of goods under a contract which is voidable at the option of the lawful owner by fraud, misrepresentation, coercion (S.19) or on the ground of undue influence (S.19-A), he is entitled to make valid pledge until the voidable contract is rescinded. There is in such a case a de facto contract, though voidable on the ground of fraud and the like. But the case would be different if the goods are obtained by theft as defined in S.378 of the Indian Penal Code or where the possession is obtained under a void agreement. It is further necessary that the pledgee must be acting in good faith and without notice about the pledgor's defect in title. III. Pledge by a person having limited interest [S.179] Section 179 reads :
"Where a person pledges goods in which he has only a limited interest, the pledge is valid to the extent of that interest". It denotes that where the pledgor is not the owner of the goods, but has only a limited interest in the goods which he pledges, for example, where he is a mortgagee, or he has lien with respect to those goods, the pledge would be valid to the extent of such interest. Thus when a pledgee further pledges the goods the pledge would be valid only to the extent of his interest and his interest is the amount for which the goods have been given to him as a security. If he pledges for a larger amount, the original pledgor will still be entitled to his goods on paying the amount for which he himself pledged the goods. For example, where A pledges certain jewellery with B for Rs. 10000/- and B further pledges it to C for Rs. 15000/- here A has the right to take back the jewellery by paying Rs.10000/- only because B's interest in the jewellery is Rs. 10000/- only. Pledge by seller in possession after sale Section 30(1) of Indian Sales of Goods Act 1930 says that where a person has sold goods but continues in possession of them or of documents of title to them, he may sell them to a third person, and if such person obtains delivery thereof in good faith and without notice of the previous sale, he gets a good title to them, although the property in the goods has passed to the first buyer. A pledge, mortgage, or any other disposition of goods is equally valid. The disposition may be made not only by the seller in possession, but also by a mercantile agent acting for him. For example, A sells goods to B. B for his own convenience leaves the goods with A. A fraudulently sells the goods to C, who buys them in good faith and with out notice of the sale to B. C gets a good title to the goods. The delivery of the goods by A to C has the same effect as if A were expressly authorised by B to deliver the goods. the transaction would be equally valid if A pledges or mortgages the goods to C. Thus to enable the seller to pass a good title the following condition must be complied with : (1) the seller must continue in possession of the goods or of the documents of title to goods as a seller. Possession as a hirer or bailee of the goods from the buyer after delivery of goods to him will not do; (2) the goods must have been delivered to the buyer or the documents of title must have been transferred to him. A mere agreement for sale, pledge or other disposition will not do; and (3) good faith and absence of notice of the previous sale on the part of the second buyer. Pledge by buyer in possession after sale Section 30(2) of the Sale of Goods Act deals with the converse case of a sale or other disposition by the buyer of the goods in which the property has not yet passed to him. Section says that if the buyer obtains possession of the goods before the property in them has passed to him, with the consent of the seller, he may sell, pledge or otherwise dispose of the goods to a third person, and if such person obtains delivery of the goods in good faith and without notice of any lien or other right of the original 309 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
seller in respect of the goods, he will get a good title to them. Thus to enable the buyer to pass a good title following conditions must be fulfilled : (1) there must be possession of the goods or documents with the consent of the seller; (2) the goods must have been delivered to the buyer or the documents of title transferred to him. A mere agreement for sale, pledge or other disposition will not do ;and (3) there must be good faith, and absence of notice of the seller's right of property on the part of the second buyer (Mulla, pp.73-74) 5.6 TERMINATION OF PLEDGE By a bailment in pledge, the pledgee impliedly undertakes to return the goods pledged to the pledgor upon payment of the debt or the performance of the promise. Upon payment or the performance of the promise, the contract is extinguished, and the pledgee is divested of his special property in the goods. 5.7 RIGHTS OF PLEDGEE The pledgee or the pawnee has the following rights under the Indian Contract Act 1872; (1) Right to retain goods pledged [Section 173-174] "173: The pawnee may retain the goods pledged, not only for a payment of the debt or the performance of the promise, but for the interest of the debt, and all necessary expenses incurred by him in respect of the possession or for the preservation of the goods pledged". "174: The pawnee shall not, in the absence of a contract to that effect, retain the goods pledged for any debt or promise other than the debt or promise for which they are pledged; but such contract, in the absence of anything to the contrary, shall be presumed in regard to subsequent advances made by the pawnee. The statutory provision u/s 173 recognises the pledgee's right of retaining. He may retain the goods pledged not only for payment of the debt or the performance to the promise, but for the interest of debt, and all necessary expenses incurred by him in respect of the possession or for the preservation of goods pledged. It has been held by the Supreme Court in Lallan Prasad v. Rahmat Ali and Another [AIR 1967 SC 1322] that the pledgee cannot maintain a suit for recovery of debt and at the same time retain the pledged property. The right of retainer is limited by the prescription u/s 174 of the Act, that the pledgee cannot, in the absence of a contractual stipulation, retain the goods pledged for any debt or promise other than the debt or promise for which they are pledged,but such contract, in the absence of anything to the contrary, shall be presumed in regard to subsequent advances made by the pledgee. Bombay High Court in Cowsji Muncherji Banaji v. Official assignee of Bombay [AIR 1928 Bom. 507] held that the pledge and subsequent advances raise a presumption that there is a contract to hold the pledge for such advances. Where, however, the latter advance is separately secured, such presumption does not arise. The right of retainer ends on proper tender of payment. 310 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
(2) Right to recover extraordinary expenses incurred [Section 175] "175: The pawnee is entitled to receive from the pawnor extraordinary expenses incurred by him for the preservation of the goods pledged". Whereas under the preceding section a pledgee can 'retain' the possession of the goods for various claims, including the claim for necessary expenses incurred by him in respect of the possession or for the preservation of the goods pledged, section 175 confers an additional right on the pledgee i.e., a right to receive from the pledgor extraordinary expenses incurred by him for the preservation of the goods. For example, where a horse is pledged and it suffers an injury by accident, the pledgee is entitled to recover the expenses which he incurs on the treatment of the horse. (3) Right to sell the pledged goods [Section 176] In case of default on the part of the pledgor in the payment of the debt, or performance of the promise at the stipulated time, pledgee has been vested with the right of selling the goods under section 176 of the Act, which reads : "If the pawnor makes default in payment of the debt, or performance, at the stipulated time of the promise, in respect of which goods were pledged, the pawnee may bring a suit against the pawnor upon the debt or promise and retain the goods pledged as a collateral security; or he may sell the thing pledged, on giving the pawnor reasonable notice of the sale. If the proceeds of such sale are less than the amount due in respect of the debt or promise, the pawnor is still liable to pay the balance. if the proceeds of the sale are greater than the amount so due, the pawnee shall pay over the surplus to the pawnor." Under the above section pawnee has the following two alternate rights : (1) Right to Sue The pawnee u/s 176 of the Act has been vested with the right of bringing the suit for the amount due to him while retaining the goods pledged as a 'collateral security', on the pawnor's default, in payment, at the stipulated time [See T.S. Kotagi v.Tehsildar, Gadag and Others, AIR 1985 Kant. 265; M/s. Tapanga Light Foundry v. State Bank of India, Khurda, AIR 1987 Ori. 174]. Where a pawnee files a suit for recovery of debt, though he is entitled to retain the goods, he is bound to return them on repayment of debt. If the debt is paid he has to return the goods. But if he sues on the debt denying the pledge, and it is found that he was given possession of the goods pledged and had retained the same, the pawnee has the right to redeem the goods so pledged by payment of the debt. If the pawnee is not in a position to redeliver the goods he cannot have both the payment of the debt and also the goods. Where the value of the pledged property is less than the debt and in a suit for recovery of debt by a pledgee, the pledgee denies the pledge or is otherwise not in a position to return the pledged goods he has to give credit for the value of the goods and would be entitled then to recover only the balance [Lallan Prasad v. Rahmat Ali, AIR 1967 SC 1322]
It is not incumbent on the creditor that he must proceed against the pledged property alone, and should not file suit for the recovery of loan. For example, if on security of shares lender advances an amount with a agreement that he will keep his lien over the shares till amount is fully repaid with interest, lender cannot be debarred from obtaining a personal money decree against the borrower. This indicates that though one is in possession of valuable security against the loan advanced he is not barred from filing a suit for its recovery. This is what the Allahabad High Court laid down in Kurilal Rungta v. Smt. Banarsi Devi and Others [AIR 1986 All 94]. In this case the lender had agreed to advance to the defendant-appellant a sum of Rs.30000/- at the rate of 9% interest per annum against the securities of shares. It was specifically mentioned in the deed of arrangement that the lender will have a lien on the shares till the borrower pays the full amount of loan with accrued interest up to the date of repayment. The borrower agreed that he will not in anyway assign, sell or dispose of the said shares without previous knowledge and consent of the lender and without repaying the full amount of Rs. 30000/- together with interest there on and the shares of a certain mill were merely pledged as security. Under the circumstances it was held that plaintiffs were not obliged to proceed to get the said shares transferred in their names or to proceed to recover the amount by proceeding only against the said security. Further more pawnee (pledgee) is required to take care of the goods pledged to him as a man of ordinary prudence would take of his own goods. If he fails in his duty he would be liable to the pawnor. In Central Bank of India v. M/s.Grains & Gunny Agencies [AIR 1989 M.P.28] food grain stocks pledged against loan with the bank were damaged or lost. Bank took no action to minimise the loss even on request of the pawnor. On a suit for the recovery of out standing dues, bank claimed exemption from liability for loss and damages by virtue of special contract including negligence of his servants. It was observed that section 152 (of the act) provides that the bailee, in the absence of special contract, is not responsible for the loss, destruction or deterioration of the things bailed, if he has taken the amount of care prescribed by section 151. Thus section 152 is subject to section 151 which requires the bailee to take care of the goods bailed to him as a man of ordinary prudence would take of his own goods. Section 161 makes the bailee responsible for delivery or tender at the proper time of the goods bailed and in default makes him liable for any loss, destruction, or deterioration thereof from that time. It is well settled that in cases governed by sections 151 and 152, the loss or damages of goods entrusted to a bailee is prima facie evidence of negligence and therefore the burden to disprove negligence lies on the bailee. The bailee has to prove that he exercised due care and was not negligent. If inspite of this the loss occurred, he is absolved of all responsibility. Even if the bank is entitled to claim exemption by virtue of special contract including negligence of its servants, still the bank has to show that it took as much care of the pledged goods as an ordinary prudent man under similar circumstances takes of his own goods of the same quality and value as required by section 151. It was held that
the bank is liable for the loss of goods and, therefore, it was not entitled to succeed in his claim against the pawnor in the absence of the proof that care was taken by the bank to preserve the goods. (2) Right to Sell Section 176 lays down that if the pawnor makes default in payment of the debt, or performance, at the stipulated time of the promise, in respect of which the goods were pledged, the pawnee may bring a suit against the pawnor upon the debt or promise, and retain the goods pledged as collateral security, or he may sell the thing pledged, on giving the pawnor reasonable notice of the sale. A notice of the character contemplated by section 176 cannot be implied. Such notice must be clear and specific in its language and must indicate the intention of the pawnee to dispose of the security. [Prabhat Bank ltd. v. Babu Ram, AIR 1966 All 134]. Hence the provision of section 176 of the Act is clear to the effect that the pawnor is entitled to reasonable notice before sale of the pawned goods and the provisions are mandatory in character. [See M/s. Tapanga Light Foundry v. State Bank of India, Khurda AIR 1987 174]. Even if there is a term in the contract of pledge to waive notice, still, the pledgee is not relieved of his obligation to give notice before the sale of pledged goods [Sri Raja Kakarl Puni Venkata v. Andhra Bank (1960)1Andh WR 234]. Thus a sale by the pawnee without giving a reasonable notice to the pawnor is void, and a vendee without notice of the pledge takes only the limited rights or interests of pledgee, in other words, he steps into the shoes of pledgee. [See. T.S. Kotagi v. Tehsildar, Gadag and Others, AIR 1985 Kant 265]. The notice must refer to the debt for which the goods were pledged and for recovering of which goods are to be sold. mere intimation that 'failing payment by certain date we shall arrange for sale' is not sufficient notice u/s 176. The object of the notice is to give the pawnor an opportunity to redeem; for the right of redemption can be exercised till the moment of sale. The right to sell is perfected with the giving of the notice of sale, and it is open to the pawnee to sell at any time thereafter. A sale by the pawnee after reasonable notice to the pawnor confers a good title on the buyer of such goods. In brief, sale under section 176 means the intended sale and not the sale that has been actually arranged by the pawnee. The law does not require that the pawnee should arrange for the sale before hand and then give the pawnor a notice of the date, time and place of that sale. All that is necessary is that a notice should be given of the pawnee's intention to sell in default of payment by the pawnor within a specified date. The reasonable notice of sale u/s.176 therefore, does not require specification of date, time and place of the sale [Hulas Kunwar v. Allahabad Bank Ltd. AIR 1985 Cal.644]. Purchase by Pawnee Supposing that a due notice of sale has been given so that the pledgee gets the right to sell, may he buy the goods himself ? Though the pawnee is not prevented from buying the pledged 311 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
property himself in a bonafide sale, yet, if, in effect he takes over the pledged property himself without the pledgor's authority, the pawnee would be guilty of conversion.A noticeable aspect is that though the pawnee would be liable for conversion, the sale itself would not be liable to be set aside, and at the same time, the pawnor would be entitled to damages in case of improper sale. In Neekram v. Bank of Bengal, [(1891)19 Cal.322 (PC)] judicial committee said that the effect of the sale to himself by the pawnee (without the authorisation of the pledgor) was not to altogether terminate the contract of pledge so as to entitle the pawnor to recover the article without payment of the debt. [See also Dhani Ram & Sons. v. Frontier Bank, AIR 1962 Punj 321]. 5.8 RIGHTS OF PLEDGOR Pledgor's right to redeem Section 177, which confers the right to redeem on the pledgor reads: "If a time is stipulated of the debt, or performance of the promise, for which the pledge is made, and pawnor makes default in payment of the debt or performance of the promise at the stipulated time, he may redeem the goods pledged at any subsequent time before the actual sale of them; but he must, in that case, pay, in addition, any expenses which have arisen from his default". According to English Law where no time is stipulated for redemption, the pledge is redeemable within the life time of owner. Under section 176 the right of pawnor is extinguished only when the pawnee makes actual sale of goods. Hence under the Indian law the rule is that, so long as the sale does not take place the pawnor is entitled to redeem the goods on payment of the debt. It follows therefore, that where a pawnor is entitled to redeem the goods on payment of the debt, on a suit for recovery of debt, though the pawnee is entitled to retain the goods he is bound to return them on payment of the debt [Lallan Prasad v. Rehmat Ali, AIR 1967 SC 1322]. The principle underlying is that the pawnee does not become the owner of the goods automatically if the pawnor fails to redeem the goods pledged with the pawnee within specific time. The ownership in the goods remains in the pawnor and wholly revests in him on payment of the debt or performance of the promise [See M.R. Dhawan v. Madan Mohan, AIR 1969 Del. 313]. Where jewels pawned with a pawn broker, were held not to have been
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redelivered to the pawnor during his life time and the heir brought a suit for redemption of the jewels, the court held that in a case of wrongful detention, the pawnbroker was liable to pay the value of the jewels as at the time of decree. Right of redemption of goods also includes a right to any accretion to the goods pledged. Thus, if a debtor pledges his shares of a certain company with a bank, and during the period of pledge the company issues bonus shares and right shares, the pawnor on redemption will be entitled to such bonus and right shares also [M.R. Dhawan v. Madan Mohan, AIR 1969 Del 313]. Under section 177 if the pawnor fails to seek redemption within a reasonable time, he becomes liable to pay any expenses which may have arisen from his default. The pawnor also has a right of redemption under Art.70, Sec.1, of the Limitation Act 1963 where the period for a suit to recover a thing pledged is 30 years. 5.9 ADDITIONAL RIGHTS OF a HYPOTHECATEE All rights and obligations of the pawnor and the pawnee are applicable equally to an hypothecator and an hypothecatee respectively. The hypothecatee has of course an additional right to secure possession of the property of the goods, the title document of which is already with the hypothecatee. Hypothecation is analogous to equitable mortgage by depositing title deeds of immovable property with the simple difference that the ownership documents or title documents in hypothecation relate to movable goods for which the hypothecator did not pay the full consideration. It has been already pointed out that in a pledge some movable goods are kept in security whereas in hypothecation ownership documents of some movable goods are kept in security. As such on failing to 'receive the debt' the hypothecatee has the right to take possession of the movable goods. At that stage when he takes possession of the goods, hypothecation is turned into a pledge. Therefore, non-payment of the dues by the debtor will entitle the creditor i.e. the hypothecatee to secure possession of the goods. Hypothecation in this sense is a pledge in abeyance. Correspondingly the hypothecator has an additional duty over and above the duty and liability attached to a pawnor. He has to facilitate the transfer of possession of goods to hypothecatee. As for example if an omnibus is hypothecated with a bank against a loan sanctioned with a bank, the bank can attach the omnibus in case the payment of loan is not fully made.
