What are Contracts and why do you need to understand basics of Contracts?

As an Entrepreneur, you will need to enter into Contracts when you do any of the following activities:

  • Buy Property
  • Enter into a lease agreement
  • Buy Goods or Services
  • Enter into a Joint Venture
  • Provide Services as a Consultant / Independent Professional
  • Enlist services of an Agent

Checklist of Essential Clauses of a Contract

  • Date the contract is signed, and date of enforcement
  • Parties to the contract need to be defined
  • Jurisdiction of contract
  • Arbitration
  • Terms of contract
  • Geographic limitations (if any)
  • Exit options

Indian Contract Act- Legal Basics

The Contract Act consists of limiting factors subject to which contract may be entered into, executed and breach enforced. It only provides a framework of rules and regulations which govern formation and performance of contract. The rights and duties of parties and terms of agreement are decided by the contracting parties themselves. The court of law acts to enforce agreement, in case of non-performance.

Essential Ingredients of a Contract

As per the Indian Contract Act an agreement enforceable by law is a contract. The term ‘agreement’ as defined in the Contract Act requires mutual consideration.

  • Meaning of Proposal- When one person indicates his willingness to do/abstain from doing something, with a view of obtaining the acceptance of the other to the act/abstinence, he is said to make a proposal [Section 2(a)]. English Law uses the word ‘Offer’, while Indian Law uses the word ‘Proposal’. Both are used interchangeably, but the correct term to use would be ‘Proposal’.
  • Meaning of Promise- When the person to whom the proposal is made indicates his acceptance, the proposal is said to be accepted. A proposal when accepted becomes a promise. Only the person to whom the proposal is made can accept the proposal.
  • Promisor and Promisee – The person making the proposal is the promisor, the person accepting the proposal is called promisee.
  • Reciprocal Promises - Promises which form the consideration or part of the consideration for each other are called reciprocal promises.
    • Consideration for Promise - The definition of ‘agreement’ itself states that the mutual promises should form consideration of each other. Thus, ‘consideration’ is essential for an agreement. A promise without consideration is not ‘agreement’ and hence naturally, it is not a ‘contract’.
  • Definition of Consideration – When, at the request of the promisor, the promisee or any other person has done/abstained from doing or promises to do/abstain from doing; such an act or abstinence or promise is called a consideration for the promise.

Steps Involved in Contract

  1. Offer (promise) and its acceptance
  2. Free consent of both parties
  3. Mutual and lawful consideration for agreement
  4. It should be enforceable by law
  5. Parties should be competent to contract
  6. Object should be lawful
  7. Certainty and possibility of performance
  8. Contract should not have been declared as void under Contract Act or any other law

Communication, acceptance and revocation of proposals- Communication of proposal/ revocation/acceptance are vital to decide validity of a contract. A ‘communication’ is complete only when other party receives it.

Essential Ingredients of a Contract (cont.)

  • 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 prescribes the manner in which it is to be accepted
    3. Conditional acceptance or qualified acceptance is no acceptance.
  • Promises, Express or Implied – If the proposal or acceptance is made in words, then it is considered to be express. If however, the proposal or acceptance is made otherwise than in words, then the promise is said to be implied.
  • Voidable Contract – An agreement which is enforceable by law, at the option of one of the parties, not the others is a voidable contract. Also voidable when:
    1. When consent is obtained by coercion, undue influence and misrepresentation or fraud is voidable by the aggrieved party. The other party cannot terminate the contract.
    2. When a contract contains reciprocal promises and one party to contract prevents the other from performing his duty, the contract becomes voidable at the option of the party prevented.
    3. When time is of the essence of a contract and a party fails to perform in time, then the contract is voidable at the behest of the other party.
  • Void Contract – A contract which ceases to be enforceable by law becomes void.

What Agreements are Contracts? All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful considera­tion and with a lawful object, and are not hereby expressly declared to be void.

Who are Competent to Contract? 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.

Free Consent- Consent of both parties must be free. Consent obtained through coercion, undue influence, fraud and misrepresentation is not free consent.

Void Agreements – agreements not enforceable by law are treated as 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.

Contingent Contract - 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.

Contracts Which Must be Performed - 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 representatives of the promisors in case of the death of such promisors before performance, unless a contrary intention appears from the contract.

