DBB1212: Legal and Regulatory Framework

BACHELOR OF BUSINESS ADMINISTRATION

SEMESTER 2

DBB1212
LEGAL AND REGULATORY FRAMEWORK
Unit: 2 - Indian Contract Act, 1872 1
DBB1212: Legal and Regulatory Framework

Unit – 2
Indian Contract Act, 1872

Unit: 2 - Indian Contract Act, 1872 2

DBB1212: Legal and Regulatory Framework

TABLE OF CONTENTS

Fig No /
SL SAQ / Page
Topic Table /
No Activity No
Graph
1 Introduction - -
4
1.1 Objectives - -
2 Definition and Meaning of a Contract - 1 5-6
3 Essentials of a Contract - 2
3.1 Offer or proposal - -
7 - 10
3.2 Acceptance of proposal - -
3.3 Revocation of offer - -
4 Types of Contracts - 3 11 - 13
5 Capacity of Parties - 4 14 - 16
6 Modes of Discharge of a Contract - 5 17 - 20
7 Remedies for Breach of Contract - 6 21 - 22
8 Concept of Indemnity and Guarantee - - 23 - 25
9 Pledge & Bailment - - 26 - 30
10 Summary - - 31 - 32
11 Glossary - - 33
12 Terminal Questions - - 34
13 Answers - - 35 - 36
14 References - - 37

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1. INTRODUCTION
Contracts are an indispensable part of our lives. We enter into various types of contracts in our
everyday life without realising that we are doing so. Your day may start with a cup of tea. Where does
it come from? When you purchase tea leaves, sugar and milk, or when you buy a t-shirt, a cake of soap
or a music system, you enter into a contract. The Electricity Board has agreed to provide your house
with electricity against the promise of payment by you. You deposit your money in the bank or take a
loan against some predetermined conditions. All these are forms of contracts that we enter into
voluntarily.

Whenever you buy something or enjoy some service you agree to pay a certain amount of money to
the seller or service provider, and the provider agrees to give you that something. This is the basic
principle of a contract.

The Indian Contract Act, 1872 (ICA), which has its source in the usage and practices of merchants in
Europe, is the most important law governing business transactions. This law codifies how we enter
and execute a contract and implement its provisions. It also deals with the issues of breach of contract.

In this unit you will become familiar with the basic provisions of this law.

1.1. Objectives
After studying this unit, you should be able to:
• Define the essential provisions of a contract
• Discuss the modes of discharge of a contract
• Explain the remedies for breach of contract

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2. DEFINITION AND MEANING OF A CONTRACT

According to the Indian Contract Act, 1872, “an agreement enforceable by law is a contract.” A
contract, thus, is an agreement between two parties to do something or abstain from doing something
for each other subject to certain terms and conditions. The conditions laid down in the contract are
binding and enforceable by law by both the parties. Each party is free to enter into a contract on any
terms as per his/her choice. Thus, a contract has two main elements:

i) An agreement between two parties.

ii) Enforceability of the agreement by a court of law.

I. Agreement- The term agreement given in Section 2 (e) of the act is defined as- “every promise and
set of promises, forming the consideration for each other”.

Section 2(b) defines promise as- “when the person to whom the proposal is made signifies his
assent there to, the proposal is said to be accepted. Proposal when accepted, becomes a promise”.

The following points emerges from the above definition:

1. When the person to whom the proposal is made

2. Signifies his assent on that proposal which is made to him
3. The proposal becomes accepted
4. Accepted proposal becomes promise

Thus, we can say that an agreement is the result of the proposal made by one party to the other
party and that other party gives his accepted thereto of course for mutual consideration.

Agreement = Offer/Proposal + Acceptance + Consideration

II. Enforceability by law – An agreement to become a contract must given rise to a legal obligation
which means a duly enforceable by law

Thus, we can say that-

Contract = Agreement + Enforceability + Consideration

So, Law of Contract deals with only such obligations which has resulted from agreements. Such
obligation must be contractual in nature. However, some obligations are outside the scope of law
of contract.

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The ICA lays down the norms for a contract to be entered into, executed and dealt with in case it is
breached. However, the rights and duties of parties and terms of agreement are decided by the
contracting parties themselves. In case of breach, the courts have the right to enforce the contract or
impose compensation costs or damages on the defaulting party.

A contract may be oral or in writing. A verbal contract that can be proved is also enforceable. However,
some contracts, especially the ones that require stamping and registration like sale of immovable
property, Bill of Exchange or Promissory Note, Trust Deed, promise to pay a time barred debt are
valid only if they are in writing.

Difference between Agreement and Contract

Basis of differences Agreement Contract

Meaning Every promise and every set of Agreement enforceable by law.
promises, forming the (Agreement + Legal enforceability)
consideration for each other.
(Promise + Consideration)
Scope It’s a wider term including both It is used in a narrow sense with the
legal and social agreement. specification that contract is only
legally enforceable agreement.
Legal obligation It may not create legal obligation. Necessarily creates a legal
An agreement does not always obligation. A contract always grants
grant rights to the parties certain rights to every party.
Nature All agreement are not All contracts are agreements.
contracts.

SELF-ASSESSMENT QUESTIONS – 1
True or False:
1 Contracts can be made only by legal persons.
2 A contract is enforceable by law.
3 A valid contract must be in writing.