6. LEASING AND HIRE PURCHASE SUB-TOPICS 6.1. Leasing agreement - Nature and meaning 6.2. Rights and duties of the Lessor & the Lessee 6.3. Hire Purchase agreement - nature and meaning 6.4. Difference between Hire purchase, Instalment purchase agreement & Lease 6.5. Rights & duties of Hire - purchaser and hire vendor. 6.1 LEASING AGREEMENT- NATURE AND MEANING In India there is no law relating to leasing of movable property. Lease agreements of movable properties are taken as a contract of bailment, plain and simple, with no element of sale, in which one allows another party the right to use goods for hire on payment. In fact, under section 148, bailment is defined as delivery of possession for some specific purpose, on the accomplishment of which the goods are to be returned as per the direction of the bailor. Strictly speaking bailment is a contract for service on the goods bailed like repairing, treating or adding any art or design on the goods bailed. As such, lease agreements allowing use of goods against hire charges can be broadly covered by bailment agreement but not rigidly as such. As for example, in a contract of bailment the lessee does not have a right to purchase at the end of the lease term. In case a contract specifically includes this right, the lease becomes confused with hire purchase contract. This leads to anamolous situation where the ownership of the leased asset at the end of tenure would not be definite. This type of understanding of leasing is befitting with the definition of the term lease as provided in section 105 of the Transfer of Property Act. A lease of an immovable property has been defined as 'a right to enjoy, such property for a certain time or in perpetuity in consideration of a price to be rendered periodically or on specified occasion to the transferor by the transferee'. This definition of lease of immovable property only allows the lessee to enjoy the property but does not vest in him any right of ownership. Leasing agreements, on the other hand, relating to movable goods is based on a pair of contract in which the creditor purchases some goods on paper and allows the lessee i.e., the principal debtor to enjoy the property and pay the total consideration plus the rent on lease in instalments or on such other terms, on payment of which the lessee or the principal debtor becomes owner of the property. In the modern world these types of lease agreements have increased to a very large number for various types of consumer and durable goods and services. It is true that rights of the parties are governed by the terms of the contract inter se. But very often the contract tends to become one sided with residual right of the lessee in a state of limbo . It is therefore necessary to have definite law relating to the lease. This leasing can be of two varieties, namely, operating lease and financial lease. In the lease agreement stipulated above
the type is financial lease where the rent includes the entire capital value of the goods. In operating lease however the rental value does not cover the capital cost. It only includes charges of the use. As a matter of fact, operating lease of movable goods is analogous to the lease of valuable goods as defined in section 105 of the Transfer of Property Act. In the operating lease the lessee must return the goods subject to fair wear and tear. But in financial lease the lessee has to be the owner at the end of the period within which the payment is to be made. As has been already pointed out a financial lease has a couple of agreements between the three parties namely, the supplier, the principal debtor or the lessee, and the financial institution which is the creditor and the lessor. But in operating lease there are only two parties i.e., the lessor and the lessee. A financial lease therefore requires a detailed drafting of the agreement between the parties to respond to all eventualities. In case of any doubt the laws of bailment in India may not be providing adequate legal protection to the lessor and the lessee. There are other problems as well. It has been pointed out by Prof. P.M. Bakshi (Member, Law Commission), in one of his articles that agreements bind the immediate parties and their assignees and heirs but not the whole world. In juristic language, a right in personam created between the lessor and the lessee, will not be adequate to protect the interest of the lessor who is more anxious in defending his right in rem, as he is out of possession. This particular problem may need legislative intervention. Prof. Bakshi has also stipulated two practical and legal difficulties that may arise even in operating lease. Firstly, the instruments 'lease' may become embeded in the sale agreement and therefore it will be impossible to get the possession back after the lease period. Forceable entry to take back the possession may become a serious problem of law and order. Secondly, the contractual laws for recapture and seizure may be held by the court as 'against public policy'. Some other questions may also arise according to him in absence of any suitable provision of law. Is the lessor bailee liable if the equipment causes loss to some one by reason of any defect or danger due to wrong operations ? Does the liability arise only against the actual user of the equipment or can it be projected against the owner as well ? In India the development of insurance law specially in this area has been very slow. Among other intricate problems it may be pointed out that large finance lease may involve several parties as co owners and the current tax laws do not allow depreciation to the limited owners. 6.2 RIGHTS & DUTIES OF THE LESSOR & THE LESSEE Rights of the Lessor (a) In operating lease the lessor has the right to receive the rent as stipulated in the contract whereas in financial lease the lease charge contains both rent for use and the capital cost. 313 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
(b) In operating lease the lessor is entitled to get back the goods subject to reasonable wear and tear at the end of the lease period. In financial lease this right is not there, because at the end of the lease period the lessee becomes the owner. (c) In case of failure to pay rent or lease charge the lease agreement may provide the right to recapture and seizure in both operating and financial lease. This right may be extended by clear provision in the contract, a right of entry to the premises of the lessee. (d) The lessor has a right to reasonable expenses for implementing his rights on the failure of the lessee to pay the rent or the leasing charges. Duties of the Lessor (a) Lessor has a duty to give the lessee an undisturbed and peaceful possession. If there is a defective title of the lessor for which the lessee has to suffer, the lessor is liable to compensate the lessee. (b) Lessor is under a duty to disclose all particulars of the goods leased. In a modern contract lease of equipment, the lessor is liable to pass on all technological information and the technique of use including possible environmental impact. In the event of non fulfilment of this duty the lessor is liable to compensate the lessee for all wrong application of the instrument, environmental hazards and non application of safety measures. Rights of the Lessee (a) Lessee has a right to free and fair enjoyment of the property during the lease period. (b) Lessee has all other rights of a bailee, which includes right to mix the goods with his own property, right of application, right to separate, use and application etc. (c) In case of a financial lease the lessee becomes the owner of the property after payment of the lease charges. Duties of the Lessee (a) Lessee has to pay rent and lease charges in time. (b) On failure to pay in time, an interest as agreed upon has to be paid. (c) To return back the commodity at the end of the lease period. 6.3 HIRE PURCHASE AGREEMENT - NATURE & MEANING Hire purchase agreement is an agreement in which the hire vendor agrees to sell to the hire purchaser some movable goods, after the hire purchaser pays in full over a period of time through some instalments at regular intervals or in lump sum at the end of a stipulated time. During this intermittent period the hire purchaser is put into the possession of the goods for use as if he is a hirer or a lessee. According to section 4(3) of Sale of Goods Act, 1930 "where the transfer of property of goods is to take place at a future time or subject to some condition thereafter to be fulfilled, the contract is called an agreement to sell. Thus hire purchase entitles the hire purchaser only to the possession 314 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
of goods for use and the title to the goods passes only after the full terms and conditions are satisfied. In modern economy hire purchase agreement assumes a very important role. Many of the new consumer products are sold by the vendors to middle class consumers on their terms and conditions. Hire purchase not being sale is not subject to sales tax until it becomes a sale. The hire vendor remains a lessor and the hire purchaser a lessee until the final payment is made. Presently in India there is no law relating to hire purchase agreements excepting the general Contract and Sale of Goods Acts. In 1983 a Bill was passed which was never made into force. An Amendment Bill was moved in Rajya Sabha in 1989 but nothing further is known about the fate of the Bill. As on date there is no specific statute governing hire purchase contracts. Issues which are not covered by the Indian Contract Act and the Sale of Goods Acts, are treated as a grey area where Indian courts generally depend upon the law of England. Hire purchase agreement is a kind of bailment and as such the rights, duties and obligations of the parties are determined either by the parties through agreement or by the law of bailment. 6.4 DISTINCTION BETWEEN HIRE PURCHASE, INSTALMENT PURCHASE AGREEMENT AND LEASE 1. Hire purchase and instalment purchase It has already been pointed out that hire purchase is only an agreement to sell, whereas, instalment purchase is a sale. Though in both the cases the principal amount and interest on the unpaid balance is paid in instalments, in instalment purchase the ownership of goods passes to the buyer immediately, but in hire purchase the ownership in the goods is to pass on a future date on fulfilment of all terms and conditions. Consequently other incidental issues arise out of the legal position. As for example, if there is any accidental loss of the goods in the possession of hire purchaser, the loss accrues to the hire vendor, therefore the hire vendor has to take up insurance against the risk. But in case of instalment purchase the risk of accidental loss falls upon the instalment purchaser because he is the owner of the property, without having any regard to the question as to whose possession loss occurred. In case of a hire purchase the hire vendor remains the owner of the goods. So in the event of hire purchaser failing to pay an instalment the hire vendor may possess the goods because the hire purchaser does not have a better title than a lessee on consent of the lessor. But if it is an instalment purchase the vendor cannot take back the commodity. His remedy lies in compensation in so far as money can do it. 2. Hire purchase and lease It has already been pointed out that an operation lease is almost a hire purchase. In the last few years leasing institutions have had a rapid growth. The institutional and operational leasing are slightly different from the conventional hire purchase contracts on the ground that there are three parties in a lease, whereas in hire purchase there are only two parties. A leasing
firm purchases the instrument on paper and leases it out to the user charging rent for the use, whereas in hire purchase the vendor remains as a lessor and the purchaser as lessee until the full payment is made. In an operational lease the lessee can never claim the property in goods whereas hire purchase agreement is to conclude naturally with the transfer of ownership. Hire purchase agreement is analogous to financial lease. In financial lease also the lessee after paying all lease charges which include hire charges, charges against capital and interest, becomes the owner of the property. Truely speaking, institutional financial lease and hire purchase agreements are institutionally different because in hire purchase the hire vendor remains the creditor whereas in financial lease the vendor is paid off by the leasing company and the leasing company thereafter becomes the creditor to whom the lessee must pay the entire sum of capital, interest and hire charges for the equipment. Thus there are two contracts between three partners in financial lease, i.e., a contract of sale between the financier and the vendor and a contract of hire purchase between the financier and the buyer (lessee), 6.5 RIGHTS & DUTIES OF HIRE PURCHASER & HIRE VENDOR A. Rights of hire purchaser (a) A hire purchaser has the right of possession over the property. (b) In case he has to suffer due to a defective title and possession derived from hire vendor he has a right to be compensated.
(c) He has a 'right to use' the goods, unlike a bailee for service. (d) He has a right to acquire ownership of the goods on fulfilment of requisite terms & conditions. B. Duties of a hire purchaser (i) He has to pay the prescribed instalments in time, failing which he has to pay the interest thereof. (ii) In case of failure to pay he has to allow the hire-vendor to take back the possession. (iii) He has a duty to take reasonable care of the goods as an ordinary prudent man would, if the goods were his own. C. Rights of the hire vendor (i) He has the right to receive the instalment payment as per the agreement. In case the hire purchaser fails to pay any instalment, the payment already made on whatever account becomes hire charges. (ii) He has all the rights of a bailor according to the Indian Contract Act. (iii) He has a right to enter into premises and seize the goods, as per the terms of the contract, in case the hire purchaser fails to make payment in due time. D. Duties of a hire-vendor (i) The hire vendor has to put the hire purchaser in lawful & undisturbed possession of the goods, failing which he is liable to compensate the hire purchaser. (ii) He has all other duties of a bailor as per the law of bailment.
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7. CARRIER SUB-TOPICS 7.1. Introduction 7.2. Overview of Law of Carriage (a) by land (b) by air (c) by sea 7.1
INTRODUCTION
Law relating to carriage regulates the contract with carriers. Unlike any other special contracts, contract with carriers has a very special significance for two reasons: one, a group of carriers are known as 'common carriers' making the contract not only a domain of private law but also a domain of public law. Secondly, law relating to carriers contract in India, statutorily speaking, is older than the general law of contract. As for example, the 'Carriers Act' governing all contracts with common carriers was codified in 1865. Some other related laws dealing with common carriers are 'Indian Railway Companies Act, 1854, subsequently replaced by Act of 1890 & 'Indian Tramways Act, 1863'. 'Carriage by Sea' had to be codified separately in 1925 with a view to update the law in tune with Brussels conference, 1922. Subsequently the law had to be up-dated to incorporate some of the international agreements in this regard. Similarly, the complexities in law relating to carriage by air has compelled the government to bring out a new Act on 'Carriage by Air' in 1972, in place of the old Act of 1934. The new Act internalizes Warsaw Convention, 1929 and Hague Protocol, 1955. The general framework of the Carriers Act of 1865 is applicable in all cases specially to the common carrier's in order to limit their liability for loss or damage to property delivered to them to be carried. It also empowers the common carriers to declare the extent of their liability for criminal or negligent acts of their servants. A common carrier has been defined as ,'carrier managed by person other than the government, engaged in the business of transporting for hire, property from place to place by land and inland navigation'. To the extent of limiting liability these contracts fall under special category. 7.2 (A) LAW OF CARRIAGE BY LAND Contract of carriage is essentially a contract of bailment. The objective of Carriers Act stipulates that it empowers a common carrier to limit and define its liability for the negligent or criminal acts of servants. As such, the Carriers Act makes certain statutory limitations on liability of the common carrier. As for example, sec. 3 insulates a common carrier from liability for loss of certain goods if the value of the goods is more than
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Rs.100, unless the person delivering the property declares the value and description of the goods. But Indian Railways does not come under the definition of common carriers, therefore, the limitation of its liability cannot be based on the Carriers Act. This is to be done within the parameters of the Indian Railways Act, 1890. As for example, under sec. 72 of the Act, the sender is bound to give such particulars as may be prescribed by the railway administration, in respect of animals and other enlisted goods under sec. 6 delivered for carriage. Sec.73 limits the general responsibility of the railway administration as carrier of animals & goods. 7.2 (B)
LAW OF CARRIAGE BY AIR
The 'Carriage by Air Act, 1972' gives effect to the convention for the unification of certain rules relating to international carriage by air, signed by the contracting parties at Warsaw in 1929 as amended by the Hague protocol of 1955. According to Sec.3 of the Act, the provision of the convention relating to rights and liabilities of the carriers, passengers, consignees, and other persons being specified in the first schedule have become law in force in India. The Act specifies the liability on various accounts. The first schedule contained in the Act specifies the rules regarding documents of carriage, liability of the carrier and general provisions. The second schedule, under sec. 4 provides the amended convention relating to the rights and liabilities of the carriers, passengers, consignors, consignees and others. So, the law relating to carriage by air is now regulated completely by the two schedules specified under Ss. 3 & 4 of the Act. 7.2 (C) CARRIAGE BY SEA The 'Carriage by Sea Act, 1925' has internalized the convention adopted in Brussel in 1922 and the Rules adopted at the same place in 1923, specially unifying international rules on bill of lading. The Act also defines the responsibility, liabilities, rights and immunities attaching to carriers under bill of lading. As for example, under Sec.3 there is absolute warranty of sea worthiness not to be implied in contracts to which the rules apply. Sec.4 requires every bill of lading or similar document of title to contain an express statement, that, the rules as laid down in the schedule shall apply. The schedule contains detailed rules relating to bill of lading on risks, responsibilities and liabilties of the carrier, rights and immunities, surrender of rights and immunities and corresponding increase of responsibility and liabilities, special conditions and limitations of liabilities. The rules contain 10 articles each having one or more clauses.
8. RELEVANT PROVISIONS OF THE ACT Of Indemnity and Guarantee 124. "Contract of indemnity" defined -- A contract by which one party promises to save the other from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person, is called contract of indemnity". 125. Rights of indemnity-holder when sued -- The promisee in a contract of indemnity, acting within the scope of his authority, is entitled to recover from the promisor". (1) all damages which he may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies; (2) all costs which he may be compelled to pay in any such suit if, in bringing or defending it, he did not contravene the order of the promisor, and acted as it would have been prudent for him to act in the absence of any contract of indemnity, or if the promisor authorized him to bring or defend the suit; (3) all sums which he may have paid under the terms of any compromise of any such suit, if the compromise was not contrary to the order of the promisor; and was one which it would have been prudent for the promisee to make in the absence of any contract of indemnity, or if the promisor authorized him to compromise the suit. 126. "Contract of guarantee", "surety", "principal debtor" and "creditor" -- A contract of guarantee" is a contract to perform the promise, or discharge the liability of a third person in case of his default. 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"; and the person to whom the guarantee is given is called the creditor". A guarantee may be either oral or written. 127. "Consideration for guarantee" -- Any thing done, or any promise made, for the benefit of the principal debtor, may be a sufficient consideration to the surety for giving the guarantee. 128. Surety's liability -- The liability of the surety is coextensive with that of the principal debtor, unless it is otherwise provided by the contract. 129. Continuing guarantee -- a guarantee which extends to a series of transactions is called a "continuing guarantee". 130. Revocation of continuing guarantee -- A continuing guarantee may at any time be revoked by the surety, as to further transactions, by notice to the creditor. 131. Revocation of continuing guarantee by surety's death -- The death of the surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee, so far as regards future transactions. 132. Liability of two persons, primarily liable, not affected by arrangement between them that one shall be surety in
other's default -- Where two persons contract with a third person to undertake a certain liability and also contract with each other that one of them shall be liable only on the default of the other, the third person not being a party to such contract, the liability of each of such two persons to the third person under the first contract is not affected by existence of the second contract, although such third person may have been aware of its existence. 133. Discharge of surety by variance in terms of contract - Any variance, made without the surety's consent, in the terms of the contract between the principal debtor and the creditor, discharges the surety as to transactions subsequent to the variance. 134. Discharge of surety by release or discharge of principal debtor -- The surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released, or by any act or omission of the creditor, the legal consequence of which is the discharge of the principal debtor. 135. Discharge of surety when creditor compounds with, gives time to or agrees not to sue principal debtor -- 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 sue the principal debtor, discharges the surety, unless the surety assents to such contract. 136. Surety not discharged when agreement made with third person to give time to principal debtor -- Where a contract to give time to the principal debtor is made by the creditor with third person, and not with the principal debtor, the surety is not discharged. 137. Creditor's forbearance to sue does not discharge surety -- Mere forbearance on the part of the creditor to sue the principal debtor or to enforce any other remedy against him does not, in the absence of any provision in the guarantee to the contrary, discharge the surety. 138. Release of one co-surety does not discharge others -Where there are co-sureties, a release by the creditor of one of them does not discharge the others; neither does it free the surety so released from his responsibility to the other sureties. 139. Discharge of surety by creditor's act or omission impairing surety's eventual remedy -- If the creditor does any act which is inconsistent with the right of the surety, or omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is thereby impaired the surety is discharged. 140. Rights of surety on payment of performance -- Where a guaranteed debt has become due, or default of the principal debtor to perform a guaranteed duty has taken place, the surety, upon payment or performance of all that he is liable for, is invested with all the rights which the creditor had against the principal debtor. 317 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
141. Surety's right to benefit of creditor's securities -- A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not; and, if the creditor loses, or, without the consent of the surety, parts, with such security, the surety is discharged to the extent of the value of the security.
with the use of them, or expose the bailee to extraordinary risks; and if he does not make such disclosure, he is responsible for damage arising to the bailee directly from such faults.