Performance of reciprocal promises - Promises which form the consideration or part of the consideration for each other are called reciprocal promises.

Contracts which need not be performed – If a contract is replaced with a superior contract, then the old contract need not be performed.

Quasi Contracts - ‘Quasi’ means ‘almost’ or ‘apparently but not really’ or ‘as if it were’. This term is used when one subject resembles another in certain characteristics but there are intrinsic differences between the two. ‘Quasi contract’ is not a ‘contract’. It is an obligation which law created in absence of any agreement. It is based on equity. There are certain relations resembling those created by contract. These are termed as ‘quasi contracts’.  These are –
(a) Supply of necessaries (section 68)
(b) Payment of lawful dues by interested person (section 69)
(c) Person enjoying benefit of a gratuitous act (section 70)
(d) Finder of goods (section 71)
(e) Goods or anything delivered by mistake or coercion (section 72).

Consequences of Breach of Contract - Compensation is payable for breach of contract. Penalty is also payable if provided in contract. Breach of contract may be actual or anticipatory.
Summary of principles of compensation and damages - Following points are important:

-Compensation for loss or damage is payable. Since the word used is ‘compensation’, punitive damages cannot be awarded.
-These should be in usual course or known to parties i.e. both parties must be aware
-No compensation for remote and indirect loss or damage
-Same principle applies to quasi contract also.

  • General Damages – These are damages that result from ‘direct or proximate’ consequences from breach of contract. Normally, what can be awarded is compensation for loss or damage which can be directly or proximately attributed to the breach of contract.
  • Consequential Loss or Special Damage - Special damages or consequential damages arise due to existence of special circumstances. Such damages can be awarded only in cases where the special circumstances were foreseeable by the party committing the breach or were specifically known to the party.
  • Promisee Should Take Steps to Mitigate the Loss or Damage - Explanation to section 73 specifically provides that in estimating loss or damage, the means available for remedying the inconvenience caused by breach of contract shall be taken into account. Thus, promisee should take all reasonable steps to mitigate the losses
  • Vindictive or Exemplary Damages - Vindictive or exemplary damages cannot be awarded under Contract Act. However, these may be awarded by Court under tort under special circumstances.

Contract of Agency

Principles of a Contract of Agency are:

  1. Excepting matters of a personal nature, what a person can do himself, he can also do it through agent (e.g. a person cannot marry through an agent, as it is a matter of personal nature)
  2. A person acting through an agent is acting himself, i.e. act of agent is act of Principal. - - Since agency is a contract, all usual requirements of a valid contract are applicable to agency contract also, except to the extent excluded in the Act. One important distinction is that as per section 185, no consideration is necessary to create an agency.

Some Definitions

Agent and Principal Defined - An “agent” is a person employed to do any act for another or to represent another in dealings with third persons. The person for whom such act is done, or who is so represented, is called the “principal” [section 182].

Who May Employ an 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. [Section 183]. - - Thus, any person competent to contract can appoint an agent.

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, so as to be responsible to his principal according to the provisions in that behalf herein contained. [section 184]. - - The significance is that a Principal can appoint a minor or person of unsound mind as agent. In such case, the Principal will be responsible to third parties. However, the agent, who is a minor or of unsound mind, cannot be responsible to Principal.

Consideration not Necessary - No consideration is necessary to create an agency. [section 185]. Thus, payment of agency commission is not essential to hold appointment of Agent as valid.

Key Aspects

  • Agents Duties to Principal: -
    • Conducting business as per the Principal’s guidelines
    • Carry out work under normal skill and diligence
    • Render Accounts
    • Communicate with principal
    • Not to deal on his own account
    • Duty to pay sums received by Principal
    • Agent’s duty on termination of agency by Principal’s death or insanity
  • Remuneration to Agent: - No consideration necessary, however, if there is an agreement, the agent is entitled to remuneration as per contract
  • Rights of Principal: -
    • Recover damages from Agent if directions are disregarded
    • Obtain accounts from Agent
    • Recover money collected by Agent
  • Duties of Principal
    • Pay remuneration as agreed
    • Indemnify Agent for lawful acts done by him as Agent
    • Indemnify Agent for all acts done by him in good faith
    • Indemnify Agent for all acts done by him in good faith
  • 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 for the relief of insol­vent debtors. [Section 201].