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3. ESSENTIALS OF A CONTRACT
3.1. Offer or Proposal
According to Section 2 (a) of the Indian Contract Act, 1872, “ 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”

Essential of a Valid Offer:

• It must be capable of creating legal relations: For an offer to be legally valid, it must be
something that can be accepted and lead to a legal agreement. If the offer is not meant to create
a legal relationship, it isn't considered a real offer under the law. For example, if you invite a
friend to dinner and they accept, it doesn't create a legal contract because it's just a social
invitation, not meant to have legal consequences.
• It must be certain, definite and not vague: If the terms of an offer are vague or indefinite, its
acceptance cannot create any contractual relationship.
• It must be communicated to the offeree: An offer is only complete when the person it's made
to knows about it. If the offer isn't communicated to them, they can't accept it. If someone
accepts an offer without knowing it exists, it's not a valid acceptance and gives them no legal
rights.
• It must be made with a view to obtaining the assent of the other party: Offer must be made
with a view to obtaining the assent of the other party addressed and not merely with a view to
disclosing the intention of making an offer.
• It may be conditional: The person making an offer (the offeror) can set any rules or
conditions they want for the offer.
• Offer should not contain a term the non-compliance of which would amount to
acceptance: Thus, one cannot say that if acceptance is not communicated by a certain time the
offer would be considered as accepted.
• The offer may be either specific or general: Any offer can be made to either public at large
or to the any specific person.
• The offer may be express or implied: An offer may be made either by words or by conduct.

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3.2. Acceptance of Proposal

The ICA states that a proposal is said to be accepted when the offeree signifies his/her assent. A
proposal when accepted becomes a promise. The offeree agrees to be bound by the terms of the offer
by accepting it. Acceptance of offer must fulfil the following conditions:

• Acceptance can be given only by the person to whom offer is made: In case of a specific
offer, it can be accepted only by the person to whom it is made.
• Acceptance must be absolute and unqualified: For acceptance to be valid, it must be clear
and without any changes. It should be done in a normal and reasonable way unless the offer
specifies a particular way to accept it. If the offer does say how to accept, then it must be
accepted in that specific way.
• The acceptance must be communicated: For a contract to be formed, acceptance must be
clearly communicated. If the acceptance adds conditions or changes the original terms, it’s not
really acceptance but a new offer that the original offeror must agree to. Also, the person
accepting the offer must know about the offer; otherwise, it isn’t real acceptance. The
acceptance must match the exact terms of the original offer for it to become a contract.
• Acceptance must be in the prescribed mode: if an offer specifies how it must be accepted,
then it must be accepted in that specific way. However, if the person who made the offer does
not object when it is accepted in a different way, it means they agree to the acceptance as it is.
• Time: Acceptance of an offer must be made within the time limit given. If no time limit is
mentioned, it should be accepted within a reasonable time before the offer expires.
"Reasonable time" isn't specifically defined by law and depends on the details of each situation.
• Mere silence is not acceptance: you can't assume someone has accepted an offer just because
they didn't respond or stayed silent, unless they have previously shown through their actions
that silence means they agree.
• Acceptance by conduct/Implied Acceptance: if someone does what the offer asks for or
accepts something in return for a promise, it counts as accepting the offer. This means that
doing what the offer asks for can be as valid as saying "yes" verbally or in writing. So, if you do
the action the offeror wants, you are accepting the offer through your actions.

‘Express/ Implied’ and ‘Specific/ General’ offers and acceptances

a. Express / Implied:

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i) Express offers and acceptances are made in words, spoken or written. For example, A
offers to sell his house to B for a specified sum either verbally or in writing and B agrees.
ii) Implied offers and acceptances are offers not made in words but inferred from the conduct
of a party or circumstances of the case. For example, the electricity board does not send
letters to people but the offer to sell electricity is implied.

b. Specific / General:
i) Specific offers and acceptances: A specific offer is made to a particular person or a group
of persons and only he/they are competent to accept the offer. Acceptance can be made only
by the person or a group of persons to whom the offer has been made.
ii) General Offers: A general offer is made to the world at large and not to a particular person
or a group of persons. A general offer can be accepted by any member of the general public
by fulfilling the terms of the offer.

Case: Carlill v. Carbolic Smoke Ball Company (1892)

A company manufacturing smoke balls advertised in all leading newspapers that a reward of £100
would be given to any person who contracted influenza in spite of using the smoke balls of the
company as per the printed instructions. One person, Mrs. Carlill, used the smoke balls as per
instructions but contracted influenza. Held, she is entitled to the reward as by using the smoke balls,
she had accepted the company’s offer.

3.3. Revocation of Offer

An offer may be revoked by the promisor at any time before it has been accepted. However, once
acceptance has been made, the offer cannot be revoked except in the following circumstances:

i) If acceptance is not made and communicated within the specified time.

ii) Death or insanity of either party.
iii) Non-fulfilment of the conditions of the offer.
iv) A counter (fresh) offer that nullifies the first one.
v) Acceptance not made in the prescribed or usual mode.
vi) Offer contravening legal limits.

Mode of revocation of offer:

• By notice
• By lapse of time
• By non-fulfilment of condition precedent

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• By death or insanity
• By counter offer
• By the non-acceptance of the offer according to the prescribed or usual mode
• By subsequent illegality.