142. Guarantee obtained by misrepresentation, invalid -Any guarantee which has been obtained by means of misrepresentation made by the creditor, or with his knowledge and assent, concerning a material part of the transaction, is invalid.
152. Bailee when not liable for loss, etc., of thing bailed -The bailee, in the absence of any special contract, is not responsible for the loss, destruction or deterioration of the thing bailed, if he has taken the amount of care of it described in Section 151.
143. Guarantee obtained by concealment, invalid -- Any guarantee which the creditor has obtained by means of keeping silence as to material circumstances, is invalid.
153. Termination of bailment by bailee's act inconsistent with conditions -- A contract of bailment is avoidable at the option of the bailor, if the bailee does any act with regard to the goods bailed, inconsistent with the conditions of the bailment.
144. Guarantee on contract that creditor shall not act on it until co-surety joins -- Where a person gives a guarantee upon a contract that creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join. 145. Implied promise to indemnify surety -- In every contract of guarantee there is an implied promise by the principal debtor to indemnify the surety; and the surety is entitled to recover from the principal debtor whatever sum he has rightfully paid under the guarantee, but no sums which he has paid wrongfully. 146. Co-sureties liable to contribute equally -- Where two or more persons are co-sureties for the same debt or duty, either jointly or severally, and whether under the same or different contracts, and whether with or without the knowledge of each other, the co-sureties, in the absence of any contract to the contrary, are liable, as between themselves, to pay each an equal share of the whole debt, or of that part of it which remains unpaid by the principal debtor. 147. Liability of co-sureties bound in different sums -- Cosureties who are bound in different sums are liable to pay equally as far as the limits of their respective obligations permit. Of Bailment 148. "Bailment", Bailor, and Bailee defined -- 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, be returned or otherwise disposed of according to be the directions of the person delivering them. The person delivering the goods is called the" bailor". The person to whom they are delivered is called the "bailee". 149. Delivery to bailee how made -- The delivery to the bailee may be made by doing anything which has the effect of putting the goods in the possession of the intended baliee or any person authorized to hold them on his behalf. 150. Bailor's duty to disclose faults in goods bailed -- The bailor is bound to disclose to the bailee faults in the goods bailed, of which the bailor is aware, and which materially interfere 318 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
151. Care to be taken by the bailee -- In all cases of bailment the bailee is bound 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 of the same bulk, quality and value as the goods bailed.
154. Liability of bailee making unauthorized use of goods bailed -- If the bailee makes any use of the goods bailed which is not according to the conditions of the bailment, he is liable to make compensation to the bailor for any damage arising to the goods from or during such use of them. 155. Effect of mixture, with bailor's consent, of his goods with bailee's -- If the bailee, with the consent of the bailor, mixes the goods of the bailor with his own goods, the bailor and the bailee shall have an interest, in proportion to their respective shares, in the mixture thus produced. 156. Effect of mixture, without bailor's consent when the goods can be separated -- If the bailee, without the consent of the bailor, mixes the goods of the bailor with his own goods, and the goods can be separated or divided, the property in the goods remains in the parties respectively; but the bailee is bound to bear the expense of separation or division, and any damage arising from the mixture. 157. Effect of mixture, without bailor's consent, when the goods cannot be separated -- If the bailee, without the consent of the bailor mixes the goods of the bailor with his own goods, in such a manner that it is impossible to separate the goods bailee from the other goods, and deliver them back, the bailor is entitled to be compensated by the bailee for the loss of goods. 158. Repayment by bailor, of necessary expenses -- Where, by the conditions of the bailment, the goods are to be kept or to be carried, or to have work done upon them by the bailee for the bailor, and the bailee is to receive no remuneration, the bailor shall repay to the bailee the necessary expenses incurred by him for the purpose of the bailment. 159. Restoration of goods lent gratuitously -- The lender of a thing for use may at any time require its return, if the loan was gratuitous, even though he lent it for a specified time or purpose. But, if, on the faith of such loan made for a specified time or purpose, the borrower has acted in such a manner that the return of the thing lent before the time agree upon would cause him loss exceeding the benefit actually derived by him
from the loan, the lender must, be compels the return, indemnify the borrower for the amount in which the loss so occasioned exceeds the benefit so derived. 160. Return of goods bailed, on expiration of time or accomplishment of purpose -- It is the duty of the bailee to return, or deliver according to the bailor's directions, the goods bailed, without demand, as soon as for which they were bailed has expired, or the purpose for which they were bailed has been accomplished. 161. Bailee's responsibility when goods are not duly returned -- If, by the default of the bailee, the goods are not returned, delivered or tendered at the proper time, he is responsible to the bailor for any loss, destruction or deterioration of the goods from that time. 162. Termination of gratuitous bailment by death -- A gratuitous bailment is terminated by the death of either of the bailor or of the bailee. 163. Bailor entitled to increase or profit from goods bailed -- In the absence of any contract to the contrary, the bailee is bound to deliver to the bailor, or according to his directions, any increase or profit which may have accrued from the goods bailed. 164. Bailor's responsibility to bailee -- The bailor is responsible to the bailee for any loss which the bailee may sustain by reason that the bailor was not entitled to make the bailment, or to receive back the goods, or to give direction respecting them. 165. Bailment by several joint owners -- If several joint owners of goods bail them the bailee may deliver them back to, or according to the directions of one joint owner without the consent of all, in the absence of any agreement of the contrary. 166. Bailee not responsible on redelivery to bailor without title -- If the bailor has no title to the goods, and the bailee, in good faith, delivers them back to, or according to the directions of the bailor, the bailee is not responsible to the owner in respect of such delivery. 167. Right of third person claiming goods bailed -- If a person, other than the bailor, claims goods bailed, he may apply to the Court to stop the delivery of the goods to the bailor, and to decide the title to the goods. 168. Right of finder of goods: may sue for specific reward offered -- The finder of goods has no right to sue the owner for compensation for trouble and expense voluntarily incurred by him to preserve the goods and to find out the owner. but he may retain the goods against the owner until he receives such compensation; and where the owner has offered a specific reward for the return of goods lost, the finder may sue for such reward, and may retain the goods until he receives it. 169. When finder of thing commonly of sale may sell it -When a thing which is commonly the subject of sale is lost, if the owner cannot with reasonable diligence be found, or if he refuses, upon demand, to pay the lawful charges of the finder, the finder may sell it "
(1) When the thing is in danger of perishing or of losing the greater part of its value, or (2) When the lawful charges of the finder, in respect of the thing found, amount to two-thirds of its value. 170. Bailee's particular lien -- Where the bailee has, in accordance with the purpose of the bailment, rendered any service involving the exercise of labour or skill in respect of the goods bailed, he has, in the absence of a contract to the contrary, a right to retain such goods until he receives due remuneration for the services he has rendered is respect of them. Of pledges 172. Pledge, Pawnor, and Pawnee, defined -- The bailment of goods as security for payment of a debt or performance of a promise is called pledge". The bailor is in this case called the pawnor”, the bailee is called the pawnee". 173. Pawnee's right of retainer -- The pawnee may retain the goods pledged, not only for a payment of the debt or the performance of the promise, but for the interest of the debt, and all necessary expenses incurred by him in respect of the possession or for the preservation of the goods pledge. 174. Pawnee not to retain for debt or promise other than that for which goods pledged: Presumption in case of subsequent advances -- The pawnee shall not, in the absence of a contract to that effect, retain the goods pledged for any debt or promise other than the debt or promise for which they are pledged; but such contract, in the absence of any thing to the contrary, shall be presumed in regard to subsequent advances made by the pawnee. 175. Pawnee's right as to extraordinary expenses incurred -- The pawnee is entitled to receive from the pawner extraordinary expenses incurred by him for the preservation of the goods pledged. 176. Pawnee's right where pawnor makes default -- If the pawnor makes default in payment of the debt, or performance, at the stipulated time, of the promise, in respect of which the goods were pledged, the pawnee may bring a suit against the pawnor upon the debt or promise, and retain goods pledged as a collateral security; or he may sell the thing pledged, on giving the pawnor reasonable notice of the sale. If the proceeds of such sale are less that the amount due in respect of the debt or promise, the pawnor is still liable to pay the balance. If the proceeds of the sale are greater than the amount so due, the pawnee shall pay over the surplus to the pawnor. 177. Defaulting pawnor's right to redeem -- If time is stipulated for the payment of the debt, or performance of the promise, for which the pledge is made, and the pawnor makes default in payment of the debt or performance of the promise at the stipulated time, he may redeed the goods pledges at any subsequent time before the actual sale of them, but he must, in that case, pay, in addition, and expenses which have arisen from his default. 319 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
178. Pledge by mercantile agent -- Where a mercantile agent is with the consent of the owner, in possession of goods or the documents of title to goods, any pledge made by him, when acting in the ordinary course of business of a mercantile agent, shall be as valid as if he were expressly authorised by the owner of the goods to make the same. Provided that the pawnee acts in good faith and has not at the time of the pledge notice that the pawnor has authority to pledge. 178-A. Pledge by person in possession under voidable contract -- When the pawner has obtained possession of the goods pledged by him under a contract voidable under section 19 or section 19-A, but the contract has not been rescinded at the time of the pledge, the pawnee acquires a good title to the goods, provided he acts in good faith and without notice of the pawnor's defect of title.)
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179. Pledge where pawnor has only a limited interest -Where a person pledges goods in which he has only a limited interest, the pledge is valid to the extent of that interest. Suits by bailees or bailors against wrong-doers 180. Suit by bailor or bailee against wrong-doer -- If a third person wrongfully deprives the bailee of the use or possession of the goods bailed, or does them any injury, the bailee is entitled to use such remedies as the owner might have used in the like case if no bailment had been made; and either the bailor or the bailee may bring a suit against a third person for such deprivation or injury. 181. Apportionment of relief or compensation obtained by such suits - Whatever is obtained by way of relief of compensation in any such suit shall, as between the bailor and the bailee, be dealt with according to their respective interests.
9. CASE LAW 1 Gajanan Moreshwar v. Moreshwar Madan [AIR 1942 Bom 302] The plaintiff was a lease holder of a plot of land under the Bombay municipality. He transferred the lease to the defendant. The Municipality gave its approval but did not execute a separate lease in favour of the defendant. So, the lease continued to stand in the name of plaintiff. The defendant borrowed Rs.5000/ - from A. The lease hold interest was given as security to A. Since the lease hold interest stood in the name of plaintiff, at defendant's request plaintiff executed the mortgage though it was the defendant that was interested and was really liable to pay. The mortgage contained a personal covenant under which the plaintiff could be made liable. The defendant did not pay interest on the mortgage loan. Then the plaintiff brought the suit for: (i) a declaration that he was entitled to indemnity from defendant, (ii) an order that defendant should procure the plaintiff's release from the mortgage debt. The defendant contended that the suit was premature as the plaintiff had not yet suffered any loss. The points in issue were (1) can the plaintiff sue on the indemnity before he has suffered any loss? (2) is plaintiff entitled to the relief claimed under sections 124 and 125 of the Contract Act? It was held that the defendant had not denied that he should indemnify the plaintiff. So there was no need for a declaration. Sections 124 and 125 are not exhaustive. They deal only with one kind of indemnity, that is indemnity which arises when loss is occasioned by the conduct of indemnifier or of a third party. They do not cover indemnity arising by plaintiff doing something at defendant's request (which is the case here) or from accident. As to remedies also section 125 is not exhaustive. The indemnified has his remedies when he suffers loss. But in equity in England he can sue when his liability has become absolute and need not wait until he has suffered loss. This remedy is available in India also. So the plaintiff will be granted a decree that the defendant should procure his release or pay into court the mortgage amount. 2 Amritlal Goverdhan Lal v. State Bank of Travancore [AIR 1968 SC 1432]. The respondent bank opened a cash credit account for D which was guaranteed by the appellant. Goods pledged by D were found on checking by the bank to be in deficit to the extent of Rs.40,000/- and time was given to him to make up the deficit. The appellant contended that he is thereby discharged from liability. Point at issue was whether under such circumstances the appellant is discharged from his liability. It was held that extension of time for payment given to the principal debtor, discharges the surety (S.135). But giving time to make up the quantity of goods found to be short when weighed cannot be considered to be a promise to give time for payment. Shortage of goods to the extent of Rs. 40000/- gives rise to rights under S.141. The bank has lost the security to the
extent of this shortage. The term security" in this context means any kind of right which the creditor had against the property at the date of the contract. Since the bank has lost goods to the extent of Rs.40,000/- the liability of the surety (appellant) is reduced by Rs.40,000/-. For the balance only he is labile. 3 E. H. Parakh v. King Emperor [AIR 1926 Oudh 202] The applicant E. H. Parakh was the proprietor of a firm of Motor engineers and coach builders at Lucknow. The firm was entrusted with the possession of an American car "Moon" for sale, by Raja Amarpal Singh, a talaqdar of the Partabgarh district. While the car was still with the applicant's firm and had not yet been sold, the management of the Raja's estate was taken over by the Court of Wards. The manager of the Court of Wards directed the applicant's firm to handover the car belonging to Raja to Court of Wards. The applicant's firm did not deliver the car in an attempt to exercise the right of general lien over it, in respect of its claims against the Raja. The Deputy Commissioner Partabgarh, thereupon issued a notice to the applicant to show cause as to why he should not be prosecuted for refusal to hand over the car in obedience to the orders of the lawful authority. Applicant's firm challenged the order and claimed the right of general lien over it. It was held that the applicant's firm had a right of general lien over this car, and its refusal to deliver the car in exercise of this right could not make him liable for the alleged offence. It was observed. "there can be no doubt as to the fact that his (applicant's) plea that under a factor's lien he is entitled to retain the car until the general balance of account is settled is a plea which cannot be ignored. In respect of criminal charges which the Deputy Commissioner proposes to make against him it is sufficient to say that the applicant cannot possibly be considered to have offered any resistance to the taking of any property by the lawful authority of any public servant, nor can he be considered to have voluntarily obstructed a public servant in the discharge of his public functions". 4 Union of India v. United India Fire, etc. Insurance Co Ltd [AIR 1981 Mad 162] Cotton bales belonging to the consignee company were unloaded by the consignee company itself and kept outside the railway goods shed and covered with tarpaulin. The consignee company did not have sufficient warehousing facilities, and its many goods including the cotton bales were lying in and outside the goods shed. The company had provided watchman and the railway protection staff was also there to take care of the goods. The company did not take delivery of the goods inspite of repeated requests to do so, and 13 days after the unloading of the said bales, the cotton bales caught fire for unknown reasons. The railway staff took all possible steps to extinguish the fire. Consignee company filed a suit for damages due to the negligence on the part of the railway authorities. 321 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
The main issue for decision was whether under the circumstances of the case railway authorities could be held liable for the loss suffered by the consignee. It was held that the railway authorities could not be held liable for negligence under these circumstances. 5 Bank of Bihar v. Damoda Prasad [AIR 1969 SC 297] The plaintiff bank lent money to Damodar Prasad, on the guarantee of Paras Nath Sinha. Inspite of demands by the bank the loan was neither repaid by Damodar Prasad (principal debtor), nor by Paras Nath Sinha (the surety). The bank then filed a suit against both the principal debtor and the surety. A decree was passed in favour of the bank but with the condition that the plaintiff bank shall be at liberty to enforce its dues against the surety only after having exhausted its remedies against the principal debtor. The plaintiff bank challenged the validity of the condition in the decree that the bank should enforce the decree against the surety only after exhausting all remedies against the principal debtor. The main issue was whether the condition imposed by the court was valid? Supreme Court allowed the plaintiff's appeal and the condition laid down in the decree was set aside. Court observed: "The demand for payment of the liability of the principal debtor was the only condition for the enforcement of the bond. That condition was fulfilled. Neither the principal debtor nor the surety discharged the admitted liability of the principal debtor inspite of demands. Under Section 128 of the Indian Contract Act, save as provided in the Contract, the liability of the surety is co-extensive with that of the principal debtor. The surety thus became liable to pay the amount. His liability was immediate. It was not deferred until the creditor exhausted his remedies against the principal debtor." 6 Morvi Mercantile Bank v. Union of India [AIR 1965 SC 1954]. A business firm consigned certain goods through Railway for being carried from Bombay to Okhala near Delhi, and to be delivered to 'self'. The firm borrowed a sum of Rs.20,000/from the applicant bank and executed a promissory note in favour of the bank and also endorsed the railway receipts representing the goods, to constitute the railway receipt as a security for the loan. The goods were lost in the transit. The plaintiff bank brought an action against the railway as the pledgee of the goods, which were lost during transit. The point at issue before the Supreme Court was whether by the transfer of the railway receipt the possession of the goods had been transferred to the bank. The respondent contended that the endorsement of the railway receipt does not amount to pledge of the goods, and it at best means the pledge of the railway receipt and not the goods. It was held by a majority decision that according to the prevailing Indian Law railway receipt is a document of title and, therefore, delivery of railway receipt means delivery of 322 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
goods represented by the railway receipt. The transaction was held to be a valid pledge and as such the bank was held entitled to a claim against the railway for the value of the loan given against the security of the railway receipt. 7. Ram Gulam and another v. Government of U.P. [AIR 1950 All. 206] Order:- The suit giving rise to this application in revision was instituted by the plaintiffs/applicants against the Government of United Province for the recovery of certain ornaments, and in the alternative for the recovery of Rs. 599.4 as their price. These ornaments were stolen from the house of the plaintiffs. They were recovered from another house, on a search made by the police and seized as stolen property, in exercise of powers conferred in that behalf by the Cr.P.C. They were produced as exhibits at the trial of those, who were prosecuted in connection with the theft. They were accordingly kept in the collectorate Malkhana, from where they were stolen, and were untraceable. The plaintiffs applied unsuccessfully to the Magistrate for an order for their restoration to them and then instituted the present suit, which was dismissed on the finding that the Government was not liable to compensate the plaintiffs. It appeared that the claim for the return of the ornaments was not pressed for want of any cause of action, disclosed in the plaint. These allegations did not disclose any cause of action for the return of the ornaments. There was no averment of any wrongful detention, but on the contrary there was the suggestion that the ornaments were not in the possession of the defendant. Indeed, it was an admitted fact during the trial that the ornaments were stolen from the Malkhana and untraceable. The plaintiffs, therefore, pressed the alternative relief only, for the recovery of their price on the ground that the ornaments were lost on account of the negligence of the Govt. servants, and the Government was hence liable. The decree of the court below had been assailed on the ground that the position of the Government was that of a bailee and it was liable to indemnify the plaintiffs, if the ornaments were lost on account of the negligence of its servants. This ground was held to be manifestly untenable and not deserving any serious consideration, for the obligation of a bailee is contractual obligation and sprang only from the contract of bailment. It cannot arise independently of a contract. In this case, the ornaments were not made over to the Government under any contract whatsoever, in fact the ornaments were not at all handed over by the plaintiffs to the Government. The Government therefore, never occupied the position of a bailee and is not liable as such to indemnify the plaintiffs. 8. Vasireddi Seetharamaiah v. Srirama Motor finance Corporation Kakinada [AIR 1977 A.P. 164] The plaintiff who had advanced certain loan to the defendant for the purchase of a lorry got executed a promissory note and a hire purchase agreement from defendant as the principal debtor and defendant 2 as the guarantor. The lorry was involved in an accident when nine instalments were paid and there was default
in payment. The suit was filed for recovery of balance loan against the principal debtor and the surety. The question before the Court was whether the conduct of the plaintiff in not seizing and selling the lorry on default by defendant 2 discharged the surety from liability. Held that the mere fact that the plaintiff did not file the suit immediately or seized the lorry, did not absolve 2nd defendant from his liability as a surety. 9. Yeung v. Honkong and Shanghai Bank [(1980)2 All.E.R. 599] Where a Bank acted in good faith at the request of the appellantstock brokers to transfer shares to one 'W' and the signatures of the transferor were forged, which fact was not known to the
Stock-Broker, the Privy Council held that the stock-broker is liable to indemnify the Bank on the principle that if a person acts at the request of another which affects the rights of a third person, yet if such act is not apparently illegal in itself but is done honestly and bonafide in compliance with such request, then he shall be bound to be indemnified against the consequences of such act by the person making such request. In the present case, the request by the stock-broker also included a promise to indemnify the bank, if by acting on the request, it caused actionable injury or damage to a third party. The promise was acted by the bank acting on the request and became a contractual indemnity.