SELF-ASSESSMENT QUESTIONS – 2
Fill in the Blanks:
4 Every________ and every_______ forming the _________ for each other is an agreement.
5 A ‘proposal’ can be to do a __________ act or to abstain from doing an act (i.e., _________ act).
6 The person making the proposal is called the _______ and the person accepting the proposal is
called the _________.
7 Acceptance is not considered valid unless it has been ___________ to the concerned party.

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4. TYPES OF CONTRACTS
1. According to enforceability by law
i) Valid contract: A contract or an agreement between two parties becomes valid and
enforceable by law when it fulfils all the essential elements of a valid contract.
ii) Voidable contract: A contract that can be nullified at the option of a party under certain
circumstances is called a voidable contract.
iii) Void contract: Void means null. A void contract is a contract which has no legal validity.
According to the ICA, ‘a contract which ceases to be enforceable by law becomes void when it
ceases to be enforceable.’

Basis Void Contract Voidable Contract

Meaning A Contract ceases to be An agreement which is
enforceable by law enforceable by law at the option of
becomes void when it one or more of the parties thereto,
ceases to be enforceable. but not at the option of the other
or others, is a voidable contract.
Enforceability A void contract cannot be It is enforceable only at the option
enforced at all. of aggrieved party and not at the
option of other party.
Cause A contract becomes void A contract becomes a voidable
due to change in law or contract if the consent of a party
change in circumstances was not free.
beyond the contemplation
of parties.
Performance A void contract cannot be If the aggrieved party does not,
of contract performed. within reasonable time, exercise
his right to avoid the contract, any
party can sue the other for
claiming the performance of the
contract.
Rights A void contract does not The party whose consent was not
grant any legal remedy to free has the right to rescind the
any party. contract within a reasonable time.
If so rescinded, it becomes a void
contract. If it is not rescinded it
becomes a valid contract.

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iv) Unenforceable contract: An unenforceable contract is one which is valid in itself, but is not
capable of being enforced in a court of law because of some technical defect such as absence
of writing, registration, requisite stamp etc.
v) Illegal or unlawful contract: A contract which violates the law of the land is considered void
ab-initio (void since the inception).

2. According to the mode of creation

i) Express contract: When both the offer and the acceptance constituting an agreement
enforceable by law are made in spoken or written words, they form an ‘Express Contract’.
ii) Implied contract: Where both the offer and acceptance constituting an agreement enforceable
by law are made other than in words i.e., by acts and conduct of the parties, it is an implied
contract.
iii) Constructive or Quasi contract: When the law infers or recognises a contract under certain
special circumstances even though the parties have not made an agreement, express or
implied, it is called a Quasi or Constructive Contract.
iv) Wagering and Contingent contract: A wager is a bet. Wagering contract promises to give
money or money’s worth upon the determination of an uncertain event like a lottery.
A “contingent contract” is a promise to do or not to do something in case of a contingency. For
example, A agrees to pay B Rs. 10,000 if B’s house is burnt.
v) E-contracts: When a contract is entered into by two or more parties using electronics means,
such as e-mails is known as e-commerce contracts. In electronic commerce, different
parties/persons create networks which are linked to other networks through ED1 - Electronic
Data Inter change. This helps in doing business transactions using electronic mode. These are
known as EDI contracts or Cyber contracts or mouse click contracts.

3. According to the extent of execution

i) Executed contract: When both the parties to a contract have completely performed their
share of obligations, the contract is said to be executed.
ii) Executory contract: A contract is said to be executory when all the obligations and terms have
not yet been fully carried out by either or both the parties to a contract, but will be carried out
in future.
iii) UnilateraL contract: Unilateral contract is a one sided contract in which one party has
performed his duty or obligation and the other party’s obligation is outstanding.

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iv) Bilateral contract: A Bilateral contract is one where the obligations or promise is outstanding
on the part of both the parties.

SELF-ASSESSMENT QUESTIONS – 3
True or False:
8 A valid contract is enforceable by law.
9 A void contract has legal validity.
10 Contracts can be classified only according to mode of creation.

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5. CAPACITY OF PARTIES
According to the ICA, the following persons are incompetent to contract:
1. A minor.
2. A person of unsound mind.
3. A person legally disqualified from contracting.

1. Minors
According to the Indian Majority Act ,1875 a person, domiciled in India, who is under 18 years of age,
is a minor.

The law acts as the guardian of minors with the aim of protecting their rights, because their mental
faculties are not mature. An agreement made by a minor is treated as follows:
i) It is considered void ab-initio and hence, inoperative.
Case: Mohiri Bibi V. Dharamadas Ghose
A minor mortgaged his house in favour of a money lender to secure a loan of Rs.20,000, out
of which the minor was paid Rs.8000. Later, the minor sued for setting aside the mortgage,
claiming that he was underage. Held, mortgage was void and cancelled. Moneylender’s
contention that the minor should repay the amount was not accepted.
ii) A minor can be a beneficiary under a contract provided that he is not required to bear any
obligation.
iii) It cannot be ratified even when he reaches the age of maturity.
iv) The principle of ‘estoppel’ does not apply to a minor. A minor is not estopped from pleading
minority to escape liability.
v) If he gets some benefit by fraudulently misrepresenting his age, the court can direct him to
restore that benefit to the other party.
vi) A person supplying necessities to a minor is entitled to be reimbursed from his/her property.
vii) A minor cannot enter into a partnership except through his legal guardian and with the
consent of the other partners.
viii) A minor can be an Agent but he cannot be held personally liable for any negligence or breach
of contract.
ix) A minor cannot be declared insolvent, for he is considered legally incapable of contracting
debts.