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10 PROBLEMS 1. X a customer approached a BPL agent to buy a washing machine on instalments. The agent agreed to the proposal on the term that 25% of the value must be paid down and the balance alongwith interest was to be deducted from the monthly salary and paid to the agent's bank account. X's employer also agreed to this term. Accordingly, X paid Rs.6000/-, and agreed to pay Rs.2000/- pm as capital cost and interest deductible from salary. Both the parties agreed to take the delivery of the machine after 15 days. On the 13th day, the agents shop was set afire by a mob. The shop including the merchandise were insured against all types of risks. Insurance company refused to pay for the washing machine. Decide. 2. X lends Y Rs.10,000/- at 6% interest per annum on a promisory note. Z guarantees repayment of the loan. After Y becomes embarrassed, X without the knowledge of Z obtains a mortgage deed from Y by which Y agrees to pay the sum on demand at 9% interest per annum. On Yís default X files a suit against Y and Z. Discuss the liability of Z. 3. A consigned goods worth Rs.40,000/- from Bombay to Calcutta by rail. He pledged the railway receipt to the Bank and borrowed Rs.20,000. The goods were lost in transit. The plaintiff sued the railway i.e., government of India for recovery of Rs.40,000/-. Discuss: (1) Whether pledge of the railway receipt can be treated as pledge of goods. (2) If so can the pledgee sue for the value of the goods (Rs.40,000) or only for the amount advanced by him (20,000)? 4. A bank advanced money to B on the security of sugar bags. The sugar bags were in B's godown, which was locked and the key was surrendered to the bank. C, the government borke open the lock and seized 5000 maunds of sugar under seizure order of the Rationing authority. The sale proceeds of sugar was adjusted for recovery of arrears of Cane Cess due from B to the Cane commissioner. The bank claims the amount from the government. Discuss the rights and duties of bank, government and the cane commissioner with the support of case law, if any. 5. A gave a piece of cloth to B, a tailor to be stiched. B retained the cloth for a period longer than was necessary and neglected to return the suit even on A's persistent demand. Subsequently a fire broke out in B's shop and the cloth was destroyed. Is B liable for the loss? Suggest your answer on the basis of statutory & case law.
6. Pesticides India wanted to purchase some goods from a chemical corporation, and they gave some earnest money and also bank guarantee by the State Bank of Jaipur. On the supply of goods by the corporation, Pesticides India was not satisfied with the performance and according to them the supply had been wrongly made on "ex-godown" basis instead of highsea" basis. The corporation demanded the amount of the bank guarantee from the bank but the Pesticides India sought to reastrain the bank from making the payment. The bank had undertaken to pay on first demand without protest or demur and without reference to " Pesticides, and notwithstanding existence of any dispute whatsoever" between the parties. Under such situation can Pesticides India prevent the bank from honouring its promise to pay? Discuss bank's dury. 7. The credit limit of the debtor which had been fixed at Rs.1,00,000 was first reduced to Rs.50,000 and then again raised to Rs. 1,00,000 without consulting the surety. This was done by oral instruction to the cashier only, (and not by altering any document). Is it alteration under the contract Act which discharges the surety thereby? Discuss the law on the subject briefly. 8. A, pledged some packages of tobacco to the Bank. The packages were lying in A's godown. The godown was locked and the key of the godown was given to the bank. A failed to clear some income tax dues and the I.T.O ordered the attachment of those packages of tobacco. The goods were attached by the Collector and they were kept in the same godown, the godown was locked and the key was handed over to the Police. There were heavy rains, roof of the godown leaked and the goods inside got damaged. Discuss the liability of the government. 9. A wooden shop was hired under a written agreement that the shop will be returned in the same condition, and the hirer will be liable for any loss or damage to the shop. The shop is burnt by the mob during the communal riots in the City. Discuss the liability of the hirer. 10. A's porperty had been stolen. The same recovered by the police and was kept in the police malkhana. From there it was again stolen and could not be traced. A brought an action to revocer the value of the property. Discuss the liability of the State.
[Note: Specify your name, I.D. No. and address while sending answer papers]
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11 SUPPLEMENTARY READINGS 1. 2. 3. 4. 5. 6. 7. 8.
Avtar Singh, (1994), Law of Contract: Eastern Book Co., Lucknow. Atiyah, P.S. & Others (Editors), (1983), Chitty on Contracts: Sweet & Maxwell, London. Bangia, R. K. (1994), Indian Contract Act: Allahabad Law Agency, Allahabad. Cheshire and Fifoot, (1986), Law of Contract: Butterworths, London. Cheshire and Fifoot, (1977), Cases and Materials on Contract: Butterworths, London. Joga Rao, S.V., (1991), Case book on Special Contracts: NLSIU Publication, Bangalore. Pollock & Mulla, (1986), Indian Contract & Specific Relief Acts: N.M. Tripathi Private Ltd., Bombay. Venkataraman, S., (1987), Iyer's law of contracts: Asia Law House, Hydearabad.
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Master in Business Laws Law of Contracts Course No: I Module No: IX
DIGITAL CONTRACT
Distance Education Department
National Law School of India University (Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 3211010 Fax: 3217858 E-mail:
[email protected] 326 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
Materials Prepared By : 1. Prof. M.K. Nagaraja MA, LL.D, MBL., Indian Police Service, Bangalore
© National Law School of India University
Published By Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.
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Digital Contracts TOPICS 1.
Formulation of Digital Contracts ............................................................ 329
2.
Problems/Questions....................................................................................... 346
3.
Case Laws......................................................................................................... 347
4.
Bibliography.................................................................................................... 349
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FORMULATION OF DIGITAL CONTRACTS INTRODUCTION: “A legally binding agreement between two or more persons by which rights are acquired by one or more to acts or forbearance on the part of the other or others”. -Sir William Anson. Before analyzing the formulation of digital or e-contracts, it is incumbent on every one of us to understand how exactly a contract is formulated in the legal perspective. The juristic concept of a contract comprises of two components, such as vinculum juris (obligation) and consensus ad idem (agreement). The former relates to the doing or abstaining from doing a particular act, while the latter denotes meeting of identical minds for mutual communication of their intentions. The obligations must have a source in agreements (Sir John Salmond). One of the two categories of moveable property, namely; chose-inaction referring to ‘Right in Personam’ is enforceable through courts. For instance; shares, cheques, insurance policies and debentures. The chose-in-possession referring to ‘Right in Rem’ is enforceable by use of force as a right to property. For instance: right of private defence. An agreement fulfilling all the requisites becomes a valid contract. Section-2 (h) of the Indian Contract Act, 1872 defines a contract as “an agreement enforceable by law”. An agreement being the most significant component of a contract, it denotes “every promise or every set of promises, forming consideration for each other” [Section-2 (e)]. The consideration denotes some right, interest, profit or benefit accruing to one party, or some forbearance, detriment, loss or responsibility, given, suffered or undertaken by the other [Currie Vs Misa (1875) L.R. 10 Ex. 162] is another criterion that determines the terms of the contract. Consideration is defined as- “When, at the desire of the promisor, the promissee or any other person has done or abstained from doing, or does or abstains from doing or promises to do or to abstain from doing something, such act or abstinence or promise is called a consideration to promise”[Section-2 (d)]. Consideration means one party agreeing to give something in lieu of something else, except the social obligations that are excluded from its purview. If goods are subject matter, price is the valuable consideration. A promise is defined as “When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal when accepted becomes a promise” [Section-2 (b)]. It is evident that the promisor is a person making the proposal, while the promissee is a person accepting the proposal. A proposal 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 another to such act or abstinence is said to make a proposal” [Section-2(a)]. Whereas, an agreement having no legal effect is a void contract and an agreement enforceable by law at the option of parties to the contract is voidable contract. Illegal, immoral and agreements contrary to the public policy are not sustainable under law. An offer, invitation to offer (chaffer), tenders and quotations must be drawn a clear distinction in every agreement. An
advertisement is an offer in certain cases, but need not always be a mere invitation to offer. A tender is in the nature of a continuing offer, but not necessarily an offer to the entire public. Every offer must be communicated to the offeree, which must be accepted (Lalman Vs Gouri Dutt, 11 A.L.J. 459). An offer must contain definite terms, while acceptance must be absolute. It is pertinent to observe that all agreements are contracts if they are made by free consent of parties competent to contract, for a lawful consideration and with a lawful object and are not void contracts (Section-10 Act). The legal relationship between the promisor or a person making the proposal and the promissee or a person accepting the proposal forms the binding force in all valid agreements. The offer and acceptance is complete when the acceptor receives an offer and the acceptor sends his communication of acceptance to an offeror. Under the provisions of the Contract Law, an offer can be revoked before the promisee accepts the offer, while an acceptance can be revoked before it is communicated to the offeror. If the parties intend to enter a contract by executing a written document as a pre-condition and if no document is prepared, there is no valid contract [Chillingworth Vs Esche, (1924) Ch. 97]. This old concept may be overcome by proper documentation in the digital environment. However, there cannot be a contract to make contract or agreements to agree in future, except in the futures contracts. How far the contracts made by word of mouth or telephonic conversations are sustainable in the digital or electronic environment becomes a relevant issue in the context of using the mobile telephones in respect of e-business transactions. The corporate companies can enter e-contracts, acquire properties, right to sue, liability to be sued and to do anything, which is not beyond the scope or object for which it is brought into existence. Under the privity of contract, a stranger to the contract cannot sue and only a party to the contract becomes entitled to sue [Beswick vs. Beswick]. However, the rights and obligations of the parties in the context of franchising and sub-licencing should be examined in the digital environment vis-à-vis privity of contract. Whether the third party can sue the parties to the digital contract? All the digital contracts are a matter of choice between the parties. The digital contracts should not be contrary to the law of the land or against the public policy as in the case of other contracts. A contract may be express or implied. An express contract is either written or oral, but evidence regarding the formation of the contract must exist. On the other hand, implied contracts are ordinarily by the behaviour of the party. For instance, non-returning of the material sent for examination. The parties to the contract should be legally competent. Under the Force Majure Clause, a contract may not be possible to perform if it is beyond the control of the party. Status of e-document in the digital contracts: This cogent issue will have to be analyzed in the context of practical examples of e-commerce and other transactions taking 329 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
place in the digital environment. The unprecedented growth of information and communication technologies has produced several far-reaching implications on the formation of e-contracts. The communication of offer and acceptance is a complex phenomenon in the digital contracts, as compared to the contracts in a physical situation. All e-mails, hard copy of a title document scanned with the help of a computer and transmitted electronically or any other type of e-records downloaded from the Internet or a Website by the authorized user will qualify to be electronically disseminated documents. In this regard, fax machines, copier machines, computer mainframes or computer laptops inclusive of mobile telephones and telephony would be of vital importance in electronic transactions. The US court held that use of communication in the formation of contract was held to be valid [Beatty Vs. First Exploration Fund Company (1999). There are three different categories of rules in the formulation of digital contracts, such as1. General terms provided by the communication networks. 2. Specific rules for contractual relationship. 3. Rules under the legal framework. The communication network service providers prescribe certain general terms regarding the usage of the Internet or Website. Similarly, the terms and conditions as may be prescribed by the proprietors of software will have to be complied before availing of software. As regards the specific rules for contractual relationship, it is the choice of the parties to the digital contract to provide terms and conditions for performance of the contract and to settle the dispute likely to arise in future. Such terms shall include the jurisdiction, nature of contract, mode of electronic payment, electronic documentation, delivery of goods and the nature of services being rendered in the digital contract. The parties have always an option to incorporate such terms while formulating the digital contracts for easy enforcement. The reference clause should be incorporated in the data message. The terms and conditions of the digital contract must be made known to the other party, which should be acceptable to the parties. Once a valid e-agreement has been reached, the parties to the contract perform the contract, failing which there is a breach of contract. A party that breaches an agreement is liable to pay damages without an agreement between the parties, the rights and obligations of the parties to the digital contract would not arise. Further, an agreement requires documentation security procedures and the terms and conditions between the parties. It is imperative that Article-9 (1) & (2) of the UNCITRAL Model Law on Electronic Commerce, 1996 assures not only the evidential weight to such transactions, but also admissibility to e-records in evidence. Article-9 (1) reads, “In any legal proceedings, nothing in the application of the rules of evidence shall apply so as to deny the admissibility of a data message in evidence: a) on the sole ground that it is a data message or, b) if it is the best evidence that the person adducing it could reasonably be expected to obtain, on the grounds that it is not 330 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
in its original form”. Further, Article-9 (2) reads, “Information in the form of data message shall be given due evidential weight. In assessing the weight of a data message, regard shall be had to the reliability of the manner in which the data message was generated, stored and communicated, to the reliability of the manner in which the integrity of information was maintained, to the manner in which the originator was identified, and to any other relevant factor”. The purpose of Article-9 of the Model Law is to assure both the admissibility of data in evidence and its evidential value. Article-5 of the Model Law applies specifically to the contractual relationships between the parties, while Article-11 ensures the validity of digital contracts by electronic means. Article-11 of the Model Law specifically deals with the formation of digital contracts as well as the form in which an offer and acceptance may be expressed. Article-11 (1) reads, “In the context of contract formation, unless otherwise agreed by the parties, an offer and the acceptance of an offer may be expressed by means of data message. Where a data message is used, that contract shall not be denied validity or enforceability on the sole ground that a data message was used for that purpose”. As between the originator and the addressee, a data message is deemed to be that of the originator if it was sent by a person who had the authority to act on behalf of the originator or by any information system programmed by or on behalf of the originator to operate automatically [Article-13 (2) (a) & (b) of the Model Law]. In certain cases, computers generate the data message, expressing offer and acceptance without immediate human intervention, which might create doubts about the intent by parties. The majority of the uncertainties inherent in the mode of communication may be overcome by means of proper documentation. The e-mail, EDI (computer to computer transmission of data in a standard format) and any other modern means of communication are significant from the legal perspective, which involve two issues, such as 1) legal nature of e-document warranting admissibility & evidential weight and 2) validity of e-document requiring authenticity and integrity of data text. The nonadoption of I.T. Laws by the Nation-States or inadequacies of law might result in uncertainties as to the legal nature and validity of data message. Therefore, sound I.T. laws and standard technical practices are essential wherever EDI, e-mails, or other modern means of communication are used in the formulation of digital contracts. A data message initiated as oral communication may end up in the form of telecopy or the data message starting as telecopy may end up as EDI message. All the ‘constructed contracts’ in the digital environment could be inferred based on proper documentation, which is said to be complete when the technical and legal requirements are met. The signature in the digital terminology refers to the hash value of an e-document. Unlike paper-based documents, EDI message and e-mails are intangible in nature until they are reduced to hard copies or displayed on the screen of the mainframe. Electronic communication, such as e-mail and EDI assures instantaneity and reduces the cost of communication in the digital contracts. By availing e-mails, written or graphic
communications could be ensured between the parties in respect of their designated information system. The EDI assures exchange of data message or electronic payments in a standard format between the parties. In the digital contracts, the franchising e-records should adequately cover the relationship between the parties while adopting e-mails or EDI communications in the performance of a contract by the third party. In such circumstances, it becomes necessary that a Franchisor and Franchisee enter an agreement regarding the use and exchange of e-mails or EDI messages without posing any threat to the confidentiality and integrity of data. If the third party adopts e-mail or EDI processing, the agreement should specify clearly the custodial structure of e-records to meet the evidentiary requirements. In such situations, the data message should be double or further encrypted to render it unintelligible in the event of its interception during the transmission. The data transmitted electronically splits into packets and travels by different mode of communication before reaching and assembling at the destination point. It is also pertinent to realise that the Model Law adopts the “functional equivalent approach”, so that each party can hold a hard or soft copy of the same data that may be acceptable to public authorities and courts. The levels of security to edocument could be a matter of degree of care and caution, both in the paper-based documents and the data message. In other words, the parties to the digital contract should enable the data message to enjoy the same level of legal recognition as corresponding paper documents performing the same function. It is even more necessary to understand that the functional equivalent approach has been dealt with respect to the concepts of ‘writing’, ‘signature’ and ‘original’ [Articles-6 to 8 of the Model Law]. However, the Model Law does not create a functional equivalent for the existing storage requirements of the data message. This kind of ambiguity shall not be precipitated to the national laws also. Following are the general principles on which the Model Law is based1. To facilitate e-commerce among and within nations. 2. To validate all transactions entered into by availing the new technology. 3. To implement new information technologies. 4. To ensure uniformity of law all over the globe to facilitate global transactions. 5. To ensure standard commercial practices. The amendments to the Indian Penal Code of 1860, Indian Evidence Act of 1872, Reserve Bank of India Act of 1034, Company Act of 1956 and Banker’s Books Evidence Act of 1991 have been brought about as a short-term measure. However, the Shere Committee (1991) has recommended the enactment of Data Protection Act, E-Commerce Act and E-Commerce Support Act as a long-term measure. The Data Protection Act forms an important Act in the formulation of digital contracts as far as the corporate companies are concerned.
The notion of data message shall include all types of data message generated, transmitted and stored by electronic or optical means. The addressee is a person to whom the originator intends to communicate by transmitting the given data message, as opposed to any person who might receive or copy the data in the course of its transmission. The originator is the person who originates the data message even if that message is transmitted by another person on his behalf. If an addressee communicates his acceptance to the offer made by the offeror, the ‘focus of intent’ is also shifted to the addressee in the contractual relationship. In the digital contracts, both offer and acceptance are communicated purely in electronic environment. An intermediary is a mere conduit in so far as receiving, transmitting and storing data messages on behalf of another person. The additional value added services may be performed by network operators and other intermediaries, such as formatting, translating, recording, authenticating, certifying, providing security services for electronic transactions and preserving data messages. The focus is on the rights and obligations of the parties about their contractual relationship. An e-document is deemed to have been despatched at the place where the originator has a place of business or residence, while it is deemed to have been received at the place where the addressee has a place of business or residence. It is incumbent that parties entering contract must indicate their e-mail ID for future communications in the electronic environment. Whether a web page is an open offer from the owner of a Website if the contents imply his intention to enter an e-contract? What is the responsibility of a web server or ISP? Whether an acceptance of an open offer available on the web page by a netizen or a subscriber would amount to the formation of e-contract? These are a few questions, which might arise in the formation of digital contracts. The information system intends to cover the entire spectrum of technical scenario including the communications network, email box or even a Telecopier used for transmitting, receiving and storing information. The information cannot be denied legal effectiveness, validity and enforceability solely because it is in the form of data message. While using the modern means of communication, the solutions to the technical, legal and administrative challenges lies in the adoption of policies by the corporate companies and the governments. Even then, the well-established rules and standard commercial practices are relevant [INCOTERMS]. The contractual relationship between the originator and the addressee of a data message with a focus on the intent of the parties forms the backbone of digital contracts. All e-agreements entered between the parties, either bilateral or multi-lateral will create rights and obligations in the performance or enforcement of digital contracts. Conventional paper vs. Data message communication: The notion of data message is to fulfil the requirements of a document, which involves four aspects namely: 331 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
1. 2. 3. 4.
Original-Authenticity of data message. Writing-Hard copy or computer printout. Witnessing-Proper documentation. Signature-Hash value of the digital signature.
In the paper-based environment, the original document is only accepted to minimise the chance of its alteration, which would be difficult to detect in copies. Whereas, the technical means in the digital environment are available to certify the contents of a data message to confirm its originality. The medium on which the data is stored at the first instance is readable by machine language only. If this proposition were to be taken into consideration, the data message that an addressee receives would only be a copy. It is true that the document should be original from the viewpoint of evidence. When the computer printout is made admissible in evidence, the notion of ‘original’ document in the digital or electronic environment does not arise at all. The importance of the integrity of data message vis-à-vis its originality lies in the systematic recording of the information at the first instance, inclusive of affording protection against data alteration. The simple criterion regarding the originality of e-document or the first data depends on the levels of authentication and integrity of data. As long as the data remain intact and complete, necessary additions would not affect the originality of an electronic document. All documents including electronic records produced for the inspection of the court fall within the definition of evidence [Amendment to Section-3 of the Indian Evidence Act]. Where the law requires information to be presented or retained in its original form, that requirement is met by a data message if- a) there exists a reliable assurance as to the integrity of the information from the time when it was first generated in its final form, as a data message or otherwise and b) where it is required that information be presented, that information is capable of being displayed to the person to whom it is to be presented [Article-8 of the Model Law]. The Mumbai High Court Judge Justice Mr. Promod Khode in the TADA case against Hindi cine artiste Mr. Sanjay Dutt observed that even if the medium on which the data evidence is stored were to be produced before the court for inspection, the presiding officer of the court cannot make out the machine readable language and the computer print out being the replica of what data has been stored in the medium should be admissible in evidence. In the electronic realm, authentication together with data integrity is equivalent to the traditional signature. The source of the data message could be confirmed by test case and call back procedures, apart from adopting the appropriate security measures. The parties intending to use EDI should agree to avail the means to authenticate e-documents. The electronic media is no obstacle in the formulation of digital contracts in India, especially after the enactment of the I.T.Act, 2000. The information presented in writing means that such information be contained in e-document [Article-6 of the Model Law]. The purpose is to fulfil all conceivable functions of a writing, which focuses upon the information being reproduced or read and accessible, so as to be usable for subsequent references or purposes. There has been a debate about the 332 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
feasibility of the formation of digital contracts in electronic environment, as against the existing paper-based contracts. In this regard, the fulfillment of two requirements is essential, such as-1) tangible evidence about the existence of data message in a computer or the storage media and 2) the intent of the contracting parties to bind themselves to an agreement already entered. The data message need not be tangible as in the case of paper-based contracts, but the evidence must be tangible. After all, the parties are well aware of the consequences before entering contracts in the digital environment. The levels of security to an e-document are increasing with the advancement in cryptographic technology. The computerized information security assures confidentiality, authenticity (Kerberos system is the best form of authentication in USA) and integrity of data. Above all, the information is made accessible only to the parties possessing the relevant keys. Once the Data Encryption Standards are adopted, the parties to a digital contract can safely transmit an e-document from the originator to the addressee. The double and further encryption of the data text would assure full security to an e-document, which is transmitted electronically. The hash value helps the addressee to verify the genuineness of electronic record by adopting the checksum method. Encryption and decryption depends on the effective ‘key management’ by the parties to the digital contract. The certification authorities, such as Satyam, Infoway etc certifies the encrypted e-document or the digital signature, which can be revoked under specific circumstances [Sections-37 & 38 of the I.T.Act, 2000]. The information goes in a secured manner during its electronic transmission between the contracting parties and even to the banks for payment [OFT]. The Organization for Economic Cooperation and Development (OECD) adopted guidelines on cryptography on March 27, 1997 which aims at prompting the used of cryptography for digital signatures. These guidelines include the choice of cryptographic methods, privacy protection, lawful access to the keys and encrypted data, liability of those offering cryptographic services and international cooperation. The digital signature in electronic environment supplements the ‘writing’ and ‘signature’ of the physical environment. The application of cryptography as a security tool would take care of the integrity of the data against any kind of alteration, modification and deletion of data during its transmission. The parties to the digital contract should ensure that e-document remains unaltered over a period and a permanent record of transaction as in the case of a paper-based document. Each party can hold a soft copy in addition to the hard copy of the data for its reproduction whenever the necessity arises. It is imperative that e-documents are acceptable to the public authorities and courts since the stress is laid on e-governance in these days. With the tremendous advancement made in the storage technology, it is easier to store an electronic document and preserve it for a long time. One must realise that after the incident of attack on the WTC in USA, the back-up as well archival concepts have assumed prominence. Every important corporate company is going in for disaster security plans after the WTC incident. In short, the focus should be on the intent of the parties to formulate a contract in the digital environment
than the document in a written form, which is taken care of, for the reasons adduced supra. Therefore, the data message constitutes as an electronic record of the intent of the parties. The intangible electronic document becomes tangible the moment it is retrieved from its storage device or a computer printout is obtained [Read TADA case against Sanjay Dutt]. The legal rights and obligations of the parties to the contract remains unchanged even in respect of an electronic document. It would suffice if the requirement of ‘writing’ were fulfilled, which provides distinct levels of traceability, reliability and unalterability. It cannot be construed that the data presented in the written form should be a ‘signed writing’, as the data message performs the conceivable functions of writing. Further, the information is capable of being reproduced and read. The software (Keys) necessary to render such information readable shall be preserved. After all, the data message is intended to be used as original e-document in a contractual transaction between the originator and the addressee. Hence, there could be no discriminatory treatment between the data message or a paper based document. Moreover, it is incumbent to realise that the paper-based transactions are also prone to fraud and forgery. In the physical situation, the witnesses attest the document or signatures of the contracting parties. In the electronic environment, there is no scope for any one to attest his signature to e-document. The proper documentation itself would be the witnessing process of an electronic document. The notion of signature is linked to the paper-based transaction. The requirement of a signature in relation to a data message is met if-a) a method is used to identify the originator and to authenticate the data message by means of his approval of the contents in the electronic document and b) adoption of appropriate and reliable method by which the data message is communicated in any relevant agreement [Article-7 of the Model Law]. The function of a signature requires strict proof of identity of originator of the data, certainty of his personal involvement in the act of signing and his association with the content of electronic document or data message. The signature performs several functions, such as the intent of the party to bind by the content of a signed contract, intent to endorse authorship of the text and vetting the contents of the text. In addition to the signature, the stamping, perforation and printed letterhead provide another level of certainty to e-document. In the electronic environment, the highest level of certainty about authentication is a substitute for signature. The digital signature authenticates an e-document transmitted or stored electronically. Once the data message is authenticated and legal value assigned, it fulfills the requirements of a signature in as much as it confirms the identity of the author of e-document who approves its contents. In other words, the legal functions of a signature are performed by means of a method that identifies the originator of a data message and confirms that the originator approved the content of e-document. The method should be reliable for which the data message is generated or communicated in any agreement between the originator and the addressee. In order to determine whether the method used is appropriate and fulfills the legal
and technical standards, several parameters may be taken into consideration. They include the technical sophistication used by the parties to the digital contract, nature of the contract, functions of signature requirements, compliance to authentication procedures and the significance of the content of e-document. The legal certainties: The information stored accurately replicates by precision, except where the data message is decoded or compressed or converted in order to be stored. Wherever the need arises to retain the data message or e-document, such document should be accessible for the use of subsequent reference or purpose and it should be retained in a format in which it was generated, sent or received, an electronic document so retained should be able to identify its origin. The Model Law ensures legal certainty about the conclusion of contracts, especially the form in which an offer and acceptance could be expressed since the technical and legal solutions to certain uncertainties in the formulation of digital contracts are essential, all e-agreements should be made to overcome such uncertainties by way of express terms and conditions. The legal recognition, admissibility and authentication of e-document create the legal effectiveness and legal value as evidence. The formation of contracts should be designed to dispel uncertainty as to the time and place of formation of contracts in cases where offer or acceptance is exchanged electronically [Article-15 of the Model Law]. The proper identity of the parties to the digital contract in electronic environment assumes as prominent issue, which could be ensured by authentication and subsequent documentation of all correspondences between the parties to the contract. The legal uncertainties inclusive of conflicting national laws could be overcome by either amending the national laws or the parties expressing their clear intent on the formation of digital contracts without violating the public policy of the state or the national laws. The authentication, identity of parties and the content endorsement processes in the electronic environment would remove uncertainties or ambiguities in the formation of digital contracts. It becomes certain that the data message owes to the originator, which acts as a substitute to the signature in the paper-based contracts. Where the originator sends an offer in a data message and requests acknowledgement of receipt within a specified time, such acknowledgement evidences that his offer has been received by an offeree [Article-14 of the Model Law]. The purpose of Article-14 (2) is to validate acknowledgement of any communication made by an offeror. The originator of an offer is free to transfer the offer to another party if he does not receive the requested acknowledgement from the offeror (Addressee) within the specified time frame. The addressee is prevented from denying legal effect of the data message sent by the originator, requesting an acknowledgement within a certain time under the agreement if the requested acknowledgement is not communicated. The I.T.Act, 2000 propagates the basic principles that there should not be any discrimination between the data message and the paper based documents, which facilitates 333 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
formulation of digital contracts since the parties can rely upon the data message in all their electronic communications. It also assures certainty to the digital contracts with authentication of data message. The data messages could be attributed to the originator, who generates, sends, stores or transmits or causes to do so to any other person [Section-2 (1) (za)]. The authentication of the data message by code of encryption confirms that the e-record originated from or on behalf of its author. The technology helps the parties to adopt electronic procedures as ‘functional equilant’ of acknowledgement (traditional way of RPAD) in the case of digital contracts. If the originator requires that the data message shall be binding on the addressee only upon receiving an acknowledgement from him, the terms and conditions prevails. This procedure would facilitate the offeror or originator to transfer his offer to contract to another person if no response or acknowledge has been received from the addressee. The originator is relieved of the legal implications if the requested acknowledgement is not received from the addressee. On the other hand, the addressee has an option either to accept or not to accept an offer made by the originator. In the digital contracts, it becomes necessary to indicate the time and place of receipt of electronic communication by the offeror and offeree. The location of information system becomes irrelevant for the simple reason that the parties communicate from one country to another without being aware of the information system through which they operate. The more objective criterion would be the place of business of the parties. The moment a data message enters the information system of an intermediary or an offeror beyond the purview of an offeror, the time of dispatch of such data message starts. The term ‘dispatch’ denotes the commencement of transmission of data message electronically. The dispatch is complete when the data message enters the designated information system of an offeree. It would suffice if the data message enters the addressee’s unilaterally designated information system for receipt of the message. It would be irrelevant for an offeror to ascertain whether the offeree opens the mailbox or not. In other words, the information system may or may not be the information system of an offeree and the message is deemed to have been received by an offeree. On the other hand, an offeror must expressly specify the address to which the acceptance should be sent. The mere indication of e-mail or telecopy address on the letterhead or data message can never be treated as an express designation of one or more information systems. Hence, the notion of information system assumes importance from the viewpoint of dispatch and receipt of the data message. Another criterion should be that the data message is intelligible and capable of being used by the offeror. The encrypted message is deemed to have been received before it is used by an offeree. Whether improper or non-functioning of the information system where data message cannot enter, could it be the parameter to impose liability? This question must be analyzed in the context of the technical issues and other circumstances inclusive of the integrity of an addressee. The place of receipt of data message assumes significance in the digital contracts. The offeree may 334 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
receive the data message transmitted by an offeror from his own information system, located in his jurisdiction or retrieve such data message from some other designated information system located outside his jurisdiction. A logical connection should be established between the offeror and offeree in order to determine the designated information system as the place of receipt of the data message. The originator or an offeror can ascertain the place of receipt of the date message by an offeree. Moreover, the parties to the digital contract may agree by consensus what should be the designated information system for receiving the data message. The United Nations Convention on Contracts for International Sale of Goods, 1980 applies to all international commercial contracts of sale of goods between the trading and business houses, except the consumer goods. A contract of international sale of goods need not be evidenced in writing since the writing is defined along the lines of UNCITRAL Model Law to mean “any mode of communication that preservers the record of the information contained therein and is capable of being reproduced in tangible form” [Article1.10]. The distinction between the deemed place of receipt and the designated place of receipt should be analyzed copiously. The deemed place of receipt of data message at the time of its receipt contrary to the place where the data message actually reached would be inappropriate if it does not fall within the scope of computerized transmission of data message. The location of information systems of the contracting parties cannot be taken as the sole criterion to determine the place of business for the simple reason that the data messages are received at a particular information system. The dispatch of data messages confirms the commencement of the electronic transmission as the time of entering the information system, which is outside the control of the originator. As regards the time of receipt, the I.T.Act, 2000 lays down certain criteria, such as the receipt of data messages occurs the moment it enters the computer resource of the addressee or when the data message enters the designated information system of the addressee and the receipt is deemed to have occurred when the data message is retrieved by the addressee. What happens if the data message is not intelligible or unusable by the addressee? The addressee has an option to communicate to the originator of the data about it. If the data message fails to enter the information system of the addressee, he cannot be held responsible. If the originator of the addressee has more than one place of business, the principal place of business shall be the place of business. If they have no place of business, the usual place of residence shall be the deemed place of business, including the place where the body corporate is registered. The designated information system evidences the reasonable connection between the parties of the contract. Significance of authentication procedures: The principle of attribution of e-document or data message to the originator forms an important issue vis-à-vis application of authentication procedures. In principle, the originator is bound by the e-document, which is transmitted to the addressee electronically in a digital contract. The addressee should have proper access to the authentication procedure by virtue of his