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x) Where an adult stands as a surety for a minor in a contract, the adult is liable under the
contract, not the minor.
xi) The parents of a minor are not liable for agreements made by a minor unless the child is
contracting as their agent.
xii) A minor, being incompetent to contract, cannot be a shareholder of a company except
through his lawful guardian.

2. Persons of unsound mind

According to the ICA, “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 judgment
as to its effects upon his interests.”

The person making a contract must be sane and rational enough to know what is good or bad for
him. The following people are not considered to be of sound mind:
i) An idiot who has completely lost his mental faculties.
ii) A lunatic whose mental powers are deranged due to some mental sickness or abnormality.
iii) A person who is drunk or in a state of intoxication and therefore incapable of making a
contract during such state.

The Act makes the following exceptions:

i) “A person who is usually of unsound mind, but occasionally, of sound mind, may make a contract
when he is of sound mind.” For example, a patient in a lunatic asylum, who is mentally sound
at intervals, may contract during those intervals.
ii) “A person who is usually of sound mind, but occasionally of unsound mind, may not make a
contract when he is of unsound mind.” Thus, a sane man, who is delirious from fever or is drunk
or intoxicated, cannot contract while he is in such delirious, intoxicated or drunken state.

3. Disqualified persons
ICA disqualifies the following persons from contracting:
i) Alien friend can contract but an alien enemy cannot. It means that a foreigner living in India
can enter into a contract during peace time between his country and India. But he cannot do
so if his country is at war with India.
ii) Foreign ambassadors or diplomats can enter into a contract and can sue others to enforce the
contract but they cannot be sued without obtaining prior sanction of the Central Government.
Thus, they are in a privileged position and are ordinarily considered incompetent to contract.

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iii) A convicted and imprisoned person is incompetent to make a contract or to sue on contracts
made before his conviction. However, he can do so on the expiry of his sentence.
iv) A person declared insolvent cannot enter into a contract relating to his property.

SELF-ASSESSMENT QUESTIONS – 4
Fill in the Blanks:
11 A contract made by a minor is considered ______________.
12 A person of _______________ mind is incompetent to contract.
13 Alien _________________ can contract but an alien _________________ cannot.
14 _______________________ are in a privileged position and considered incompetent to contract.

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6. MODES OF DISCHARGE OF A CONTRACT

When the rights and obligations arising out of a contract are fulfilled by both the parties, the contract
is said to be discharged or terminated. A contract may be discharged in the following ways:
1. By performance
A contract may be discharged by performance in the following ways:
i) Actual performance: When each party to a contract fulfils his obligation as per the stipulations
of the contract, it amounts to actual performance and the contract stands discharged. But if
only one party fulfils his promise, he alone is discharged and gets a right of action against the
party guilty of breach.
ii) Attempted performance or tender: When the promisor offers to perform his obligation under
the contract, but is unable to do so because the promisee has not yet accepted the performance,
it is called ‘attempted performance’ or ‘tender.’

In order to be considered legally valid, a tender must:

i) Be unconditional.
ii) Be made at proper time and place.
iii) Refer to the whole obligation and not just a part thereof.
iv) Be made by a person who has the capacity and willingness to perform the promise.
v) Be made to the promisee or his duly authorised agent.
vi) If there are several joint promisees, an offer to any one of them is a valid tender.
vii) In case of tender of money, exact amount should be tendered.

2. By mutual agreement
A contract may be discharged by mutual consent through:
i) Novation: When a new contract is substituted for the original one, the latter stands discharged.
ii) Rescission: When one or all the parties cancel the contract, it is called rescission.
iii) Alteration: When alterations are made to the original contract with mutual consent of both the
parties, the original contract stands discharged.
iv) Remission: Remission means acceptance by a promisee of a lesser amount, or lesser degree of
performance than what was contracted for.
v) Waiver: Waiver is the willing relinquishment of rights by any one of the parties to the contract.

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3. By subsequent or supervening impossibility or illegality

i) Initial impossibility: If a contract stipulates the performance of an act that is obviously
impossible at the time the contract is made, it is not considered valid.
ii) Subsequent or Supervening impossibility: If the act stipulated in the contract becomes
impossible subsequent to the forming of the contract, it becomes void. However, supervening
impossibility must be beyond the control of the promisor. It should not be self-induced nor
arise due to his negligence.
Case: Howell V. Coupland (1876)
The Defendant agreed to sell a specified quantity of potatoes grown on his farms. The crop
failed largely due to a disease and was not within the Defendant’s control. Held, contract is
discharged.
Discharge is not permissible in case of difficulty of performance, commercial impossibility, default
of a third party, strikes, lockouts and civil disturbances or partial impossibility. Supervening
impossibility is considered valid on the following grounds:
i) Destruction of subject-matter, subsequent to the formation of the contract, without the fault
of either party.
ii) Failure of the ultimate purpose for which the contract was entered into, though the
performance of the contract remains possible.
iii) Death or personal incapacity of the promisor.
iv) Change of law that may render the contract illegal.
v) Outbreak of war between India and another country renders all contracts made between an
Indian and a national of the other country during the time of war, void and illegal. Contracts
entered into before the outbreak of war are suspended during the war and maybe revived after
the war is over, provided they have not already become time- barred.

4. By lapse of time
The Limitation Act, 1963 states that in case of breach of contract, the suffering party can initiate
legal action within a specified period, called the period of limitation. If he does not do so, the case
becomes time-barred and the contract cannot be enforced.

5. By operation of law
A contract terminates by operation of law in the following cases:

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i) Death: The death of the promisor discharges the contract that is of a personal nature. In other
contracts the rights and liabilities of the deceased person pass onto the legal representatives
of the dead man.
ii) Insolvency: When a party of the contract is declared insolvent by law and the court passes
an ’order of discharge’ exonerating the insolvent from liabilities on debts incurred prior to his
being declared insolvent, the contract is discharged.
iii) Merger: Where an inferior right accruing to a person merges with a superior right vesting in
the same person, the contract pertaining to the inferior right stands automatically discharged.
iv) Unauthorised material alteration: Any alteration made in a written document or contract by
one party without the consent of the other renders the whole contract void.

6. By breach of contract
When a party to the contract defaults in fulfilling its part of the agreement, the contract stands
breached, and hence, terminated. The aggrieved party has the right to sue for damages for breach
of contract as per law. Breach of contract may be of two kinds:
i) Anticipatory breach of contract occurs when one party declares its intention not to fulfil its
obligations under the contract before the performance is due. It can be of two types:
a) Express: When one party to the contract communicates his intention not to perform to the
other party, in words, either spoken or written, before the due date of performance.
b) Implied: When a party implies its unwillingness to perform through its conduct.
Case: Lovelock v. Franklyn
A promised to assign to B all of his interest in a lease for a sum of £140, within 7 years. Before
the end of 7 years, he assigned the interest to another person. Held, this was anticipatory
breach by implied repudiation.

ii) Actual breach occurs in the following ways:

a) Breach of contract on the due date of performance occurs when one of the parties fails to
perform as per the terms of the contract at the time fixed for performance.
b) Breach of contract during the course of performance occurs when a party performs partially
but refuses to complete the performance.

SELF-ASSESSMENT QUESTIONS – 5
Give the term for:
15 Substitution of the original contract by a new one.

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16 Agreement of the promisee to accept lesser fulfilment of the promise.

17 Impossibility of fulfilment of contract subsequent to its formation.

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7. REMEDIES FOR BREACH OF CONTRACT

Whenever there is breach of a contract, the aggrieved party becomes entitled to seek remedies in any
one or more of the following ways:

1. Rescission: The aggrieved party may decide not to take any legal action against the guilty party
but they can rescind the contract and need not perform their part of obligations under the contract.

If the aggrieved party decides to sue the guilty party for damages for breach of contract, they have
to file a suit for rescission. When the court grants rescission, the aggrieved party is freed from all
their obligations under the contract; and becomes entitled to compensation for damages.

2. Suit for damages: Damages are monetary compensation allowed for the loss suffered by the
aggrieved party as a result of the breach of contract. By granting damages, the court aims not to
punish but to compensate. Damages are not awarded if actual loss cannot be proved.

Damages are of four kinds:

i) Ordinary damages: These are damages that are awarded for direct consequences of the
breach of contract.
ii) Special damages: Special damages arise because of special or unusual circumstances
affecting the plaintiff. Special damages cannot be claimed as a matter of right. Such damages
must be in contemplation of the parties at the time when the contract is made.
iii) Exemplary damages: The cardinal principle of damages is to award compensation to the
aggrieved party. However, damages may be awarded with a view to punishing the guilty
party as in the following cases:
a) Breach of a promise to marry which may have caused mental injury to the aggrieved
party.
b) Wrongful dishonour of a cheque by a banker though there are sufficient funds to the
credit of the customer.
iv) Nominal damages: Nominal damages are awarded when the breach has occurred due to a
technical violation and no actual loss has been caused to the aggrieved party. These are
token damages.
v) Damages for inconvenience and discomfort: The aggrieved party can claim damages for
physical discomfort and inconvenience caused due to the breach of contract.

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vi) Liquidated damages and penalty: Liquidated damages means a pre-determined sum fixed at
the time of the formation of the contract. It is a fair and genuine pre-estimate of the probable
loss that would be payable in case of a breach of contract.
vii) Penalty is the specified sum which is in excess of the loss likely to be caused due to breach
of contract.
viii) Stipulation for interest: The payment of interest may or may not be in the nature of penalty.
The court adjudicates whether interest is payable or not, and from which date on a case-to-
case basis.

ix) Forfeiture of security deposits: Certain contracts stipulate the forfeiture of security in case of
a breach of contract.

3. Suit for specific performances: The aggrieved party may file a suit to seek the court’s direction
to compel the defaulting party to perform his/her part of the contract.

4. Suit upon quantum meruit: It is a claim for equitable compensation for partial performance of
the contract. ‘Quantum Meruit’ literally means ‘as much as is earned’ or ‘in proportion to the work
done’. A party can claim compensation for the work already done.

5. Suit for an Injunction: ‘Injunction’ is an order from the court directing a party to do a certain act
or to restrain the party from doing a certain act.

SELF-ASSESSMENT QUESTIONS – 6
True or False:
18 Rescission means the decision of the aggrieved party not to take any action.
19 Ordinary damages arise indirectly due to breach of contract.
20 Vindictive damages are awarded with a view to punish.
21 ‘Quantum Meruit’ means ‘as much as is earned’.