contractual relationship with the originator and applies such procedures properly as agreed by the originator. The originator has an option to deny by issuing notice to the addressee that he had not communicated any e-document to him. Similarly, the addressee having come to know that e-document was not that of the originator, he need not proceed with the formation of the digital contract. Once the originator agree that an addressee to apply the authentication procedure, he is estopped at a later stage to retract, provided that such application was an outcome of proper verification of the originator as the source of edocument. Even if the originator enters an agreement with an intermediary (third party) to bind himself to the authentication of e-document or authentication procedures, the requirements corresponding to the authentication procedures are fulfilled. In all such circumstance, the originator cannot be relieved upon the consequences of transmission of e-document to an addressee. The originator is excluded from the binding effect from the date and time of receipt of notice by the addressee, but not earlier to it. If the addressee proves that he had properly applied the agreed authentication procedures of e-document sent by the originator, the latter cannot escape from his liability. The rights of the addressee would arise the moment he applies the agreed authentication procedures of electronic document or data message sent by the originator. On the other hand, the originator is absolved of his liability the moment he issues the notice to the addressee if the data message was not initiated by him or by any other authorized person on his behalf. In today’s digital world, authentication of electronic transmission assumes tremendous importance. In the physical world, the signature authenticates ‘writing’ and identifies the party signing the document, who is aware of legal and commercial implications. It also signifies his consent to the contracts of the document. Under the digital contracts, an e-document denotes a data message or paperless electronic form while the signature refers to the digital signature. A digital signature is an encryption form of e-document with the help of a ‘hash function’. The digital signature authenticates the originator of the data message or an e-document. The I.T.Act 2000 recognises the digital signature and provides for its use. The digital signature means “authentication of an electronic record by means of an electronic method or procedure” [Section-2 (p)]. The provision regarding the authentication of electronic record or a data message is laid down under Secton-3 of the I.T.Act, 2000. An electronic record means “data, record or data generated, message or sound stored, received or sent in electronic form or micro-film or computer generated micro- fitche” [Section-2 (t)]. An electronic form is defined as “any information generated, sent, received or stored in media, magnetic, optical, computer memory, micro-film, computer generated micro-fitche or similar device” [Section-2 (r)]. The certifying authority grants the digital signature who has got powers to suspend or revoke such digital certificates [Sections-35, 37 & 38]. Legal framework of Information Technology Act, 2000: The formulation of the digital contracts in India is in a primitive stage since there are no court precedents to develop
jurisprudence on the contractual relationship between the parties in the digital or electronic environment. Therefore, we have to fall back upon the basic principles of Contract Law. The Council of Europe has formulated e-contracts for its member States in Europe. The formulation of digital contracts in electronic environment and proper documentation are the two crucial issues, which could be pondered over copiously. A peep into the Information Technology Act, 2000 gives us an idea about the formulation of the digital contracts in electronic environment. The I.T.Act assures legal recognition to all types of e-commerce carried out by means of Electronic Data Interchange as an alternative to paper based transactions, which may be defined as “electronic transfer from computer to computer of information using an agreed standards to structure the information” [Article-2 (b) of Model Law]. EDI has replaced paper transaction with a structured electronic message, which is more secured with enhanced efficiency than the e-mail transactions. The International Chamber of Commerce (Paris) assures uniform rules of conduct for interchange of trade by Tele-transmission. Article-4 of the European Model Electronic Interchange Agreements cover the content protocol, acknowledgement, confirmation, accuracy and storage of content. The European Council has adopted by its Directive No. 94/820/EC in December 1994 on Model Interchange Agreement, which obligates the network providers and the users to comply with the procedures. The United Nations Economic Commission for Europe has framed rules for electronic data interchange based on the internationally agreed standards relating to e-contracts. Article-4 of the European Model Electronic Data Interchange Agreement provides that EDI messages complying the terms of agreement shall constitute as evidence admissible in law courts. The fundamental issue involved in the digital contracts relate to the following two issues(a) In the digital contracts, the time of despatch and time of receipt of the proposal would take care of the time factor. As regards the place of agreement, the transmission of electronic document through the Internet defeats the geographical boundary. Article-11 of the UNCITRAL Model Law removes uncertainties about the conclusion of econtracts and deals with the form in which an offer or an acceptance to be communicated electronically. After all, electronic records and the digital signatures generated, stored, processed, communicated are used in the formation of digital contracts. (b) In the authentication of electronic document in the digital contracts, the authenticity, non-repudiation and integrity of/to electronic record are essential elements in the formation of digital contracts. Since the originator of an electronic message or data text corresponds to an offer, the authenticity of an electronic document that owes to its creator would be of tremendous significance in all types of electronic communications. When the e-mail sent by the offeror enters the addressee’s computer resource or the addressee retrieves the e-mail, the proposal/offer is 335 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
complete. In this context, Section-2 (za) of the Information Technology Act of 2000 is a relevant provision, which reads, “Originator means a person who sends, generates, stores or transmits any electronic message or casuses any electronic message to be sent, generated, stored or transmitted to any other person but does not include an intermediary”. On the other hand, the addressee corresponding to a person accepting such offer shall be an acceptor within the scope of the definition given under Section-2 (1) (b) of the Information Technology Act of 2000, which reads, “Addressee means a person who is intended by the originator to receive the electronic record but does not include any intermediary”. When the addressee dispatch e-mail to the offeror from his computer resource, the acceptance is complete. A valid agreement entered between the competent parties in the formation of digital contract and any kind of breach thereafter would entail civil action against the party concerned. An acknowledgement regarding the receipt of offer by the offeree appears to be a decisive factor in the formation of e-contracts, which will be decided by an offeror. In this regard, Section-12 of the Information Technology Act, 2000 is a relevant provision, which reads, (1) Where the originator has not agreed with the addressee that the acknowledgement of receipt of electronic record be given in a particular form or by a particular method, an acknowledgement may be given by(a) any communication by the addressee, automated or otherwise; or (b) any conduct of the addressee, sufficient to indicate to the originator that the electronic record has been received. (2) Where the originator has stipulated that that the electronic record shall be binding only on receipt of an acknowledgement of such electronic record by him, them unless acknowledgement has so received, the electronic record shall be deemed to have been never sent by the originator. (3) Where the originator has not stipulated that the electronic record shall be binding only on receipt of such acknowledgement, and the acknowledgement has not been received by the originator within the time specified or agreed or, if no time has been specified or agreed to within a reasonable time, then the originator may give notice to the addressee stating that no acknowledgement has been received by him and specifying a reasonable time by which the acknowledgement must be received by him and if no acknowledgement is received within the aforesaid time limit he may after giving notice to the addressee, treat the electronic record as though it has never been sent”. If the transactions carried out in the electronic environment materialize into a valid agreement between the parties, the digital contract is complete. The attribution of electronic record is 336 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
made to its originator if he or his agent on his behalf transmits it or from his designated information system where automated response is ensured (Example: Website). In this perspective, Section-11 of the Information Technology Act of 2000 would be a relevant provision, which reads, An electronic record shall be attributed to the originator(a) if it was sent by the originator himself; (b) by a person who had the authority to act on behalf of the originator in respect of the electronic record; or (c) by an information system programmed by or on behalf of the originator to operate automatically. Conspicuously, the time and place of despatch and receipt of erecord is of immense relevance in the formulation of the digital contracts. Normally, the parties to the contract agree to communicate electronically between their designated information systems. The control over the data message by the originator ceases the moment it is dispatched from his information system. Similarly, the acceptance by the addressee is complete the moment he communicates his acceptance to the offeror from his designated information system. The liability of the originator would not seize if he dispatches the data message to the addressee. It is important that the data message should enter the addressee’s designated information system for retrieval. Even the intelligible message received by the addressee would not absolve the liability of the originator. Section-13 of the Information Technology Act, 2000 reads, (1) Save as otherwise agreed to between the originator and the addressee, the despatch of an electronic record occurs when it enters a computer resource outside the control of the originator. (2) Save as otherwise agreed to between the originator and the addressee, the time of receipt of an electronic record shall be determined as follows, namely(a) if the addressee has designated a computer resource for the purpose of receiving electronic records. (i) receipt occurs at the time when the electronic record enters the designated computer resource: or (ii) if the electronic record is sent to a computer resource of the addressee that is not the designated computer resource, receipt occurs at the time when the electronic record is retrieved by the addressee; (b) if the addressee has not designated a computer resource along with specified timings, if any, receipt occurs when the electronic record enters the computer resource of the addressee. (3) Save as otherwise agreed to between the originator and the addressee, an electronic record is deemed to be despatched at the place where the originator has his place of business, and is deemed to be received at the place where the addressee has his place of business.
(4) The provisions of sub-section (2) shall apply notwithstanding that the place where the computer resource is located may be different from the place where the electronic record is deemed to have been received under sub-section (3). (5) For the purpose of this section(a) if the originator or the addressee has more than one place of business, the principal place of business, shall be the place of business; (b) if the originator or the addressee does not have a place of business, his usual place of residence shall be deemed to be the place of business; (c) “usual place of residence”, in relation to a body corporate, means the place where it is registered. The Information Technology Act, 2000 assures authentication of e-records and affords legal recognition to the e-record as well as the digital signature. The digital signature authenticates the e-record and affords security while it is in transmission electronically. Section-3 of the Act reads, (1) Subject to the provisions of this section, any subscriber may authenticate electronic record by affixing his digital signature. (2) The authentication of the electronic record shall be effected by the use of asymmetric crypto system and hash function, which envelop and transform the electronic record into another electronic record. Explanation: For the purpose of this sub-section, “hash function” means an algorithm mapping or translation of one sequence of bits into another, generally smaller, set known as “hash result” such that an electronic record yield the same hash result every time the algorithm is executed with the same electronic record as its input making it computationally infeasible(a) to derive or reconstruct the original electronic record from the hash result produced by the algorithm; (b) that have two electronic records can produce the same hash result using the algorithm. (3) Any person by the use of a public key of the subscriber can verify the electronic record. (4) The private key and the public key are unique to the subscriber and constitute a functioning key pair. Section-4 of the Act reads, “Where any law provides that information or any other matter shall be in writing or tin the typewritten or printed form, then, notwithstanding anything contained in such law, such requirement shall be deemed to have been satisfied if such information or matter is(a) rendered or made available in an electronic form, and (b) accessible so as to be usable for a subsequent reference”.
Section-5 of the Act reads, “Where any law provides that information or any other matter shall be authenticated by affixing the signature or any document should be signed or bear the signature of any person then, notwithstanding anything contained in such law, such requirement shall be deemed to have been satisfied, if such information or matter is authenticated by means of digital signature affixed in such manner as may be prescribed by the Central Government”. There is need for authentication of data message and e-agreement in the formulation of digital contracts. If the parties want to affix your signature digitally, the hash function must be invoked. VerySign, a web service provider offers the service of digital signature. The affixation of hand signatures to the contracts in the physical situation corresponds to private key in the digital contracts and its confidentiality becomes very essential. Evidentiary value under IEA: It is pertinent to make a mention at this juncture that in the physical environment, evidence recorded or stored by availing the electronic gadgets were given the secondary evidentiary status. For instance: the voice recorded with the help of a tape recorder. Now-a-days, the digital voice recorder, digital cameras, digital video cameras, video conferencing are adding a new dimension to the evidentiary regime. Justice Gururajan, the Karnataka High Court judge has held in a civil suit that video conferencing evidence is valid. The emergence of information and communication technology witnessed the sea change by elevating the status of evidence recorded, generated or stored electronically from the secondary to primary evidential status. The shift in the paradigm owes to the efforts of the working group of the UNCITRAL Model Law on electronic commerce and the assigning of legal recognition to e-record or data message. The new provisions have been incorporated to the Indian Evidence Act, 1972 by way of amendments mentioned belowAs regards the presumption of e-agreements, section-85A has been inserted to the Indian Evidence Act of 1872, which reads, “The court shall presume that every electronic record purporting to be an agreement containing the digital signatures of the parties was so concluded by affixing the digital signature of the parties”. Section-85A has been inserted to Section-85 of the Indian Evidence Act to assure validity to e-contracts. The presumptive value is attributed to all electronic records, electronic records of five years old, digital signature and electronic messages within the scope of Sections-85B, 88A and 90A of the Indian Evidence Act, 1972, which are reproduced belowSection-85B: (1) In any proceedings involving a secure electronic record, the court shall presume unless contrary is proved that the secure electronic record has not been altered since the specific point of time to which the secure status relates. 337 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
(2) In any proceedings, involving secure digital signature, the court shall presume unless the contrary is proved that(a) the secure digital signature is affixed by subscriber with the intention of signing or approving the electronic record; (b) except in the case of secure electronic record or a secure digital signature nothing in this section shall create any presumption relating to authenticity and integrity of the electronic record or any digital signature. Section-88A: “The court may presume that an electronic message forwarded by the originator through an electronic mail server to the addressee to whom the message purports to be addressed corresponds with the message as fed into his computer for transmission, but the court shall not make any presumption as to the person by whom such message was sent”. Explanation: For the purpose of this section, the expressions “addressee” and “originator” shall have the same meanings respectively assigned to them in clauses (b) and (za) of subsection (1) of section-2 of the Information Technology Act, 2000. Section-90A: “Where an electronic record, purporting or proved to be five years old, is produced from any custody which the court in the particular case considers proper, the court may presume that the digital signature which purports to be the digital signature of any particular person was so affixed by him or any person authorized by him in this behalf”. Explanation: Electronic records are said to be in proper custody if they are in the place in which, and under the care of the person with whom, they naturally be: but no custody is improper if it is proved to have had a legitimate origin, or the circumstances of the particular case are such as to render such an origin probable. This explanation applies to the presumption as to Gazettes in electronic form within the scope of Section-81A of Indian Evidence Act, 1872. Section-85C: “The court shall presume, unless contrary is proved, that the information listed in a Digital Signature Certificate is correct, except for information specified as subscriber information which has not been verified, if the certificate was accepted by the subscriber”. Sections-3, 17, 34 and 35 of the Indian Evidence Act, 1872 have been amended suitably to afford conceptual clarity to an electronic document or e-records. Section-65B of the Act assures admissibility of electronic records, which reads, (1) Not withstanding anything contained in this act, any information contained in an electronic record which is printed on a paper, stored, recorded or copied in optical or magnetic 338 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
media produced by a computer (hereinafter referred to as the computer output) shall be deemed to be also a document, if the conditions mentioned in this section are satisfied in relation to the information and computer in question and shall be admissible in any proceedings, without further proof or production of the original, as evidence of any contents of the original or of any fact stated therein of which direct evidence would be admissible. (2) The conditions referred to in sub-section (1) in respect of a computer output shall be the following, namely:(a) the computer output containing the information was produced by the computer during the period over which the computer was used regularly to store or process information for the purposes of any activities regularly carried on over that period by the person having lawful control over the use of the computer; (b) during the said period, information of the kind contained in the electronic record or of the kind from which the information so contained is derived was regularly fed into the computer in the ordinary course of the said activities; (c) throughout the material part of the said period, the computer was operating properly or, if not, then respect of any period in which it was not operating properly or was out of operation during the part of the period, was not such as to affect the electronic record or the accuracy of its contents; and (d) the information contained in the electronic record reproduces or is derived from such information fed into the computer in the ordinary course of the said activities. (3) Where over any period, the function of storing or processing information for the purpose of any activities regularly carried on over that period as mentioned in clause (a) of sub-section (2) was regularly performed by computer, whether(a) by a combination of computers operating over that period; or (b) by different computers operating in succession over that period; or (c) by different combinations of computers operating in succession over the period; or (d) in any other manner involving the successive operation over that period, in whatever order, of one or more computers and one or more combination or computers, All the computers used for that purpose during that period shall be treated for the purposes of this section as constituting a single computer, and references in this section to a computer shall be construed accordingly. (4) In any proceedings where it is desired to give a statement in evidence by virtue of this section, a certificate doing any of the following thins, that is to say,
(a)
(b)
(c)
identifying the electronic record containing the statement and describing the manner in which it was produced; giving such particulars of any device involved in the production of that electronic record as may be appropriate for the purpose of showing that the electronic record was produced by a computer; dealing with any of the matters to which the conditions mentioned in sub-section (2) relate,