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8. CONCEPT OF INDEMNITY AND GUARANTEE

Contract of Indemnity
The term “Indemnity” literally means “Security against loss” or “to make good the loss” or “to
compensate the party who has suffered some loss”.

The term “Contract of Indemnity” is defined under Section 124 of the Indian Contract Act, 1872. It
is “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.”

So we can say that, A Contract of Indemnity is an agreement where one party promises to protect
the other party from suffering any financial loss. This protection applies if the loss happens because
of something the promising party did themselves, or because of actions taken by someone else.
Essentially, it's a way of ensuring that if something goes wrong due to specified actions, the party
who made the promise will cover the resulting costs or damages for the other party.

Parties involved:
a) The party who promises to indemnify/ save the other party from loss- “indemnifier”,
b) The party who is promised to be saved against the loss- “indemnified” or “indemnity holder”.

A Contract of Indemnity can be made in two ways: express or implied.

1. Express Contract of Indemnity: This happens when someone clearly promises to
compensate another person for any losses that might occur. It's straightforward because the
promise is clearly stated, either verbally or in writing.
2. Implied Contract of Indemnity: This type of contract isn't explicitly stated in words. Instead,
it's understood from how people act or from the situation they're in. For example, if someone
regularly covers expenses for another person's business without discussing it each time, it
implies an agreement to indemnify (compensate for losses).

In both cases—express or implied—a Contract of Indemnity follows the same rules as any other
contract. This means it must meet all the basic requirements of a valid contract, such as mutual
consent, lawful purpose, and the capacity of the parties involved to understand and agree to the terms.

Rights of Indemnity-holder when sued

When someone holds a Contract of Indemnity and gets sued, they have certain rights under Section
125:

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1. Damages: If the indemnity-holder is legally forced to pay damages as a result of the lawsuit,
they can recover these damages from the person who promised to indemnify them (the
indemnifier).
2. Costs: The indemnity-holder can also recover any costs they had to pay for bringing or
defending the lawsuit. This includes expenses like lawyer fees, court fees, and other legal
expenses.
3. Compromise Payments: If the indemnity-holder settles the lawsuit through a compromise
and ends up paying money as part of that settlement, they can recover these sums from the
indemnifier.

In essence, the indemnity-holder is protected by the contract to ensure that if they suffer any financial
losses due to legal action, the person who promised to indemnify them must reimburse them for these
losses, including damages, legal costs, and payments made as part of a settlement. This ensures that
the indemnity-holder is not financially burdened by the consequences of the lawsuit they were
involved in.

Contract of Guarantee
A Contract of Guarantee is an agreement where one person agrees to fulfill the promise or settle the
debt of another person if that person fails to do so.

In other words, if someone takes a loan or makes a commitment to pay for something, and they can't
fulfill that obligation, the guarantor steps in to make sure it's taken care of. The guarantor promises
to cover the debt or fulfill the promise on behalf of the person who originally agreed to it.

This type of contract helps ensure that businesses or individuals can still get credit or make
agreements, even if they might not have the resources to guarantee their own commitments.

Parties involved: There are three parties involved in a contract of guarantee.

1. Surety- person who gives the guarantee
2. Principal debtor- person in respect of whose default the guarantee is given
3. Creditor- person to whom the guarantee is given

Types of Guarantees:
A. Specific Guarantee- A guarantee which extends to a single debt/ specific transaction is
called a specific guarantee. The surety’s liability comes to an end when the guaranteed debt
is duly discharged or the promise is duly performed.
B. Continuing Guarantee [Section 129] - A guarantee which extends to a series of transaction

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is called a continuing guarantee. A surety’s liability continues until the revocation of the
guarantee.

Point of
Contract of Indemnity Contract of Guarantee
distinction

Number of There are only two parties There are three parties- creditor,
party/parties namely the indemnifier principal debtor and surety.
to the [promisor] and the
contract indemnified [promisee]

Nature of The liability of the indemnifier The liability of the surety is secondary
liability is primary and unconditional. and conditional as the primary liability
is that of the principal debtor.

Time of The liability of the indemnifier The liability arises only on the non-
liability arises only on the happening performance of an existing promise or
of a contingency. non-payment of an existing debt.

Time to Act The indemnifier need not act The surety acts at the request of
at the request of indemnity principal debtor.
holder.

Right to sue Indemnifier cannot sue a third Surety can proceed against principal
third party party for loss in his own name debtor in his own right because he gets
as there is no privity of all the right of a creditor after
contract. Such a right would discharging the debts.
arise only if there is an
assignment in his favour

Purpose Reimbursement of loss For the security of the creditor

Competency All parties must be competent In the case of a contract of guarantee,

to contract to contract. where a minor is a principal debtor, the
contract is still valid.

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9. BAILMENT AND PLEDGE

Bailment
The word “Bailment has been derived from the French word “ballier” which means to deliver.
Bailment means ‘handling over or change of possession’.

As per section 148 of the act, bailment is the delivery of goods by one person to another for some
purpose, upon a contract, that the goods shall, when the purpose is accomplished, be returned or
otherwise disposed of according to the directions of the person delivering them.

Parties to bailment:
a) Bailor: The person delivering the goods
b) Bailee: The person to whom the goods are delivered.

Essential elements:
• Contract: Bailment is a legal relationship where one person (the bailor) temporarily gives
possession of a property to another person (the bailee) for a specific purpose. This relationship
is based on an agreement, which can be spoken or written (express) or understood from
actions and circumstances (implied).
• Delivery of goods: Bailment involves one person (the bailor) giving their movable property,
like a car or a piece of equipment, to another person (the bailee) for a specific reason. This
property transfer can happen in two ways:
1. Actual Delivery: The property is physically handed over to the bailee. For example, you
give your car to a mechanic for repair.
2. Constructive Delivery: The property is not physically handed over, but something is done
to give control to the bailee. For example, you give the car keys to the mechanic, allowing
them to access and repair the car.

Bailment only applies to movable goods, not to immovable property like land or buildings, or to
money.
• Purpose: The goods are delivered for some purpose. The purpose may be express or implied.
• Possession: In bailment, the control or possession of goods shifts from one person (the bailor)
to another person (the bailee). This can happen either by physically handing over the goods or
by doing something that allows the bailee to take control of the goods.

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However, this change in possession doesn't mean that the ownership of the goods changes. The bailor
still remains the owner.
• Return of goods: In bailment, the person who has the goods (the bailee) must give them back
to the owner (the bailor) in the same condition or as changed according to the owner's
instructions. The bailee cannot replace the goods with different ones, even if they are of higher
value.

For example, if you give your bike to a friend for repair, your friend must return the same bike to you,
not a different one or a better one.

Depositing money in a bank is not considered bailment because when you withdraw money, you don't
get the same exact bills you deposited.

Pledge
According to section 172 of the act, 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”.

Section 172 to 182 of the Indian Contract Act, 1872 deal with the contract of pledge.

Essentials of contract of pledge:

• There shall be a bailment for security against payment or performance of the promise,
• The subject matter of pledge is good,
• Goods pledged for shall be in existence,
• There shall be the delivery of goods from pledger to pledgee

Rights of a pawnee/pledgee:
i) Rights to retain the pledged goods: The person who holds the pledged goods (the pawnee)
has the right to keep them until several things are taken care of:

1. The debt is paid off.

2. Any promised actions are completed.
3. The interest on the debt is paid.
4. Any necessary expenses the pawnee incurred while taking care of the goods are
reimbursed.

In other words, the pawnee can hold onto the goods until they get everything they are owed,
including costs related to keeping the goods safe.

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ii) Rights to retention of subsequent debts: The person holding the pledged goods (the
pawnee) can keep them not just for the original debt or promise, but also for any other debts
or promises the owner owes. However, this is only allowed if there is a special agreement (a
contract) that says the pawnee can do this. In simple terms, the pawnee needs a specific
contract to keep the goods for any additional debts.

iii) Pawnee’s right to extraordinary expenses incurred: If the person holding the pledged
goods (the pawnee) spends extra money to take special care of those goods, they have the right
to get that money back from the owner (the pawnor). However, the pawnee cannot keep the
goods to get this money back; instead, they can go to court to make the owner pay these extra
expenses.

iv) Pawnee’s right where pawnor makes default: If the person who pledged the goods (the
pawnor) doesn't pay back the debt or fulfill the promise on time, the person holding the goods
(the pawnee) has two options:

1. The pawnee can take legal action against the pawnor to recover the debt or enforce the
promise and keep the pledged goods as security.
2. The pawnee can sell the pledged goods after giving the pawnor reasonable notice about the
sale.

If the money from the sale is less than what is owed, the pawnor still has to pay the remaining amount.
If the sale brings in more money than what is owed, the pawnee must give the extra money to the
pawnor.

Rights of a pawnor:
As the bailor of goods, pawnor has all the rights of the bailor. Along with that he also has the right of
redemption to the pledged goods which is enumerated under section 177 of the act.

Rights to redeem: If there is a set time for repaying the debt or fulfilling the promise for which the
goods were pledged, and the person who pledged the goods (the pawnor) misses this deadline, they
can still get their goods back. They can do this at any time before the goods are actually sold. However,
they must also pay any extra expenses that resulted from their delay.

Duties of the Pawnee:

Pawnee has the following duties:
a) Duty to take reasonable care of the pledged goods.
b) Duty not to make unauthorized use of pledged goods.

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c) Duty to return the goods when the debt has been repaid or the promise has been performed.
d) Duty not to mix his own goods with goods pledged.
e) Duty not to do any act which is inconsistent with the terms of the pledge.
f) Duty to return accretion to the goods, if any.

Duties of a Pawnor:
Pawnor has the following duties:
a) The pawnor is liable to pay the debt or perform the promise as the case may be.
b) It is the duty of the pawnor to compensate the pawnee for any extraordinary expenses
incurred by him for preserving the goods pawned.
c) It is the duty of the pawnor to disclose all the faults which may put the pawnee under
extraordinary risks.
d) If loss occurs to the pawnee due to defect in pawnor’s title to the goods, the pawnor must
indemnify the pawnee.
e) If the pawnee sells the good due to default by the pawnor, the pawnor must pay the deficit.

Basis of
Bailment Pledge
Distinction
Meaning Transfer of goods by one person to Transfer of goods from one person
another for some specific purpose to another as security for
is known as bailment. repayment of debt is known as the
pledge.
Parties The person delivering the goods The person who delivers the good
under a contract of bailment is as security is called the “Pawnor”.
called as “Bailor”. The person to whom the goods are
The person to whom the goods are delivered as security is called the
delivered under a contract of “pawnee”.
bailment is called as “Bailee”.
Purpose Bailment may be made for any Pledge is made for the purpose of
purpose (as specified in the delivering the goods as security for
contract of bailment, eg: for safe payment of a debt, or performance
custody, for repairs, for processing of a promise.
of goods).