And purporting to be signed by a person occupying a responsible official position in relation to the operation of the relevant device or the management of the relevant activities (whichever is appropriate) shall be evidence of the matter stated in the certificate; and for the purposes of this sub-section it shall be sufficient for a matter to be stated to the best of the knowledge and belief of the person stating it. (5) For the purposes of this section, (a) information shall be taken to be supplied to a computer if it is supplied thereto in any appropriate form and whether it is so supplied directly or (with or without human intervention) by means of any appropriate equipment; (b) whether in the course of activities carried on by any official, information is supplied with a view to its being stored or processed for the purposes of those activities by a computer operated otherwise than in the course of those activities, that information, if duly supplied to that computer, shall be taken to be supplied to it in the course of those activities; (c) a computer output shall be taken to have been produced by a computer whether it was produced by it directly or (with or without human intervention) by means of any appropriate equipment. Explanation: For the purposes of this section, any reference to information being derived from other information shall be a reference to its being derived therefrom by calculation, comparison or any other process. DIGITAL CONTRACTS BY THE CORPORATE COMPANIES: The promoters are the architects of a corporate company who are responsible for floating or coming into existence of a company, but not every member employed by the promoters [Palmer]. The company cannot ratify the contracts entered by the promoters after its incorporation [Kelner Vs Baxter, (1866) L.R. 2 C.P.174]. Since the company was not in existence at the stage of its promotion, it has no liability eventhough the promoter has acted as company’s trustee. At the most, the promoter could be made liable in his personal capacity about the pre-incorporation contracts entered by him, before floating the company. He is also accountable to the company for the secret profits or any property acquired by him in his transactions relating to the pre-incorporation contracts. Since a promoter stands in a fiduciary relationship, he has to make full disclosure
about the profits and properties acquired in the earlier transactions where a promoter sells property without making any disclosure. If the restitution is not possible, the corporate company may recover the secret profits made by the promoter by way of damages [Gluckstein Vs Barnes (1900), A.C. 240]. A promoter is also liable for any misrepresentation made while issuing the prospectus of the corporate company. At the time of winding up of the company, the promoter can be made liable for breach of trust or misfeasance. Since the global business starts with a contract, it is obvious that the multi-national or trans-national companies also explore all possibilities about the formulation of digital contract in electronic environment. In view of the radical change, all the multi-national and trans-national companies inclusive of the defence firms have entered into digital contracts. At present, the disinvestment process has further favoured such companies to formulate digital contracts with the involvement of government agencies. It is pertinent to observe that the communication and information technologies revolution has created a new business scenario for the multi-national and trans-national companies and revolutionized the cross-border trading and commercial transactions inclusive of investments. The B2B and B2C types of e-business have assumed tremendous significance in the context of globalization and liberalization of economies of different countries all over the globe. The technical collaboration between the corporate companies, located in different parts of the globe is yet another dimension of the digital contracts. The process of conclusion of digital contracts between the corporate companies by mutual consent in electronic environment would give rise to certain technical, legal and administrative challenges. The formation of digital contracts by the corporate companies shall not be contrary to the public policy of the sovereign state or the national laws. In every digital contract, there must be a preamble containing the IP address of the two contracting corporate companies, subject matter of the contract, terms of electronic payments, mode of settlement of future disputes and the nature of agreement. All e-mails, hard copy of the title document scanned with the help of a computer and transmitted electronically, or electronic records downloaded from the Internet or Website by the authorized user, as transmitted by the originator would qualify for electronically disseminated documents. In this regard, Fax Machines, Copier Machines, Computer Mainframes or Computer Laptops inclusive of the Mobile Telephones and Telephony would be of vital importance. In the digital contracts, offer and acceptance are made purely in the electronic environment. An e-record is deemed to have been dispatched at the place where the originator has a place of business or residence, while an e-record is deemed to have been received at the place where the addressee has a place of his business or residence. It is incumbent on the part of the corporate companies entering digital contracts to necessarily indicate their respective e-mail ID and the information system for contractual communication. Whether a web page is an open offer from the proprietor of a Website if the contents imply his intention to 339 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
enter the digital contract? What is the responsibility of a web server or an ISP? Whether an acceptance of an open offer available on the web page would constitute a digital contract? These are a few questions, which one should ponder over in the formation of digital contracts by the corporate companies. The evolving role of Information Technology in the formulation of digital contracts assumes significance since the interaction takes place through the technology, especially the Internet and computer networking system. The technological solutions have been evolved to overcome the technical challenges in the formation of digital contracts between the companies. The solution to the problem lies in the proper access control, authenticity and integrity of data message. As a security tool, the cryptography affords to provide better solution regarding the authentication of the data. The double or further encryption would assure better security to the data message. The Data Encryption Standards and a combination of all other solutions regarding the authentication, access control, confidentiality, integrity and non-repudiation of data could be ensured. The hash value helps to verify the integrity of an agreement document transmitted by one company to another company electronically. As regards the non-performance of the digital contracts, the legal remedy lies in the provisions of Information Technology Act, 2000 and other provisions. Digital contracts for international sale of goods: The globalization is an outcome of an integration of goods and factor markets, such as technology, labour and raw materials inclusive of the merger of national markets with the international market. Whereas, the global economy is an outcome of an under current movement of the western economic block for over 50 years. The IMF emerged as a result of ‘Washington Consensus’ to aid the countries not managing their economies properly. Since the WTO controls the multi-lateral trade, the countries negotiating with it must have ’symmetry of information’ after mobilising the opinions of the interest groups within the country. The communication and information technologies have revolutionized the cross-border movement of investment, apart from liberalizing international trade and services. Therefore, it is high time that economic institutions must integrate trade and investment. The effect of globalization sounds like “creating a system to create inter-dependency”, perhaps due to the interlocking of economies, culture, people etc. The international business starts with a contract, especially the contract of international sale of goods. The process of conclusion of digital contracts in respect of international sale of goods shall be by mutual consent only. As far as India is concerned, the Sale of Goods Act, Indian Contract Act, 1872, I.T.Act, 2000 and the international commercial practices govern the digital contracts between the parties. The forum for resolving the dispute and enforcement of award becomes yet another issue in the digital contracts, which is dealt later. In view of the conflicting legal systems and public policies of different countries, the parties to the contract have a choice of law to settle disputes under the umbrella of international law. The 340 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
parties entering digital contracts may specify terms and conditions in e-agreements. In the absence of specific agreement, the third party can find out at the time of dispute settlement what was the intention of the parties to the digital contract. The laws in the country of export or import should not conflict with each other, while the parties to the contract make an agreement. The following are the four requirements to validate the electronic agreements as far as international sale of goods is concerned1. A digital contract made not in contravention of EXIM Policy for its enforceability. 2. Currency in which remittances are made must be a convertible currency. The FEMA prescribes that the money must be brought back to the country within a period of six months from the date of such transaction. 3. The Compulsory Quality Control and Free Shipment Act must be adhered to. 4. No one shall indulge in the act of FOREX depletion by violating the Customs Act and other provisions. UCPDC-500 & URR-525 ON TRADE CONTRACTS: In the digital form of contracts on international trade and commercial transactions, the importer is not assured of qualitative goods since the entire contractual transactions rests on the documentation. In other words, there is no chance for physical inspection of goods by the buyer. In trading contracts, the following types of contracts becomes more relevant(a) Contract between the Importer and the Issuing Bank. (b) Independent contract between the Exporter and the Issuing Bank. (c) Reimbursement agreement between the Importer and the Issuing Bank located in the country of import. The UCPDC-500 governs an instrument, while the URR-525 governs the bank-to-bank transaction. Article-23 of the UCPDC deals with the Bills of Lading, while Article-4 delves on document vis-à-vis goods & services and performance of digital contracts. The Electronic UCPDC ensures the presentation of electronic instruments and e-documents in the trading and commercial contracts. The instruments must be genuine, failing which it might result in trade frauds or commercial crimes of technical sophistication. For instance, the Letter of Credit might be used for money laundering purpose. The banker may return electronic documents having any discrepancy to the porter to rectify them. The bank will not accept the disputed e-document, but it can keep the amount in reserve. It is incumbent to realise that the commercial and financial instruments play a vital role in the contractual relationship between the parties in the digital contract. The law of the country or the ICC governs a Letter of Credit, provided the parties to the digital contract agree to negotiate with the ICC. On the other hand, bill of exchange is an order given in writing by the importer to make payment in whose name it is endorsed. The bill of exchange is a financial document,
while the Letter of Credit is an instrument to receive payments by the exporter. The bill of exchange can be passed to any person any number of times, which the importer has to keep track of it. Every Letter of Credit has an expiry date, shipment date and negotiation date. The carrier who issues the Bill of Exchange forms as an essential document for selling or negotiating purpose since it is a document of title that can be exchanged between the parties to the contract. The banks provide a bridge of confidence in the business transactions between exporter and importer. The documents are presented to an Agent Bank. The exporter is assured of payment on presentation of documents, but they have nothing to do with the status of the goods. In the digital contracts relating to the international sale of goods, Bill of Lading represents the goods. The Advisory Bank verifies the authenticity of the documents, while the Confirming Bank confirms such documents. The Nominated Bank transfers the Letter of Credit and claims payment from the Issuing Bank. The Negotiating Bank acts as an agent on behalf of the Issuing Bank. The exporter must receive the payment within 180 days of the date of shipment of goods. The Clearing Bank collects money from the Issuing Bank, while the Re-imbursement Bank makes payment to the exporter. Rights of importer: The following rights of an importer are very important from the viewpoint of the digital contracts(i) Goods not sent by the exporter within the specified time. (ii) Right to sue the exporter for non-performance of the digital contract entered with him. (iii) Right to reject goods received with belated delay. (iv) Right to reject goods if they are not in conformity with the terms of the contract. (v) Right to claim damages. Acceptance Test: In the context of contracts on the international sale of goods, the ‘acceptance test’ becomes a relevant issue. Once the importer observes the acceptance test, the exporter is absolved of his liability. The acceptance test comprises of the following elements(i) When the importer communicates to the exporter about the acceptance of goods in conformity with the contract or after comparing the bulk with the sample. (ii) Upon the delivering of goods, if the importer does any act beyond the knowledge of the exporter absolves him of his liability. (iii) If the importer has not examined the goods delivered to him within the specified time and fails to issue notice to the exporter about the defects or contrary noticed by the importer, the exporter is absolved of his liability. (iv) Failure to accept goods by the importer within the specified enable time.
(v) An importer delivering the goods to the third party by way of sub-sale. The goods received by an importer must be examined within a reasonable time. The Convention on the International Sale of Goods (CISG) prescribes 365 days within which the goods must be rejected. An importer must send a notice of rejection to the exporter if any defects in the goods are noticed, so that the exporter may either cure or replace the defective goods. The damages are the monetary losses suffered by the importer, which includes actual or liquidated damages. The actual damage may be the payment made by the importer to the exporter inclusive of certain consequential damages. The liquidated damages are the notional damages of the actual damages of goods, which will be decided by the court. The Carriage of Goods by Sea Act (Amendment) Act, 1994 prescribes for payment of damages, except the damage caused due to the jettisoning of goods. UCPDC-500 also deals with credits in addition to the trading contracts. There is a provision to pay 50% of the credit to the exporter as ‘anticipatory credit’. The reliability and authenticity as applicable to all documents are also extended to the multimodal transport documents. In the international sale of goods, electronic communications are used while transferring of rights in goods by way of transfer of Bills of Lading [Articles-16 & 17 r/w Articles-6 & 8 of the Model Law]. all the transport documents irrespective of the fact whether they be negotiable or non-negotiable assumes significance in the digital contracts of international sale of goods. The trading States should decide about the inclusion or exclusion of documents as charter-parties within the scope of that charter as appropriate or inappropriate. The charter party refers to a contract between the shipper (customer) and the carrier (owner of the ship). Electronic documents or data messages are used in place of paper-based documents while formulating the digital contracts on international sale of goods, which would minimize time (instantaneity) and cost (cheaper) factors. The rights and obligations could be conveyed in any relevant agreement by using data messages, if the standard form of reliability is adopted to render such data messages unique. If the digital contract is evidenced by e-documents, the rules applicable would be different from paper-based documents. An express provision shall be made to recognize the transmission of data message as functional equivalent to the transfer of document of title representing the goods. In the context of transfer of rights through the data message, the functions performed through the single transmission of paper-based Bill of Lading would imply transmission of more than one data message. In the digital contracts on carriage of goods, rights can be conveyed to only one person at any given point of time to putforth his claim. In other words, if the procedures are laid down to enable right or obligation to be conveyed by electronic method, it becomes necessary that ‘guarantee of singularity’ shall be adopted as one of the features. The technical security devices providing such guarantee of singularity would be built into a communication system requiring to demonstrate the reliability. The single or joint ownership of rights is also possible in the 341 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
goods or other rights specified in the Bill of Lading. A reliable method of securing the data message purporting to convey any right or obligation should be used. The reliable method should ensure that no two media be used simultaneously for the same purpose and prevent multiplication of the single data to avoid the risk of duplicate transport documents. However, availing of multiple forms of communication for different purposes would not pose any problem. The use of paper-based communication for ancillary message and electronic communication for Bills of Lading would not be a problem at all. A greater degree of care should be exercised against the possibility of incorporating the same rights in the paper-based as well as data message at any given point of time. The parties to the digital contracts of international trade in goods and services must comply with the terms and conditions, if they had earlier agreed to engage in electronic communication rather than switching over to the paper-based communication. The ‘drop down’ to the paperbased communication should be subject to an agreement of all interested parties, which should not affect any right. The Hague and Hague-Visby Rules specifies clearly that a contract of carriage shall necessarily be covered by a Bill of Lading as document of title. Whether these rules would automatically apply to the digital contracts effected by one or more data message? It is incumbent on our part to ponder over this question in the context of the used of data messages in place of the paper-based Bill of Lading under the substantive rule of law, as may be applicable to the digital contracts, evidenced by data messages. It is relevant in the light of granting, acquiring, renouncing, surrendering, transferring or negotiating rights in goods under the digital contracts. The functions of Bill of Lading through EDI communication includes: (a) it serves a receipt of cargo by the carrier (b) it serves as an evidence of the contract of carriage of goods with reference to its terms inclusive of the specific details of the ship, name of the destination port, nature and quantity of goods and (c) it serves as a document of title giving certain rights to its holder. The rules of UN on Electronic Data Interchange for Administration, Commerce and Transport (EDIFACT) fulfils the first two conditions, while the Bill of Lading for Europe (BOLERO) International Ltd., provides documentation in electronic form since June 1998, based on legal binding environment and common procedures. The BOLERO Title Registry being one of its services allows the exchange of electronic Bills of Lading (
). In the use of electronic Bills of Lading through EDI, the problem lies in the carrier relying upon the guarantee of singularity and uniqueness of the message for delivering the goods. The BOLERO assures the holder of an electronic Bill of Lading to register his rights. Under the functional equivalent approach, the paper-based Bill of Lading could be utilized. The carrier must on demand by the shipper, issue Bill of Lading [Article-4 (1) of the Hamburg Rules]. ON-LINE FUTURES CONTRACTS: The on-line futures contracts are agreements between the sellers and buyers in an electronic environment, requiring the on-line sellers to deliver to the on-line buyers a specified quantity and 342 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
grades of identified commodities at a fixed time in the future and at the agreed prices. In futures contracts, the seller is called ‘SHORT’ and the buyer is called ‘LONG’. As they are highly standardized contracts, they reduce transaction cost associated with trading a deferred delivery instrument and trading is restricted to organized stock exchanges. A financial futures contract is an agreement to buy or sell, on any recognized stock exchange a standard quantity of specific financial instrument of a foreign currency at a future date and at a price agreed between the two parties. Since the clearinghouse guarantees the performance of on-line contract, the obligation lies on the clearinghouse in addition to the buyer and the seller. The trading in futures contract at all the futures exchanges confines to indices and there is no individual scrips in which trading in futures contract is permitted anywhere in the world. The stock index futures contracts are used to hedge the stocks of shares by acquiring a short position during the anticipated period of fall in prices. A long position can also be acquired against anticipated funds in futures as a hedge against the likely rise in prices. The risk management through hedging and a more accurate price are the two benefits of the futures contracts. Hedging is defined as “an activity of trading futures with an objective of reducing and controlling the price risks”. It differs from speculation where traders willingly assume the risk with a fond hope of making profits from price change. However, the uncertainty about the quantity that would be sold or brought at some future date cannot be hedged. The object of hedging is to eliminate or control the variability in a firm’s net revenue because of the change in price. The mechanism of hedging involves taking a position in futures to reduce price risk. A short hedge is a symbolic selling of a hedge, while a long hedge is a buying of the hedge. The futures cash obligation may be in a form of forwards contract to buy or sell a commodity. The value of cash position may result in the gain or loss due to the change in cash price. The speculators (profit seekers) and hedgers (risk managers) buy and sell futures because they wish to speculate about the future price levels of a particular commodity that underlines a contract, so that they can make profit from changes in the prices by buying at a low price and selling at a high price in the future. The new technology provides automated screen based trading with the advancement in computer and communication technologies. There is only one contract between the buying and selling parties, but the clearinghouse will have two contractual obligations, such as LONG and SHORT. A features contract could be settled by making or taking physical delivery or settlement by cash delivery, by making or off-selling future transactions and by engaging in an exchange for physicals. In futures contract, the rules are specified by the stock exchanges. There are delivery months and exchange designated notice days. At the beginning of the delivery month, all traders having open position in that month’s contract are required to notify their respective Futures Commission Merchants that thy intend to make or take delivery during that month. They shall also specify the quantity and the time when such deliveries are desired. The Futures Commission Merchants will notify the