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Consideration The bailment may be made for Pledge is always made for a
consideration or without consideration.
consideration.
Right to sell The bailee has no right to sell the The pawnee has right to sell the
the goods goods even if the charges of goods if the pawnor fails to
bailment are not paid to him. The redeem the goods.
bailee’s rights are limited to suing
the bailor for his dues or to
exercise lien on the goods bailed.
Right to use Bailee can use the goods only for a Pledgee or Pawnee cannot use the
of goods purpose specified in the contract of goods pledged.
bailment and not otherwise.

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10. SUMMARY
Let us recapitulate the important concepts discussed in this unit:
• Contracts are an indispensable part of our lives. We enter into various types of contracts in our
everyday life. Whenever we buy something or enjoy some service we agree to pay a certain
amount of money to the seller or service provider and he agrees to give us that something. Indian
Contract Act, 1872 is the most important law governing contracts.
• An agreement enforceable by law is a contract. ICA provides the framework within which the
contract may be entered into, executed; and also makes provisions for dealing with breach of the
contract.
• A contract becomes valid when there is proper offer and acceptance between the parties who have
the legal capacity to contract. There must be an intention to create a legal relationship, free
consent of the parties, lawful consideration for promise, competent parties and the object of the
contract must be lawful.
• Contracts can be classified according to the following criteria:
• Enforceability by law: Valid, voidable, void, unenforceable and Illegal or unlawful contracts.
• Mode of Creation: Express, implied, constructive, quasi, wagering or contingent contracts.
• Extent of execution: Executed or executory contracts.
• The parties making an agreement must be legally competent to contract. In India anyone who is a
major, is of sound mind and is not debarred by law is entitled to contract.
• A contract is discharged or terminated when both the parties fulfil their rights and obligations as
per the contract. It may be discharged by performance, mutual agreement, subsequent or
supervening impossibility or illegality, lapse of time, operation of law or breach of contract.
• When there is breach of a contract, the aggrieved party becomes entitled to seek redressal through
rescission or a suit for damages, specific performance, quantum meruit or injunction.

In the above sections, we have discussed the general principles relating to the Indian Contracts Act,
1872. Further, contracts can be classified into several types such as Bailment, Pledge, Indemnity and
Guarantee. These are contracts which are entered into for specific reasons. For example, indemnity is
the type of contract in which “one person promises to save the other from the loss caused to him by
the conduct of the promisor himself or by the conduct of any other person” (Sec.124 of the Indian
Contract Act). Here, one person undertakes to compensate for the loss suffered by another. Similarly,
bailment, pledge and guarantee are types of contracts which are entered into for specific reasons.

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However, it is important to note that for these specific contracts, all the principles relating to general
contracts hold good and there are certain unique conditions which apply to them, over and above the
general principles.

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11. GLOSSARY
Financial Management is concerned with the procurement of the least cost funds, and its effective

Ab-initio - From the beginning

Breach - Breaking of a promise or agreement

Contingent - Dependent on uncertain events or circumstances

Damages - Financial compensation for loss or injury

Injunction - Judicial order restraining a person or body from an act

Insolvency - Legally recognised inability to pay debts

Quantum Meruit - In proportion to the work done

Quasi - Apparently/seemingly

Revocation - Withdrawal

Supervening - Interrupting

Voidable - That can be rendered illegal

Wagering - Based on betting

Void - Invalid, not legally binding

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12. TERMINAL QUESTIONS

1. Discuss the essentials of a contract.
2. Explain the legal provisions pertaining to ‘Offer’ and ‘Acceptance’.
3. Explain the various types of contracts in detail.
4. Write a detailed note on the capacity of parties to contract.
5. Discuss the ways in which a contract may be discharged.
6. What remedies are available to an aggrieved party in case of a breach of contract?

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13. ANSWERS
Self-Assessment Questions
1. False
2. True
3. False
4. Promise, set of promises, consideration
5. Positive, negative
6. Proposer, propose
7. Communicated
8. True
9. False
10. False
11. Void ab-initio
12. Unsound
13. Friend, enemy
14. Foreign sovereigns and ambassadors
15. Novation
16. Remission
17. Supervening impossibility
18. False
19. False
20. True
21. True

Terminal Questions Answers

1. A valid contract must fulfil certain essential conditions like proper offer and acceptance, legal
capacity of parties to contract etc. For more details refer to section 3.
2. Offer and acceptance must be made as per the provisions of ICA. (Section 3)
3. Contracts can be classified according to enforceability by law, mode of creation and extent of
execution. For more details refer to section 4.
4. Parties making a contract must have the legal capacity to contract. For more details refer to
section 5.

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5. A contract may be terminated or discharged in various ways. For more details refer to section 6.
6. An aggrieved party can seek redressal in case the other party breaches the contract. For more
details refer to section 7.

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14. REFERENCES
• Bedi, Suresh. (2004). Business Environment. Excel Books, New Delhi.
• Tulsian P.C. (2000). Business Law. Tata McGraw-Hill Publishing Company Ltd. New Delhi.
• Pathak, Akhileshwar. (2007). Legal Aspects of Business. Tata McGraw- Hill Publishing
Company Ltd. New Delhi.

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