clearinghouse of their customer’s intentions. Then the clearinghouses match the positions of LONG and SHORT. Thereafter, delivery notices are sent via customer’s respective Futures Commission Merchants indicating to whom their delivery obligations run, when, where and what quantity the delivery shall be made. Upon the satisfactory delivery, the clearinghouse extinguishes on its books the obligations of the respective Future Commission Merchants, who in turn extinguish the obligations of corresponding customers. The futures contracts must obligate specifically the cash delivery as a settlement procedure to avoid warehouse brokerage etcetera as in the case of physical delivery. It is pertinent to note that physical delivery requires actual purchasing or selling of a commodity. The mechanism of cash delivery comprises of pricing of the relevant futures contract equal to the cash price of the underlining asset at that time at the close of the trading in that contract. The money owing to either the SHORT or the LONG on account of setting the future price equal to the cash price is transferred via clearing house and the Futures Commission Merchants from the party who owes money. The exchange of futures for physicals is another form of physical delivery and offers more flexibility in settling the contractual obligations of the parties than exchange rules may permit. For instance, LONG and SHORT may agree to deliver at a different place or time against permissible rules of delivery and may even agree to settle their contractual obligations with the delivery of different commodity than the agreed one. The price risk exists in the futures contract owing to the uncertainty of future price levels. The deposit or margin in the form of cash or securities made by the holders of futures (buyers and sellers) futures contracts with their Futures Commission Merchants (guarantee) that both LONG and SHORT ultimately met their contractual obligations. Greater is the price volatility higher is the initial margin requirement. The variation margin is based on the difference between the current exchange settlement price and previous settlement price. The features contracts are made in the electronic environment since the communication technology is suitable for such contracts. Software Contracts: Since the EC Directive assigns product liability to the software, the digital contracts in computer software assume greater significance. In St Albans City and District Council Vs. International Computers Ltd., (1996), 4 All E.R. 481, the court held that software constitute goods. The contracts for software package, software licencing, software maintenance (support contracts), agreements between the manufacturers and distributors of software, bureau service contracts (party possessing software provides facilities to another party having no software) are the different types of software contracts of the modern times. The software contracts play a vital and supportive role in the digital contracts. The utility of software in generating, transmitting, storing, encryption and decryption of data message assumes tremendous importance. The contracts in respect of software might relate to the use of computers or the Internet/
Website. The software refers to computer programs, which may comprise- a) software written for a particular user (Bespoke software) and b) software written for multiple users (off the shelf software). The standard software is necessary for basic programs, as needs of the mainframe or the Internet. The licencing system provides an appropriate approach to the exploitation of software. The proprietors of software make an offer to the users through their Website to download from the Internet and install in their mainframes. The licence has become a vehicle by which the acquirer has a right to the use software. The restricted rights of the acquirer and the obligations of the supplier should be analysed carefully before formulating the contracts in software. The licencing terms should be made apparent to the acquirer of software before offer and acceptance has occurred in a contract between the supplier and acquirer [Scottish Case: Beta Computers (Europe) Ltd., Vs. Adobe Systems (Europe) Ltd., (1996), FSR, 371]. This problem may arise in the instances of e-mail orders or such orders placed with the suppliers by the acquirers even by using mobile telephones. The contractual obligations exist in the case of bespoke or modified standard software to be compatible for the business of acquirers. The contractual liability arises for supply of defective software as a unique development in the information technology. Revocation of digital contracts: The digital contract as such cannot be revoked. However, an offer may be revoked before e-mail or EDI enters the addressee’s designated computer resource. Similarly, an acceptance could be revoked before e-mail or EDI containing acceptance is communicated to an offeror. In the digital contracts relating to the international sale of goods, the parties may agree to the revocation of the Letter of Credit before the shipment of goods is made. Jurisdiction vis-a-vis digital contracts: The place of contract would normally the place where offer is received or the place from where acceptance is transmitted. The evolution of technologies has diminished the geographical territoriality. Mr. D.Johnson and D.Post said, “There is no necessary connection between Internet and physical jurisdiction in as much as the actual location of computers through which information is routed along the Internet is of no consequences, either to the ISP or receivers of information”. The Internetbased jurisdiction has resulted more from the defendant’s purposeful availing of the privilege of doing business or electronic communication over the forum jurisdiction. The Pennsylvania district court delivered the first decision in USA setting out all analytical framework for specific personal jurisdiction based on the Internet activity [Zippo Manufacturing Company Vs. Zippo.com Inc, 952 F. Supp. 1119, 1124 (WD Pa. 1996]. The traditional analysis of personal jurisdiction would be applicable where an integral website is used actively by the defendant to carry out transactions in as much as transmitting data messages directly to an addressee. The courts have no powers to exercise personal jurisdiction on the passive websites. The exercise of jurisdiction in the ‘interactive website’ should 343 (Sys 4) - D:\shinu\lawschool\books\module\contract law_Revised
be determined by examining the ‘level of interaction’ inclusive of the commercial nature of the website. The plaintiff of Arizona Corporation alleged that the defendant Florida Corporation who infringed the trademark should be subjected personal jurisdiction of the Federal court in Arizona, because the website that advertised a product or service was intended for use on a worldwide basis [Cybercell Inc Vs. Cybercell Inc, 130 F. 3d. 414 (9th Cir. 1997)]. The ‘triple test’ principles adopted in Zippo’s case was followed in this case also to determine whether a district court can exercise specific jurisdiction over a non-resident defendant and held that the defendant using the name of ‘cybercell’ was insufficient for personal jurisdiction, as it has not conducted any commercial activity over the Internet in Arizona. The triple test principle includes: a) The non-resident defendant must do some act or consummate some transactions with the forum or perform some act by which he purposefully avails himself of the privilege of conducting activities in the jurisdiction forum, thereby invoking the benefits and protection b) The claim must be on which arises out of or results from the defendant’s forum-related activities and c) Exercise of jurisdiction must be reasonable. The purposeful availing of the website and the structured conduct on the part of the defendant would be necessary for personal jurisdiction. The court found the general jurisdiction where a manufacturer’s website allowed customers to shop on-line [Mieizkowski Vs. Masco Corporation, 997 F, Supp. 782 (E.D.TEX. 1998)]. The court held that the general jurisdiction could not be based on mere act of transmitting information through the use of interstate communication facilities [California Software Inc Vs. Reliability Research Inc, 1356 (C.D. Cal, 1986)]. The French court assumed the jurisdiction over ‘Yahoo Inc’, a corporation located in Santa Clara country to adjudicate a complaint of French resident that they could access yahoo auction site on which Nazi memorabilia were being offered for sale. When the Paris court ruled on May 22, 2000 that yahoo incorporation was required to block access to such sites in France, where sales of material are illegal, it allowed yahoo Inc two months time to develop a plan for such selective blocking. It should be noted that the US Supreme Court ruled in May, 2000 that an Internet Service Provider bore no responsibility for the material it carried and that a court in Munich last year overturned the conviction of the former head of CompuServe in Germany for aiding and abetting the dissemination of illegal content. The Eastern District of Michigan held that the sale by a Texas resident of allegedly infringing items on electronic bay’s Internet auction site to Michigan residents did not create personal jurisdiction in Michigan over the Texas resident [Winfield Collection Ltd. Vs. Mc Gauley, (E.D.Mich No. 99-EV758 75-DT, July 24, 2000)]. The American Bar Association presented the jurisdiction report in July 2000, in which six recommendations have been made1. Not to assert personal and prescriptive jurisdiction on the basis of accessibility to a passive website that does not target the State. Personal and prescriptive jurisdiction to apply to a website content provider or ASP in a jurisdiction. An ASP is a sponsor, who is a habitual resident of the jurisdiction, targeting the jurisdiction and the claim arising 344 (Sys 4) - D:\shinu\lawschool\books\module\contract Law_Revised
2. 3.
4.
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out of the content of the site and the dispute arising out of a transaction generated through a website or service that does not target any specific jurisdiction, but it is interactive and can be fairly considered to knowingly engage in business transactions. Purchasers and sellers to identify the jurisdiction in which they habitually reside. Sponsor to indicate the jurisdiction targets of their sites and services, either by defining the express content of the site or service, or listing destinations targeted or not targeted and by deciding whether to engage in transactions with those who access to site or service. To prevent access by user to a site or service through the use of disclosures, disclaimer, software and other technological blocking or screening mechanisms should insulate the sponsor from assertion of jurisdiction. Personal or prescriptive or tax jurisdiction should not be exercised merely because it is permissible under the principles of international law or take into account the sovereign interests of other States.
Regarding the ‘contractual choice’ of law, three principles should apply between the parties. i) Absence of fraud or related abuse. ii) It is mandatory that courts should enforce B2C contracts. iii) Jurisdictional choices should be enforced where the consumer bargains with the sellers. LIMITATIONS OF THE DIGITAL CONTRACT: Though the Arbitration & Conciliation Act, 1996 facilitates digital contracts, the following limitations may be noted(i) E-Contracts cannot be made applicable to Joint Venture Agreements, Sale Deeds, Wills and Lease Deeds in as much as they are applicable to e-commerce transactions. (ii) The Stamp Act and Registration Act are not amended to suit the digital or electronic environment of the digital contracts. (iii) Since the Information Technology Act, 2000 excludes the application of Negotiable Instruments Act, the electronic payments made in respect of digital contracts needs clarity. DISPUTE SETTLEMENT MECHANISM: The disputes may arise due to the non-performance or the breach of contractual obligations, which could be settled by the dispute settlement mechanism, as agreed by the parties to the digital contract. The non-performance of digital contracts might be owing to the reason that delivery is not in conformity with the contract or non-delivery of goods, breach of the terms of contract or non-performance of the contract. The following are the ways of negotiations under the dispute settlement mechanism(i) Negotiation between the parties to the contract. (ii) Negotiation by the third party, which cannot be enforced unless the parties agree in writing. They adopt conciliation and mediation methods in settling the disputes.
(iii) Arbitration method where an award passed by the arbitrators is final. The parties may nominate one arbitrator each, above whom there would be an umpire. Since most of the commercial transactions are based on contracts, arbitration also becomes a part of the contract. There should be an express clause inserted at the time of agreement between the parties to refer any dispute to the ICC for settlement at a later stage. The ICC is an international court of arbitration, which is a professional body consisting of experts in the field. If the parties belong to different countries, the arbitration is conducted as per the ICC rules. The courts in every country should recognize and enforce the award passed by the arbitration. The arbitral award shall be enforced at the place where the parties have concluded the contract. It should not be against the public
policy. The New York Convention recognizes the arbitration agreement as well as enforcement of foreign arbitral awards. This provision was given effect in India by the Arbitration and Conciliation Act, 1996. The third party resolves the settlement of a dispute between the parties since the judicial proceedings are cumbersome and time consuming. The arbitrators settle the dispute and pass an award, which is binding on the party. The arbitrators should be odd in members as each party selects his own arbitrator. Over and above, the third arbitrator acts as an umpire. The Arbitration and Conciliation Act, 1996 not only rationalized the arbitration procedures but also infused judicial element. The party can prefer an appeal within three months of the passing of an award by the arbitrators [Section-34].
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PROBLEMS/QUESTIONS: 1.
2. 3.
‘A’ & ‘B’ initially agreed to communicate electronically using their designated information systems in the formation of digital contract. Mr. ‘A’, the originator despatched his data message (offer) from his computer resource to the computer resource of the addressee. Mr. ‘A’ clearly indicated in his data message to send an acknowledgement as soon as the addressee receives the data message. Mr. ‘B’ could not send the acknowledgement, as the data message did not enter his designated information system at all. After the specified time limit, Mr. ‘A’ sends his offer to another person Mr. ‘C’, who accepts it. Mr. ‘A’ sues Mr. ‘B’ for breach of e-agreement. Advice Mr. ‘B’. Critically examine the ‘functional equivalent approach’, favoured by the UNCITRAL Model Law, 1996. Mr. ‘Z’, the addressee (offeree) sends his acceptance to the computer resource of Mr. ‘Y’, the originator (offeror) through e-mail. The computer programmer, employed by Mr. ‘Y’ has omitted to enter the IP address of Mr. ‘Z’ while installing the special software in the information system in checking out spams. Consequently, the e-mail sent by Mr. ‘Z’ could not enter the designated information system of Mr. ‘Y’ and the digital contract does not materialize. Mr. ‘Y’ transfers the same offer to Mr. ‘X’, who accepts it and enters contract with Mr. ‘Y’. Later, ‘Z’ contends that acceptance was
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4.
5.
6.
complete since he had dispatched an e-mail from his computer resource to Mr. ‘Y’ and sues him. Advice Mr. ‘Z’. Analyse the principle of ‘focus of intent’ on the part of originator in the process of conclusion of digital contracts between the parties. Mr. ‘N’, an importer passes off the Bill of Lading electronically to the third party Mr. ‘L’ without the knowledge of the exporter Mr. ‘M’ in the contract of international sale of goods. Mr. ‘L’, the holder of the Bill of Lading takes delivery of goods. After the physical inspection of goods, he notices that the goods supplied were not in conformity with the samples. Mr. ‘L’ wants to sue Mr. ‘M’ and approaches you for advice. Advice. Mr. ‘R’, a resident of New York & Mr. ‘S’, resident of Bangalore enters the digital contract to deal with computer software having the product liability. For obvious reasons, Mr. ‘S’ winds up his business and communicates his decision to Mr. ‘R’ by sending an e-mail. Mr. ‘R’ fails to open his e-mail box for quite some time since he was away on his business tour to Europe. In the mean time, one Mr. ‘Q’, an ex-employee of Mr. ‘S’ download the software product from the Website of Mr. ‘R’ by resorting to an act of masquerading. Mr. ‘R’ sues Mr. ‘S’ for non-payment. Advice Mr. ‘S’.
CASE LAWS: Sl. No
Case law
Citation of the case law
Court decision
1513, 1517 (D.Hawaii 1992)
Held that the computer evidence fulfills the best evidence rule. Held that the prosecution has successfully proved the computer printout of an Internet Chat Centre
01
Doe Vs US
02
US Vs Simpson
03
US Vs Whitaker
127, F. 3d. 595, 601 (10th Cir. 1997
Held that a computer programmer or an operator having first hand information can testify computer printout.
04
US Vs Tank
200, F. 3d. 627, 630-31 (9th Cir. 2000)
Held that the log printout of a Chat Room is admissible in evidence.
05
R Vs Sipby
(1990) 91 Cr. App. R 186
Held that e-document generated by computer automation was held to be valid evidence.
06
US Vs Glasser
773, F. 2d. 1553 (11th Cir. 1985)
07
US Vs Bonalla
858, F. 2d. 1427, 1436 (9th Cir. 1988)
US Supreme Court held that mere apprehension that data contained in computer system is an insufficient ground to render it unworthiness.
08
US Vs Allen
106, F. 3d. 695, 700 (6th Cir. 1997)
Held that raising mere doubt of the possibility of tampering data is insufficient to render evidence inadmissible.
09
US Vs Briscol
896, F. 2d. 1476, 1494 (7th Cir. 1990)
Held that e-records maintained during the normal course of the business activity are valid in evidence.
10
R Vs Cachrane
(1993) Crim. L.R. 98
Held that there should be no errors or system failure as criteria while determining the authenticity of e-document.
11
Glenclore International A-g Vs Bank of China.
34 (1995) TLR 617
Held that e-record generated by computer automation without human intervention to be treated as original
12
US Vs Poindexter
951, F. 2d. 369 App. Case (1991)
Held that the recovered deleted files are admissible in evidence.
13
Beathy Vs First Exploration Company
(1988)
US court held that the use of electronic communication was held to be valid in the formation of digital contracts.
14
US Vs Miller
771, F. 2d. 1219, 1237 (9th Cir. 1985)
Held that a bank officer incharge of computers can authenticate computerised loan data.
15
US Vs Cestinick
36, F. 3d. 904, 909 (10th Cir. 1994)
Held that e-records generated in the course of business activity are admissible in evidence.
152, F. 3d. 1241 (10th Cir. 1998)
Held that a person opposing the admissibility of computer printout must prove the type of better security needed for protection of data stored in the computer system
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Sl. No
Case law
Citation of the case law
Court decision
16
R Vs Shepherd
(1993) AC 380
Held that a witness testifying the computer printout must be familiar with the operation of the computer.
17
R Vs Pettygrew
(1980) 71 Cr. App. R 39
Held that any mistake committed by the computer programmer was an issue that relates to evidential weight than admissibility of evidence.
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BIBLIOGRAPHY A. BOOKS: 1. 2. 3. 4.
Rowland, D and Macdonald, E (1997) “Information Technology Law”, Cavendish Publishing Ltd., (London). Cristian, C (1998) “Law of International on-line Business: A Global Perspective”, Sweet & Maxwell Ltd., (London). Mittal, PP (2000) “Law of Information Technology”, Taxman Allied Services Private Ltd., (New York) Rodney DR (2001) “Guide to Cyber Laws”, Wadhwa & Company, (New York).
B. STATUTES: 1. 2. 3.
UNCITRAL Model Law on Electronic Commerce, 1996. Information Technology Act, 2000. Indian Evidence Act, 1872.
C. ARTICLES: 1. “E-commerce ands Internet Law 2001: Selected Legal Issues”-Denis T. Rice. D. WEBSITES: 1. 2. 3. 1.
“Functions of UNCITRAL”-http://www.uncitral.org. “Business Internet Jurisdiction”-http://www.suffolk.edu/ilawhightec/classes/cyberlaw/ejensen/paper.html. Haber Section and W.S. Stornetta, “How to time stamp a digital document”-http://www.crypto.org/90procs/pprs/tstdd.htm. Peritz, “Computer Data and Reliability: a call for Authentication of Business Records under the Federal Rules of Evidence”http://www.library.nwu.edu/law/depts/research.guides/libgui.html. 2. “Requirements on Electronic Signature Service”-http://www.cordis.ju.infosec/src/stud2fr.htm. 3. “International Consensus Principles for Electronic Authentication, International Working Group on Electronic Authentication”http://www.ilpf.org/digsig/int/prin.html. 4. “Secure Electronic Signature”-http://www.law.upenn.edu/library/ulc/uecicta/ect/897.htm. 5. Carole E.Handler & Criag A.Guthery, “Cyberspace Licensing: Linking, Framing and Catching-http://www.legalwks.com. 6. “Framework for Global Electronic Commerce”-http://www.Cmcnyls.edu/paper/WHGIIFra.HTM. 7. Boris Kozolchyk, “Evolution of the Ocean Bill of Lading from and Banking Law Perspective”-http://www.webcom.com/ symbolpiones.model1.htm. 8. Livermore J. ET AL, “Electronic Bills of Lading and Functional Equivalence”-http://www.eli.warwick.ac.uk/jilt/ecomm/98.2liv. 9. “Electronic Commerce and EDI MANAGING Electronic Record”-http://www.gsliutexas/symbolssay/pubs/1389c5a.htm. 10. Peter Sommer, “Digital Foot Prints: Assessing Computer Evidence”-http://www.usdoj.gov/criminal/cybercrime/search.dics/ toc.htm.
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